Service Provider and Participant-Level Fee Disclosures
Took Effect in 2012
The U.S. Department of Labor's (DOL) Employee Benefits Security Administration (EBSA) published its long-awaited final rule, "Reasonable Contract or Arrangement Under Section 408(b)(2) – Fee Disclosure," in the Federal Register on Feb, 3, 2012. The final rule required retirement plan service providers to disclose to plan sponsors the administrative and investment costs associated with their plans beginning after July 1, 2012, for new and existing contracts or arrangements between service providers and plans covered under the Employee Retirement Income Security Act (ERISA).
Another set of required fee disclosures, from plan sponsors to 401(k) plan participants (participant-level fee disclosures), took effect 60 days after the service provider fee disclosure deadline, with initial annual disclosure of "plan-level" and "investment-level" information (including associated fees and expenses) to participants beginning Aug. 30, 2012, and the first quarterly statement (for fees incurred July through September) furnished as of Nov. 14, 2012.
Recent articles addressing the U.S. Department of Labor’s (DOL) fee disclosure regulations taking effect in 2012 under the Employee Retirement Income Security Act's (ERISA) section 408(b)(2), for fee disclosures from service providers to plan sponsors, and section 404(a)(5), for participant-level fee disclosures, have largely emphasized the impact these rules will have on retirement plan vendors—how they must structure their fees, how and what types of disclosures they will provide, and how their accountability will be altered.
Retirement plan sponsors, however, will also experience a sea change in their fiduciary role and responsibilities. The DOL rules will impact plan sponsors equally, if not more, than their service providers and will require an overhaul of the plan sponsor’s approach to many formerly rote fiduciary activities.
The emphasis made in commentaries by vendors’ associations on the implications of the rules for their members has inadvertently diminished the focus on plan sponsors’ new duties under these regulations. Plan sponsors, for example, will have a responsibility to examine and audit the adequacy of their vendors’ fees. The government’s use of the word “disclosure” as the keyword in the rules serves to disguise the urgency that the rules dictate for plan sponsors and their roles.
Plan sponsors now have a responsibility
to examine and audit the adequacy
of their vendors’ fees.
A real-world vignette best illustrates the challenge plan sponsors face in understanding the shift in their obligations under the DOL regulations:
A lawyer is having lunch with a friend who is the CFO of a large, national manufacturing company. The lawyer brings up casually how busy he’s been addressing the influx of questions from clients regarding the new DOL fee disclosure rules. He says, “It’s difficult because my clients now have to make the adjustment from simply receiving fee disclosure statements to actually testing that they are correct and fair.”
The CFO looks up from his lunch and says, “That doesn’t apply to recordkeeping reports, right? I receive those regularly and am diligent about making sure we receive them on time.”
The lawyer responds, “It absolutely applies to those reports, and you now have an obligation not only to ensure you receive them but also to test their validity.”
The new rules augment plan sponsors’ existing responsibilities dramatically. This is daunting from three perspectives:
• First, it is presumed that all plan sponsors understand this shift in responsibility, when, in fact, many plan sponsors are as uninformed as the CFO subject in the above scenario.
• Second, the increase in responsibility requires more of the plan sponsor—more time, analysis, diligence and accountability—than before.
• Finally, these rules change the landscape for plan sponsors’ risk management strategies. In order to maintain regulatory peace of mind, plan sponsors must develop and implement tactics that they have never used—generating an environment of uncertainty regarding the effectiveness of their vendor management strategies and regulatory safety. Decades ago, the industrial sector faced a nearly identical challenge. The solution it crafted became known as “supply chain management.”
The Call to Action
Over the past three decades, there has been an information disadvantage—what the DOL has termed an “information gap”—in the ERISA market between plan sponsors and their vendors. Because of the esoteric nature of investment vendors’ processes and offerings, vendors are able to relay certain types of information to plan sponsors and make investment decisions that do not necessarily align with plan sponsors’ best interests.
Equipped with a baseline understanding of this issue, the DOL further researched the information gap concern and produced a public report on its findings. The DOL’s pointed language addressing the information imbalance between plan sponsors and their vendors appeared in the July 16, 2010, issue of the Federal Register, "Reasonable Contract or Arrangement Under Section 408(b)(2)-Fee Disclosure," an excerpt of which appears below:
Vendors are specialists in the design of their products, services, and compensation arrangements, and are continually engaged in marketing to plan sponsors. Plan sponsors often lack this degree of specialization. … Vendors have a strong incentive to use their information advantage to distort market outcomes in their own favor. Current ERISA rules hold plan sponsors rather than vendors accountable for evaluating the cost and quality of plan services. And vendors can reap excess profit by concealing indirect compensation (and attendant conflicts of interest) from clients, thereby making their prices appear lower and their product quality higher.
The two new fee disclosure rules—408(b)(2) and 404(a)(5)—are the DOL’s reaction to these findings and its subsequent effort to minimize the information gap before additional damage is incurred by plan sponsors and, more importantly, their plans’ participants. Both rules demand that vendors change how they relay information to plan sponsors and participants in order to become more transparent in communicating their services and related fees. However, the rules impose a hefty new responsibility on plan sponsors—requiring them to become more involved and scrupulous with their vendors in order for these rules to have their intended positive effect on the market.
‘Fee Disclosure’ or ‘Fiduciary Supply Chain Management’?
The oft-used term “fee disclosure rule,” referencing the new 408(b)(2) regulation, is somewhat of a misnomer for plan sponsors. The title implies that the primary onus lies on vendors to disclose proper and fair fees to their plan sponsors. This is only part of the rule’s dictate. The more important and impactful mandate for plan sponsors is what the rule requires of them after vendors’ fees have been disclosed.
Specifically, 408(b)(2) requires the following ongoing actions of plan sponsors:
1. Verify that they have received the appropriate disclosures from vendors.
2. Examine the disclosures to ensure that they are adequate under the new rule.
3. Determine by an “audit” process that the fees provided within the disclosure are reasonable, or fair, given the vendor services rendered.
On the above list, item one (verifying the receipt of vendor fee reports) is the only step that most plan sponsors have performed historically. Examining vendor reports for compliance with federal law and determining the fairness of vendor fees are virtually unheard of in this community.
A combination of potentially misleading vendor marketing tactics and a lack of sophistication around the intricacies of the investment vendor market has led the plan sponsor community largely to believe that if “proper” (i.e., brand-respected) retirement plan vendors are selected, those vendors’ practices are ethical and in the best interests of the plan sponsor. The DOL’s aforementioned Federal Register report disproves this clearly and definitively.
Because of this predominant brand-respected philosophy, however, plan sponsors have relied heavily on these vendors to make investment and plan management decisions on their (and their participants’) behalf—under the presumption that their vendors’ reports contain all of the information they need to oversee this process properly. The implementation of the new 408(b)(2) rule turns this assumption on its head by revealing to plan sponsors that their vendors might not be acting in their best interest and might be using certain reporting tactics to conceal excessive fees, and that plan sponsors are responsible for monitoring and determining the adequacy of their vendors’ behavior.
Hence, it is likely more useful for plan sponsors to consider the 408(b)(2) rule as a “fiduciary supply chain management law” rather than a “fee disclosure rule,” because the former implicates plan sponsors’ proactive role in this new process. Once plan sponsors adopt a proactive mindset, their next impending challenge will be to enact new strategies that have been largely foreign to this market.
From Overseer to Analyst: Adopting a New Role
The three requirements of the 408(b)(2) rule for plan sponsors place them at the forefront of accountability to their plan participants, to the rest of their executive team and to the DOL. The sense of security that plan sponsors once felt on receiving their recordkeeper, investment manager, investment advisor or other vendor reports has been replaced by a daunting realization of their responsibility. Even more significant, perhaps, is the understanding that the trustworthiness that plan sponsors once bestowed on their service providers has been challenged quite radically. Plan sponsors’ recognition that previously trusted vendors might not be acting in their best interests, irrespective of vendors’ assertions of their adherence to a fiduciary standard, is a hard pill to swallow—particularly for leadership teams that have relied on the same vendor partners for years or even decades.
The enactment of these new proactive strategies for plan sponsors is as much of an opportunity as it is a challenge. Plan sponsors have been given full reign over determining their retirement plans’ futures and ensuring the safekeeping of their plan participants’ savings. On the other hand, this newly found holistic perspective burdens plan sponsors with increased responsibility. They must employ strategies with which they do not have previous experience and about which they might feel tentative, if not uncertain.
Plan sponsors can find their way during this murky transition in order to excel in their new role and develop their go-forward approach effectively. The implementation of an annual audit of vendors’ fees and arrangements by a licensed fiduciary supply chain manager, a certified training course or a combination of these three assurance offerings can provide plan sponsors with the confidence and peace of mind they need to move forward successfully under the new regulations.
Ronald E. Hagan is chairman of the fiduciary standards committee of fiduciary services firm Roland Criss, which serves retirement plan sponsors as an independent administrative fiduciary. Hagan is chairman of board of directors of the Investment Fiduciary Leadership Council, a global advocacy group for fiduciary standards.
DOL Final Rule Extends Deadlines for Service Provider and Participant-Level Fee Disclosures, SHRM Online Benefits Discipline, February 2012
Preparing for Service Provider Fee Disclosures, SHRM Online Benefits Discipline, September 2011
DOL Issues Policy on Electronic Disclosure of Participants' 401(k) Fees, SHRM Online Benefits Discipline, September 2011
Final Rule on 401(k) Fee Disclosure to Participants Seen as 'Reasoned Approach,' SHRM Online Benefits Discipline, October 2010
SHRM Online Benefits Discipline
SHRM Online Retirement Plans Resource Page