Over the past four years or so, the U.S. Department of Labor (DOL) has issued three sets of fee disclosure regulations directed at retirement plan service providers, all under ERISA § 408(b)(2) — the proposed regulations, the interim final regulations and the final regulations. The retirement plan industry and plan sponsors have commented on the regulations at every stage. Service providers have studied the regulations and are now preparing their own fee disclosures.
However, even with all of the guidance from the DOL, questions and uncertainty abound. What do these regulations actually require? How will this impact our business model? What will be the "standard" way our industry will address certain particularly thorny disclosure issues? These are all good questions that need to be answered in short order.
And we expect questions to continue long after the final regulation's effective date, as service providers realize that they are subject to these rules after the fact or receive questions from their clients. In addition, other DOL regulatory projects will likely impact the disclosure obligation, such as the fiduciary definition project.
To assist service providers in navigating the new world of fee disclosure, we are compiling and responding to a running list of questions as our clients ask them. We encourage you to review the list as it develops and to submit your own questions about how to comply with these new rules.
Q – Are we subject to these disclosure regulations? (Or do these disclosures apply to us and our services?)
A – That depends on what you do for covered plans and how you are paid for those services. The ERISA § 408(b)(2) disclosure regulations apply only to "covered service providers." Generally, you are a covered service provider if you reasonably expect to receive at least $1,000 in compensation over the life of the contract or arrangement with a covered plan and you are in one (or more) of the following categories:
- A fiduciary to the covered plan (such as a plan trustee or investment manager).
- An investment adviser registered under either the Investment Advisers Act of 1940 or any state law.
- Provide certain specified services for indirect compensation — that is, compensation from sources other than the plan or plan sponsor, such as through revenue sharing arrangements. The specified services include auditing, actuarial, appraisal, insurance, custodial, legal, third party administration, investment brokerage, valuation, consulting and certain other services.
- A recordkeeper or broker providing services to a participant directed individual account plan (like a participant directed 401(k) plan), if one or more designated investment alternatives will be available under the plan in connection with the services provided, such as through an investment platform.
In certain situations, you can also be a covered service provider if you are a fiduciary to an investment vehicle that is deemed to hold plan assets under the ERISA plan asset rules.
Q – We only work with defined benefit plans so we don't have to worry about these disclosures, right? (Or what clients do we have to worry about?)
A – You do have to worry about the service provider disclosures with respect to most defined benefit plans, as well as most defined contribution plans. The service provider fee disclosure regulations under ERISA § 408(b)(2) apply to "covered plans." Covered plans include defined benefit plans, as well as 401(k) plans, profit sharing plans, money purchase plans, 403(b) plans and other pension plans. However, certain retirement plans are exempt from the 408(b)(2) disclosure requirements, including SEP IRAs, SIMPLE IRAs, Traditional and Roth IRAs, and certain orphaned 403(b) plans. In addition, pension plans that are not subject to Title I of ERISA, such as governmental plans, non-electing church plans or plans covering only a self-employed person and his/her spouse, are exempt from these regulations.
Note that the participant fee disclosure regulations only apply to participant directed individual account plans, such as 401(k) plans. We'll discuss the participant fee disclosure regulations in future "frequently asked questions."
Q – We only work with welfare plans. Do we have to worry about these disclosures?
A – Not yet. Welfare plans and welfare plan providers, such as insurance companies, benefit brokers, pharmacy benefit managers and others, currently are not covered by the current ERISA § 408(b)(2) regulations. However, the Department of Labor (DOL) is also concerned about fee-transparency for welfare plans. The DOL has held public hearings about welfare plan disclosures and reserved a section in the 408(b)(2) regulations for future welfare plan disclosure requirements.
Q – So what? Why should I care about these service provider disclosure rules?
A – Because you want to avoid claims that the arrangement constitutes a prohibited transaction, which could lead to your liability for significant excise taxes plus the potential loss of some or all of your fees. This comes about as follows:
A service provider is a "party in interest" for purposes of the ERISA prohibited transaction rules, which means that a service relationship between a plan and a service provider is a prohibited transaction unless an applicable exemption is available. ERISA § 408(b)(2) provides an exemption if the service arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable compensation is paid for the services. Department of Labor (DOL) regulations clarify each of these conditions to the exemption. In the DOL's view, if all of the requirements of the regulation are not satisfied, and if no other statutory or administrative exemption applies, a prohibited transaction occurs. The new disclosure requirements are one of the conditions for your service contract or arrangement to be reasonable.
Internal Revenue Code § 4975 imposes an excise tax on "disqualified persons" engaging in a prohibited transaction under rules similar to the ERISA prohibited transaction rules, and the DOL regulation provides an exemption for purposes of the excise tax as well. The IRS takes the view that, if a service arrangement does not satisfy the requirements of the DOL regulation, and if no other statutory or administrative exemption applies, the service provider is subject to an excise tax on the "amount involved" in the transaction. (The excise taxes can be substantial — 15 percent of the amount involved for each year until the transaction is "corrected," and an additional tax of 100 percent of the amount involved if the prohibited transaction is not corrected within the taxable period.) Presumably, the IRS would take the position that the "amount involved" would be the compensation the service provider received from the plan.
ERISA § 406(a)(1) imposes a duty only on fiduciaries not to cause the plan to engage in a prohibited transaction. However, the U.S. Supreme Court has held that an action for appropriate equitable relief can be brought under ERISA § 502(a)(3) against a nonfiduciary service provider engaging in a prohibited transaction, even though the nonfiduciary service provider is not subject to the duty under ERISA § 406 to avoid prohibited transactions. Appropriate equitable relief could include restitution to the plan of the service provider's "ill-gotten" gains.
Q – What happens if we don't comply?
A – As discussed more fully in the previous FAQ, "So What? Why should I care about these service provider disclosure rules?", you could be subject to liability for significant excise taxes plus the potential loss of some or all of your fees. In addition, in order to avoid being considered to have engaged in a prohibited transaction, the plan fiduciary is required to submit a written request for information if it discovers a disclosure failure. If you do not comply with the request within 90 days, the plan fiduciary must report the disclosure failure to the DOL. Finally, in accordance with the plan fiduciary' duty of prudence under ERISA, the fiduciary may be obligated to terminate its contract with you.
Q – When do we have to provide the initial disclosures to our clients?
A – July 1, 2012. The deadline for providing the initial disclosures to existing contracts or arrangements is July 1, 2012. For contracts entered into after July 1, 2012, the initial disclosure must be provided reasonably in advance of when the contract is entered into, extended or renewed.
Q – We can't comply by July 1 — any chance of a delay?
A – Further delay is very unlikely. The effective date of the regulations has already been pushed back twice, and there is a fair amount of political pressure to complete the fee disclosure projects as soon as possible.
Q – How should we draft the disclosures?
A – No particular form is required, but the disclosures must be in writing. You may reference existing documents or existing disclosures. Further, the DOL provided a model "guide" to cross reference existing documents. You may reference your service agreement or, if you are an investment advisor, you may reference your Form ADV.
Q – Can we give ranges of fees instead of client specific fees?
A – Yes — in certain situations. The preamble to the final regulations clarified that covered service provides may provide an estimate of their compensation. In addition, the preamble recognized that the disclosure of ranges of expected compensation "can" be a reasonable method, provided the ranges are reasonable based on the circumstances and the compensation arrangement at issue. However, the DOL cautioned that it prefers specific compensation disclosures over less specific ranges, "whenever it can be furnished without undue burden."
What does this mean? A broker providing the range of possible 12b-1 fees that the broker may receive based on the investment to be selected by the plan trustee in the future would generally be considered reasonable, as there is no way for the broker to provide the possible 12b-1 fee for all investment alternatives available on the market. However, providing a range of potential compensation when the covered service provider knows (or could know with minimal effort) the actual compensation it will receive is much more risky.
Q – Can our clients ask for more information?
A – Yes. As plan fiduciaries, your clients must determine that the plan's arrangement with you as a covered service provider is reasonable, that your services are necessary for the plan's operation and that the plan pays only reasonable compensation for your services. The DOL's explanation of the new disclosure requirements emphasized that plan fiduciaries must receive the information necessary to make informed decisions about the cost of services provided to the plan. To further that end, the responsible plan fiduciary must review your disclosure, and if they determine that the disclosure is incomplete, the plan fiduciary is required to make a written request to you for more information. The failure to make such a request could result in a prohibited transaction for the plan fiduciary.
If you receive such a written request, you should reply within 90 days. If you do not reply, the responsible plan fiduciary is to report you to the DOL.
Q – Our fees have changed, do we have to update our disclosures?
A – Yes. You must update your disclosures two different times. First, you must disclose changes in the information you provided about the services to be provided, status as a fiduciary or investment adviser, the compensation to be received, the manner in which that compensation would be received, and the cost of record keeping services (if applicable), as soon as possible, but no later than 60 days after the date you learn of the change (absent extraordinary circumstances). Be aware that the 60-day standard is not a safe harbor. If you can disclose a change earlier than 60 days after you learn of it, you should disclose it as soon as you can. Second, you must disclose certain changes in the investment information you provided only annually. As you might imagine, whether a change falls in the "as soon as possible" or "annual" category may not always be clear.
Q – We received a request for additional information regarding Schedule C. Do we have to respond?
A – Yes, the ERISA § 408(b)(2) regulations require covered service providers to respond to written requests from the responsible plan fiduciary for additional information relating to the compensation received by the covered service provider that is required for the plan to comply with any reporting and disclosure obligations under Title 1 of ERISA. This would include the Form 5500/Schedule C reporting requirements, as well as the participant fee disclosure requirements. If you get a written request for additional reporting or disclosure information, you must respond "reasonably in advance" of the date upon which the plan fiduciary states that such information is needed. Note that the 90-day response requirement discussed above does not apply to these types of inquiries.