The U.S. Department of Labor (the “DOL”) has issued final regulations that will impose new fee disclosure requirements on certain persons who provide services to ERISA-covered pension plans (e.g., ERISA-covered defined benefit plans, 401(k) plans, profit sharing plans, and most 403(b) plans). The regulations’ disclosure requirements do not apply to welfare plans.
Generally, ERISA prohibits a service provider from providing services to a plan. ERISA Section 408(b)(2) provides a statutory exemption to this prohibition, permitting a service provider to provide services to a plan if, among other requirements, the service contract is reasonable. Beginning July 1, 2012, a contract between a plan and a covered service provider will not be “reasonable” for purposes of ERISA Section 408(b)(2) unless the service provider discloses certain compensation information to plan fiduciaries. The primary purpose of the new regulations is to ensure that plan fiduciaries are provided with the information they need to select and monitor service providers and assess the reasonableness of service contracts, including the reasonableness of service providers’ compensation and any potential conflicts of interest. The new regulations are part of a broader initiative by the DOL to increase the transparency of fee arrangements between plans and service providers.
Existing and new contracts with covered service providers must comply with the new regulations by July 1, 2012.
The disclosure requirements apply to “covered service providers” that expect to receive compensation of $1,000 or more in connection with providing services to a plan. A “covered service provider” is a person or entity that provides one of the following:
- Services as a registered investment adviser or as an ERISA fiduciary, including in connection with an investment contract, product, or entity that holds plan assets and in which a plan has a direct equity investment. (This does not include managers of mutual funds.)
- Recordkeeping or brokerage services for plans that have participant-directed investments if one or more designated investment alternatives will be made available in connection with such services.
- The following services, if the service provider expects to receive indirect compensation or certain payments from related parties: accounting, auditing, actuarial, appraisal, banking, consulting (with respect to investment policies or the selection or monitoring of service providers or plan investments), custodial, insurance, investment advisory, legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation. “Indirect compensation” is compensation received from any source other than the plan, the plan sponsor, the service provider, or an affiliate of the service provider. “Certain payments from related parties” is discussed in the fifth bullet point in the following section. A “related party” is the covered service provider’s affiliate or subcontractor.
Covered service providers must provide plan fiduciaries with the following information, in writing, reasonably in advance of the date the services contract is entered into, extended, or renewed.
- A description of the services to be provided to the plan.
- If applicable, a statement that the covered service provider or a related party will provide services directly to the plan as a fiduciary or as a registered investment adviser.
- A description of all direct compensation, either in the aggregate or by service, that the covered service provider or a related party expects to receive in connection with its services to the plan. “Direct compensation” is compensation paid by the plan.
- A description of all indirect compensation that the covered service provider or a related party expects to receive in connection with its services to the plan. This disclosure must include the identification of the services for which the indirect compensation will be received and the payer of the compensation, and a description of the arrangement between the payer and the recipient under which the indirect compensation is paid.
- A description of any compensation that will be paid among the covered service provider or a related party in connection with services to the plan if the compensation is either (a) set on a transaction basis (e.g., commissions, soft dollars, finder’s fees) or (b) charged directly against the plan’s investment and reflected in the investment’s net value (e.g., 12b-1 fees). The covered service provider must identify the services for which such compensation will be paid as well as the payers and recipients of such compensation. This information must be separately disclosed even if it was also disclosed as direct or indirect compensation.
- A description of any compensation that the covered service provider or a related party expects to receive in connection with termination of the contract, and how any prepaid amounts will be calculated and refunded upon the termination.
- If recordkeeping services will be provided, a description of all direct and indirect compensation that the covered service provider or a related party expects to receive in connection with those recordkeeping services. If the compensation for recordkeeping services is not explicit or is rebated based on other compensation, then the covered service provider must furnish a reasonable good faith estimate of the cost of the services (including an explanation of the methodology and assumptions used).
- Additional investment-related disclosures if the covered service provider either (a) is a fiduciary in connection with an investment contract, product, or entity that holds plan assets and in which a plan has a direct equity investment, or (b) provides recordkeeping or brokerage services to a plan that has participant-directed investments and one or more designated investment alternatives will be made available in connection with those services. The additional investment-related disclosures include a description of any compensation that will be charged directly against an investment (and that is not included in the annual operating expenses), the annual operating expense if the return is not fixed and any additional ongoing expenses (or, for a designated investment alternative, the total annual operating expenses), and any other information about designated investment alternatives that the plan must disclose to participants.
- A description of the manner in which compensation will be received (e.g., whether the plan will be billed or the compensation will be deducted directly from the plan accounts or investments).
The requirement that the disclosures be in advance of the contract date is subject to certain exceptions (for example, when an investment does not initially, but does subsequently, hold plan assets). Generally, covered service providers must disclose any change to the information initially provided. Disclosures of changes to investment-related information must be provided at least annually. Changes to any other required disclosures must be disclosed as soon as practicable, but not later than 60 days after the date on which the service provider is informed of the change.
A covered service provider must also, upon written request, provide plan fiduciaries with any other information required for the plan to comply with ERISA’s reporting and disclosure requirements. Such information must be disclosed reasonably in advance of the date on which the plan fiduciary states that the plan must comply with the applicable requirement.
Failure to comply with the new disclosure requirements will result in the plan fiduciary’s and the covered service provider’s engaging in a prohibited transaction.
There are, however, a couple of exceptions to this rule. First, contracts will not fail to be reasonable under the new regulations solely because the covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the required information. This exception applies provided that the covered service provider makes the required disclosure as soon as practicable, but not later than 30 days after discovering the error or omission.
Additionally, if a required disclosure is not provided, a plan fiduciary will not have engaged in a prohibited transaction if the following conditions are satisfied:
- The fiduciary did not know of the failure and reasonably believed that the required information had been disclosed.
- Upon discovering the failure, the fiduciary requests the information in writing from the covered service provider.
- If the covered service provider fails to provide the information within 90 days, the fiduciary notifies the DOL of the failure within 30 days of the expiration of the 90-day period or, if earlier, of the service provider’s refusal to provide the information. (A model fee disclosure failure notice is available at: http://www.dol.gov/ebsa/regs/feedisclosurefailurenotice.html.)
- If the covered service provider fails to provide the information within 90 days, the fiduciary determines whether to terminate the contract. If the requested information relates to future services and is not disclosed promptly after the end of the 90-day period, then the plan fiduciary must terminate the contract as expeditiously as possible, consistent with his or her duty of prudence.
Plan fiduciaries must be proactive in obtaining the required disclosures by July 1, 2012.
Plan fiduciaries must obtain the disclosures from all covered service providers (even those with existing contracts). Plan fiduciaries should perform the following steps to ensure that they receive the required information.
- Identify all covered plans and covered service providers.
- Contact all covered service providers, in writing, and ask when the required disclosures will be made. Ask that the disclosures be made as soon as possible, but no later than a specified date before July 1, 2012 (such date should give the fiduciary sufficient time to review the disclosures).
- Review the disclosures. Compare the disclosures to the requirements in the regulations. (In order to qualify for relief from the prohibited transaction rules if a required disclosure is not made, fiduciaries must reasonably believe that the required disclosures have been made. Thus, the disclosures must be reviewed.)
- Determine whether the required disclosures have been made. If a fiduciary does not think that all the required disclosures have been made, contact the covered service providers in writing, and request that the disclosures be made.
- Determine whether the contract and the compensation paid to each covered service provider are reasonable.
The DOL’s final regulations under ERISA Section 408(b)(2) can be found at this link: http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=25781. If you have any questions about the final regulations or would like assistance with obtaining or reviewing any disclosures, please contact one of the members of our Employee Benefits Team.