- DOL Issues Service Provider Fee Disclosure Regulations
- August 30, 2010 | Authors: Eleanor Banister; Donna W. Edwards
- Law Firm: King & Spalding LLP - Atlanta Office
Plan fiduciaries have an obligation under ERISA § 408(b)(2) to ensure that the compensation paid for the services rendered for the plan is “no more than reasonable compensation”. In order to determine if a service provider’s compensation is reasonable, a fiduciary must carefully evaluate the service provider contract, the services to be rendered and the cost associated with the services. Over the last several years, the increased complexity of service provider fee arrangements, particularly § 401(k) plan fee arrangements, has made it difficult for plan fiduciaries to determine what service providers are actually paid for a specific service.
On July 16, 2010, the Department of Labor (the “DOL”) issued interim final regulations requiring certain disclosures of pension plan service providers which can be seen through the link here. The new regulations provide that no contract or arrangement for services between a “covered plan” and a “covered service provider” is “reasonable” under ERISA unless the fee disclosure requirements of the new regulations are satisfied.
Highlights of the Regulations
- Effective Date - The regulations are effective July 16, 2011 for new and existing contracts for pension plans (including 401(k) plans). The regulations do not apply to welfare plans although the DOL plans to propose separate disclosure rules for welfare plan service providers. Covered service providers must make the required disclosure by July 16, 2011 even for contracts in place prior to such date.
- Covered Service Providers - A Covered Service Provider is any service provider that enters into a service contract with a Covered Plan and reasonably expects to receive $1,000 or more in compensation, directly or indirectly, in connection with the following services:
(A) Fiduciary services directly to a Covered Plan or to an investment that holds plan assets and in which the Covered Plan has a direct equity investment;
(B) Investment advisory services provided directly to a Covered Plan by an investment adviser registered under the Investment Adviser Act of 1940 (the “1940 Act”);
(C) Recordkeeping or brokerage services to a Covered Plan in which participants direct investments if one or more designated investment alternatives is provided in connection with the recordkeeping or brokerage services; or
(D) Certain other services (for example, accounting, actuarial, banking or recordkeeping services) if the service provider receives indirect compensation or compensation from a related party for those services.
- Covered Plan - Defined benefit and defined contribution plans (including 403(b) plans) subject to ERISA.
- Required Disclosure - The Covered Service Provider must provide a written description of the:
(A) Services to be provided;
(B) Status as a fiduciary or as a registered investment adviser;
(C) Compensation reasonably expected to be received for such services;
(D) Manner in which the compensation will be received; and
(E) Certain fees and expenses associated with participant directed investments.
Covered Plan and Covered Service Provider
Covered Service Providers are required to provide certain fee disclosures, in writing, to the responsible fiduciary of a Covered Plan prior to entering into, or renewing, a contract to provide retirement plan services.
A Covered Plan is a defined contribution plan (including 403(b) plans) or defined benefit plan covered by ERISA. Simplified employee pensions, simple retirement accounts, individual retirement arrangements and individual retirement annuities are not covered plans. The regulations do not currently apply to welfare plans, however; the DOL intends to provide disclosure regulations specifically for welfare plan service providers at a later date.
A Covered Service Provider is a service provider (including affiliates and subcontractors) identified below that enters into a contract or arrangement with a Covered Plan and reasonably expects to receive $1,000 or more in compensation (as described in item C under Required Disclosure) for the certain services described below. The regulations do not indicate over what time period or contract period the $1,000 compensation threshold will apply. Service providers whose contracts have “evergreen” clauses may have to consider all compensation reasonably expected to be received from the contract at any time in the future.
The Covered Service Provider must provide the Required Disclosure only if it receives compensation for covered services paid (i) directly from the Covered Plan or (ii) from any source other than the Covered Plan, the plan sponsor, the Covered Service Provider, an affiliate or a subcontractor. The regulations do not appear to require any fee disclosure from a plan service provider whose fees are paid directly from the general assets of the plan sponsor.
The following services are covered by the regulations:
(A) Services provided directly to a Covered Plan as a fiduciary (as defined in ERISA § 3(21)). Generally, an ERISA fiduciary is an entity or individual that either exercises discretionary authority in the management or administration of the plan or its assets or provides investment advice to the plan for a fee.
(B) Services as a fiduciary to a plan investment that holds plan assets (as defined in ERISA § 3(42)) and in which the Covered Plan has a direct equity investment. Determining which plan investments, if any, hold plan assets is the responsibility of the service provider, but the plan sponsor will want to be certain such determination is accurate. Mutual funds generally do not hold plan assets, but bank common funds and insurance company general accounts do. Hedge funds and private equity funds may hold plan assets.
(C) Investment advisory services provided directly to a Covered Plan by an investment adviser registered under the 1940 Act or any state law.
(D) Recordkeeping or brokerage services to an individual account plan that permits participants or beneficiaries to direct the investment of their accounts if designated investment alternatives are offered through a “platform” or similar mechanism of the service provider.
(E) Accounting, auditing, actuarial, appraisal, banking, consulting (limited to development or implementation of investment policy or selection or monitoring of service providers or plan investments), custodial, insurance, investment advisory (to either the plan or participants), legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation services provided to a Covered Plan if the Covered Service Provider or an affiliate or subcontractor reasonably expects to receive “indirect compensation” or “related party compensation,” as defined below.
A Covered Service Provider must provide certain information to the responsible fiduciary of a Covered Plan prior to entering into a contract or arrangement with the Covered Plan. Covered Service Providers are responsible for providing the information even if the services are actually performed by an affiliate or a subcontractor. Although, Covered Service Providers must provide the information, the responsible plan fiduciary must review the information and make a determination regarding the reasonableness of the fees.
Specifically, a Covered Service Provider must provide the following information to the responsible fiduciary of a Covered Plan:
(A) Services. A description of the services to be provided pursuant to the contract. The regulations do not require any particular level of detail regarding the services to be provided and the preamble to the regulations notes that the description does not need to include every item to be performed if the parties have a common understanding of the type of service to be performed. For example, plan fiduciaries may understand that the execution of securities transactions includes valuation, clearing and settling transactions, and reporting the transaction. However, the DOL also cautions that a responsible plan fiduciary must request additional information if it believes a description does not provide sufficient detail to enable the fiduciary to determine whether the cost of services is reasonable.
(B) Status. If applicable, a statement that the Covered Service Provider will provide services as a fiduciary or as an investment adviser registered under either the 1940 Act or any State law. If the services are provided as both a fiduciary and a registered investment adviser, the statement must reflect both roles.
(C) Compensation. A description of the compensation the Covered Service Provider (including affiliates and subcontractors) reasonably expects to receive from the contract including:
(1) Direct Compensation. This category includes all compensation the Covered Service Provider reasonably expects to receive directly from the Covered Plan. Direct compensation may be disclosed as a total for all services or itemized on a service by service basis.
Note: Compensation paid directly from a plan sponsor to a service provider is not compensation for this purpose. Plan provisions that give a plan sponsor the option of paying fees may result in some confusion about what disclosure, if any, is required. The service provider and plan sponsor will need to work together to determine how the compensation will be paid prior to entering into a contract. It is unclear how compensation paid directly from the plan sponsor, but reimbursed by the Covered Plan, will be treated.
(2) Indirect Compensation. This category includes all compensation the Covered Service Provider, an affiliate or a subcontractor reasonably expects to receive from any source other than the Covered Plan, the plan sponsor, the Covered Service Provider, an affiliate or a subcontractor. The disclosure must identify the services for which the compensation will be received and the payer of the compensation.
(3) Related Party Compensation. This category describes compensation paid among a Covered Service Provider, affiliates and subcontractors on a transaction basis (for example, commissions, soft dollars, finder’s fees or other similar incentive compensation based on business placed or retained) or charged directly against the Covered Plan’s investment and reflected in the net value of the investment (such as 12b-1 fees). The disclosure must identify the services for which the compensation will be received, the payer and recipient of the compensation and the status of each payer or recipient as an affiliate or a subcontractor. The regulations require disclosure of related party compensation even if the compensation is disclosed as direct compensation or indirect compensation. If the services are provided by multiple parties and priced as a package, the Covered Service Provider is not required to create an artificial allocation of the compensation received for the services.
(4) Contract Termination Compensation. This category includes the compensation reasonably expected to be received by the Covered Service Provider, an affiliate, or a subcontractor in connection with the termination of the contract. Additionally, the Covered Service Provider must describe how any prepaid amounts will be calculated and refunded upon such termination.
Compensation may be disclosed as a monetary amount, formula, percentage of assets or any other reasonable way. Non-monetary compensation valued at $250 or less over the term of the contract is not required to be disclosed.
(D) Recordkeeping Services. If recordkeeping services are provided to the Covered Plan, a description of all compensation reasonably expected to be received by the Covered Service Provider, an affiliate or a subcontractor in connection with recordkeeping services.
If recordkeeping services are provided, in whole or in part, without explicit compensation or if the compensation is offset or rebated based on other compensation received by the Covered Service Provider, a reasonable good faith estimate of the cost of the recordkeeping services must be provided. The estimate must include an explanation of the methodology and assumptions used to prepare the estimate and describe in detail the recordkeeping services that will be provided.
(E) Manner of Payment. The Covered Service Provider must provide a description of the manner in which the compensation described in (C) and (D) above will be received, such as whether the Covered Plan will be billed or whether fees will be deducted directly from the Covered Plan’s accounts or investments.
(F) Investment Disclosure - Fiduciary and Recordkeeping Services. If the Covered Service Provider provides fiduciary services to a plan investment that holds plan assets or if designated investment alternatives are provided in connection with recordkeeping or brokerage services to a Covered Plan that permits participant directed investments, the Covered Service Provider must disclose:
(1) Any fees that will be charged in connection with the acquisition, sale, transfer of, or withdrawal from an investment alternative (for example, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees and purchase fees);
(2) The annual operating expenses (for example, expense ratio) if the return is not fixed; and
(3) Any ongoing expenses in addition to annual operating expenses (for example, wrap fees, mortality and expense fees).
In the case of Covered Service Providers that provide designated investment alternatives to individual account plans that permit participant directed investments, they may use materials provided in connection with the plan’s investment alternatives (for example, a prospectus) to satisfy these requirements provided the materials are regulated by a State or Federal agency and the Covered Service Provider does not know the materials are incomplete or inaccurate.
Timing of Required Disclosure
A Covered Service Provider must provide the required disclosures to the responsible plan fiduciary reasonably in advance of the date the contract is entered into, extended or renewed. However, for contracts entered into before July 16, 2011, the disclosure must be provided no later than July 16, 2011.
If an investment contract does not hold ERISA plan assets at the time of the Covered Plan’s direct equity investment, but subsequently is determined to hold plan assets, the Covered Service Provider must provide the disclosure to the Covered Plan as soon as practicable but not later than 30 days from the date the Covered Service Provider knows the investment holds plan assets.
The Covered Service Provider must disclose a change in information included in the initial disclosure as soon as practicable, but no later than 60 days from the date the Covered Service Provider is informed of the change, unless such disclosure is precluded due to extraordinary circumstances beyond the Covered Service Provider’s control. There is no concept of “materiality” as a limitation on disclosures, which means Covered Service Providers are required to disclose any change to information in the initial disclosure.
Failure to Comply
If a Covered Service Provider does not comply with the disclosure requirements, the Covered Service Provider will owe excise taxes (generally 15% of the amount involved for each year), and the responsible plan fiduciary may have legal exposure for breaching its fiduciary obligations under ERISA.
The regulations do provide some relief if proper disclosure is not made by a Covered Service Provider due to a mistake. An error or omission in the disclosure will not cause a contract to fail to be reasonable if the Covered Service Provider (i) acts in good faith and (ii) corrects the error as soon as practicable but no later than 30 days after discovering it.
The regulations also provide relief for responsible plan fiduciaries who “innocently” enter into a contract with a Covered Service Provider with the belief that all regulatory requirements have been met. Fiduciaries who discover an error or missing information in the required disclosure must notify the Covered Service Provider, in writing, and request the error or missing information be corrected. If the Covered Service Provider does not comply within 90 days, the plan fiduciary must notify the Department of Labor.
The regulations are not effective until July 16, 2011, which provides all parties a fair amount of time to prepare. We suggest plan sponsors, responsible plan fiduciaries and Covered Service Providers take the following actions to prepare for these new requirements:
1) Covered Service Providers should review the interim final regulations in detail.
2) Plan sponsors should identify the plan fiduciary that will be responsible for entering into service contracts and reviewing Covered Service Provider disclosure information. The fiduciary should become familiar with the information that must be provided.
3) Plan sponsors and responsible plan fiduciaries should identify which service providers will be “Covered Service Providers”. If a plan invests in hedge fund or private equity fund investments, the plan sponsor and responsible plan fiduciary should review the investment to determine if it holds plan assets.
4) Responsible plan fiduciaries should review current service contracts and contact each Covered Service Provider to discuss compliance with the new regulations.