What the DOL s New 408b 2 Rule Means

Transcription

1 What the DOL s New 408b 2 Rule Means July DOL published its long awaited 408b 2(c) regulation on July 15, The new interim final regulation makes some thoughtful upgrades to the 2007 proposed rule, including a shift from focusing on detailed contractual requirements to simpler, but still comprehensive, disclosure requirements. Retirement plan providers will need to provide updated disclosures to all clients by July 16, Preliminary Thoughts on the Interim Final Rule

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3 WHAT THE NEW 408B 2 RULE MEANS July 16, 2010 By Pete Swisher, CFP, CPC Unified Trust Company, NA The Department of Labor s long awaited amendment to its 408b 2 regulation was published yesterday, Thursday, July 15, It was published as an interim final regulation, allowing for additional public comments and amendments by DOL, but in the absence of further changes the rule becomes effective as is on July 16, What this means in simple terms is that retirement plan providers of all types need to be compliant with the rule by that date for all plans. There is no additional transition period, and no exception for existing plans: every plan a provider serves must be compliant by July 16, But this will be easier than we expected it to be: providers will not need to revise every contract for services; they simply need to make appropriate disclosure. This article highlights some key provisions and differences from the 2007 proposed rule, with thoughts on what it means for the retirement plan industry. The emphasis is on industry impact rather than legal details. A copy of DOL s Fact Sheet on the new regulation is attached. The full text of the regulation and its preamble can be found on the Employee Benefit Security Administration s website at Review: What is 408b 2 and How is it Changing? ERISA defines service providers as parties in interest and prohibits all parties in interest from providing services and receiving compensation from the plan. So if you provide services, you are prohibited from doing so, literally. Naturally, plans need services and service providers must get paid, but Congress took the approach of using this blanket prohibition then offering an exemption to the prohibition if certain conditions are met. ERISA Section 406(a) thus prohibits the provision of services and receipt of compensation from the plan, but ERISA Section 408(b)(2) provides a conditional exemption from the prohibited transaction ( PT ) rule of 406(a). DOL enforces ERISA, so it created the 408b 2 regulation 1 to clarify how it would enforce ERISA Section 408(b)(2). There are, and have been for many years, three basic requirements: 1. The services must be necessary; 2. The contract or arrangement under which services are provided must be reasonable ; 3. The compensation must be reasonable. This rule has been around for decades and is remaining mostly unchanged. What s changing is the second requirement: the new interim final rule provides a far more detailed list of requirements for a contract or arrangement to be considered reasonable. The new rule is therefore often called the 1 DOL Regulation Section b 2 Unified Trust Company, NA Copyright 2010 All Rights Reserved 1

4 July 16, 2010 WHAT THE NEW 408B 2 RULE MEANS reasonable contract or arrangement rule. Because the new rule calls for disclosure in advance of entering a new contract or arrangement 2, it has also been called the point of sale disclosure rule. The old rules were very non specific about what made an arrangement reasonable: the new rules make clear that an arrangement cannot be considered reasonable unless the provider makes certain disclosures. But it s worth noting that the disclosure alone is not the full picture: it s still up to the sponsor to determine if the arrangement is reasonable. DOL proposed changes to 408b 2 under the Bush administration in 2007, but those changes were put on hold and the regulation was never made final or implemented. The July 15, 2010 version builds on the 2007 proposal and makes changes based on the public comments. The primary concept full disclosure remains the same, but the changes between the 2007 and 2010 versions are substantial. One Big Change: Focusing on Disclosures vs. Contracts The 2007 rule would have required a redrafting of all contracts and arrangements between plans and affected providers, a monumental undertaking that would have eliminated all vacation time for ERISA attorneys for years. In the interim final rule, DOL takes a new direction by saying that it s not the contract or arrangement which must be revised but the disclosure regarding the contract or arrangement. An arrangement will be considered reasonable only if it complies with the regulation, but compliance with the regulation does not require that the arrangement itself say anything in particular (or even that it must be in writing), but instead that the arrangement must be properly described in disclosure documents. So in order for a contract or arrangement to be reasonable, it need not be in writing, but it must be described in a written disclosure. This is an interesting approach that should make compliance easier. The approach in the 2007 proposed rule, by contrast, focused on the required components of the written contract or arrangement itself. A subtle but important difference. A Side Effect of Focusing on the Disclosure Instead of the Contract: The Burden is Back on the Sponsor with Respect to the List of Services As discussed below, the disclosure need not list every single service a provider will offer, leaving the door open for providers to favor minimalistic or even vague listings of the services they provide. Here is the full text of the relevant section 3 : The covered service provider must disclose the following information to a responsible plan fiduciary, in writing (A) Services. A description of the services to be provided to the covered plan pursuant to the contract or arrangement 2 ERISA attorney Fred Reish uses a convention for discriminating between these two terms: a contract is a signed legal contract, an arrangement is a description of services and terms. A contract is signed, an arrangement is not. Both are arguably legal contracts, even when an arrangement is unwritten CFR b 2(c)(1)(iv)(A) Unified Trust Company, NA Copyright 2010 All Rights Reserved 2

5 WHAT THE NEW 408B 2 RULE MEANS July 16, 2010 This is a general enough requirement that vague might fairly describe it. This is not a value judgment the 2007 version was arguably too detailed but there is no question that sponsors might have a difficult time determining exactly what services the plan is paying for if providers are not cooperative in providing sufficient detail. A best practice will therefore be for investment brokers and advisors to articulate a robust array of services they will provide. Every provider needs a compelling value proposition, and that value proposition should be self evident from the 408b 2 disclosure. Less detail might be legally sufficient, but less detail might make the sponsor s job too difficult and may not be competitive in the marketplace. The emphasis in this discussion of how specific one s listing of services should be is on brokers and advisors because most other service providers (such as recordkeepers, attorneys, auditors) already use detailed service contracts. What Must Be Disclosed? In general, providers must disclose what services they expect to provide, their compensation (direct or indirect, monetary or non monetary) for those services, whether or not they will be fiduciaries or RIAs 4, and any conflicts of interest. A couple of key points about the disclosure: No Conflict of Interest Narrative: Just Show Me the Money. DOL decided to eliminate the requirement from the 2007 proposed rule to provide a narrative description of conflicts in favor of simply mandating that all payment sources, amounts, and recipients be clear. The logic, it would appear (and sensibly so), is that it s all about the money. Show who stands to benefit and by how much and the conflicts become self evident. This is not universally true (e.g., this requirement will miss relationship conflicts, such as when a sponsor hires his brand new stockbroker nephew to help him out ) but at first glance this appears to be a very practical approach. Services Must be Described, But Not All. The 2007 proposed rule required that a provider list ALL services to be provided. It also required (as this interim final rule does not, since it does not mandate written contracts or arrangements) that providers abide by the terms of the arrangement, with the effect that providers would arguably have been required to list every single service they provide, actually provide every service listed, and provide no others. This is impractical it s a changing world, and virtually any service provider will vary its services somewhat over time based on the needs of the plan so DOL removed the word all. Combined with the change in approach of requiring disclosure, rather than dictating elements that must be included in a written contract or arrangement, the effect is to give providers flexibility in describing and providing their services. Compensation Disclosure. The industry is sufficiently well informed by now that full disclosure is becoming mandatory: there are no surprises in the interim final rule. DOL did not 4 Registered investment advisers registered under the 1940 Act or state law. Unified Trust Company, NA Copyright 2010 All Rights Reserved 3

6 July 16, 2010 WHAT THE NEW 408B 2 RULE MEANS choose to provide a model compensation disclosure, though it remains open to the notion based on public comments. A few points: o o o $250 De Minimis Limit. No disclosure for services paying less than this. $1,000 Threshold. Unless a provider s annual compensation from all sources, monetary and non monetary, is $1,000 or more, it is not subject to the interim final rule. Direct and Indirect, Monetary and Non Monetary. It all has to be disclosed. The Fiduciary Status Disclosure: The Broker s Dilemma Still Looms Large The new rule requires only that anyone who reasonably expects to be serving as a fiduciary or as a Registered Investment Adviser clearly say so. This is different from the 2007 proposed rule, in which the provider had to state its fiduciary status, whether fiduciary or non fiduciary, though there is no effective difference. What matters is that the 401(k) broker s dilemma (see the article by that name in the August 2008 edition of ABA Trusts & Investments) is still a problem. By now, most industry observers are well aware of the unauthorized/unacknowledged fiduciary problem: brokers or advisors who meet ERISA s functional fiduciary definition but are not authorized by their broker/dealers or corporate RIAs to serve as ERISA fiduciaries and whose written arrangements with the plan specifically disclaim fiduciary status. This service model is arguably a prohibited transaction under the statute anyway (i.e., under ERISA Section 408(b)(2)), but is clearly a prohibited transaction under the interim final rule, as it was under the 2007 proposed rule. Here s the logic: the rule requires those who will serve as fiduciaries to say so. If a broker does not say he or she will serve as a fiduciary even knowing that he or she will be providing investment advice that meets the fiduciary definition, this is not a reasonable contract or arrangement on the face of it, and it clearly violates the requirement to disclose fiduciary status. Since the provision of ALL services and the receipt of ALL compensation is prohibited by ERISA, in the absence of an exemption, failure to qualify for the exemption means that the unacknowledged fiduciary arrangement is one that by its very structure is a PT. That means the sponsor is guilty of an ERISA PT and the broker is guilty of an IRC Section 4975 PT subject to the excise tax and other corrections. Brokers and advisors whose service models include actions that make them fiduciaries have long suffered in an uncomfortable grey zone in which they know what they re doing and that their parent organizations won t let them say so. That arrangement was never OK, but now it s clearly problematic by its basic structure and has to stop. Brokers and advisors will need to choose: serve as a fiduciary or not; if not, they have to truly be non fiduciaries, not merely say they re non fiduciaries. Finding a way to eliminate the unauthorized/unacknowledged fiduciary problem is one of the primary challenges for parent broker/dealers and corporate RIAs. Most such organizations are working hard Unified Trust Company, NA Copyright 2010 All Rights Reserved 4

7 WHAT THE NEW 408B 2 RULE MEANS July 16, 2010 already to find ways for their representatives to serve qualified plans in a robust but compliant manner: now that the interim final rule has finally been published, broker/dealers and RIAs can move forward in solidifying their business models. The Difficulty Drawing Lines of Fiduciary Responsibility Sponsors often struggle to understand who is responsible for what. They seldom understand that fiduciary status is not monolithic: saying I m a fiduciary does not mean you are responsible for everything, but instead that you are responsible for certain specific fiduciary tasks. It is a rare sponsor who understands which tasks are the responsibility of which vendors, and consequently which responsibilities remain with the sponsor itself. The 2007 rule took a step toward clearing the haze, but the interim final rule is non specific on this subject. Here is the text of the relevant section: [the service provider must provide] a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan (or to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment) as a fiduciary In other words, a simple statement that one is a fiduciary appears to be sufficient. By contrast, under the 2007 rule, a safe interpretation was that a provider should list all services to be provided and note its fiduciary status with respect to each individual service. The 2007 rule did not specifically say this was required but it was a conservative interpretation due to the joint requirements that ALL services be listed and that the provider give its fiduciary status with respect to those services. Under the new rule a general statement of fiduciary status may be enough. The potential problem for sponsors is best shown by an example: under the new rule, a fully discretionary investment manager or trustee might disclose its fiduciary status the same way as a computer advice provider: very different services, same disclosure, potentially very confusing for sponsors. Non ERISA 403(b)s and 457 Plans are not Affected The interim final rule only covers ERISA plans, and not all of those IRAs, including SEPs and SIMPLEs, are specifically excluded. Therefore the new disclosure rules do not apply to non ERISA 403(b)s, 457(b)s, or 457(f)s. ERISA 403(b)s are covered by the new rule. Will it Work? Plan sponsors historically have rarely known what their plans cost and what conflicts of interest exist, so the logical question we should ask ourselves is, will this rule change that? Will sponsors now know what their plans cost and how much money their providers make, and from what sources? Sponsors and participants are human; they don t read or remember much of what we already give them. So it seems unlikely they ll pay detailed attention to the new stuff, especially since the typical Unified Trust Company, NA Copyright 2010 All Rights Reserved 5

8 July 16, 2010 WHAT THE NEW 408B 2 RULE MEANS 408b 2 disclosure will necessarily be a long, legalistic document. From that perspective, the new rule won t help much. For this very reason, many who submitted comments on the 2007 proposed rule suggested the use of a summary page to make it easier to determine what a plan costs. DOL chose not to go with the summary page idea, though it remains open to it in this interim phase. The true difference that rules like 408b 2(c), participant disclosures, and Form 5500 Schedule C disclosures make is that they give people who know what to look for an easier way to find it. Sponsors will be better informed about their plans, not because they are likely to read a new five page disclosure document, but because the advisors and providers they trust will be able to point them to the data that matter most. The days when a plan sponsor or advisor calls a vendor to ask, What s it cost? only to receive misdirectional gobbledegook are over. Viewed from this perspective, the new 408b 2 disclosure rule is a good one, and it will work. Suggested Best Practices 1. Be Specific About Your Listing of Services. Even though the regulation appears to allow for a generalized, perhaps even vague, description of services, go ahead and articulate a reasonably comprehensive listing of services. But be careful to avoid committing to such specific detail that reasonable variations in service levels are not automatically encompassed. 2. Be Specific About Your Fiduciary Status With Respect to Each Individual Service. Since sponsors are no good at figuring out which specific services fiduciary status applies to without a specific statement to that effect, make it easy for them. For each listed service, clarify whether or not you are a fiduciary and specify any limitations on the extent of your fiduciary responsibility. Make it as easy as possible for clients to determine who s responsible for what. 3. Use a Summary Page. Again, sponsors struggle to understand long disclosures, so make it easy on them. Include an easily understandable summary that clarifies who does what and how much they get paid to do it. 4. View Your 408b 2 Disclosure as a Marketing Document. Do you have a compelling value proposition? Make sure your disclosure does justice to the value you bring. Look at it this way: given only the information in the disclosure, would you hire you? 5. Favor a Formal, Written Contract. The interim final rule does not require a written contract or arrangement, but use of a written contract is clearly a smart move. A separate disclosure may not be necessary or even useful, though it may make sense to include the necessary disclosures as an attachment to the contract, making it easy to update. What s Next? DOL has solicited additional public comments. It will review those and decide whether or not to make any further changes. If they make further changes, there will be a final rule to replace the interim final rule. If there are no further changes, the rule as written goes into effect next July. Unified Trust Company, NA Copyright 2010 All Rights Reserved 6

9 WHAT THE NEW 408B 2 RULE MEANS July 16, 2010 The industry s to do list appears to have been greatly simplified by the DOL s new approach to focusing on the disclosure rather than on the contents of the contract or arrangement itself. Instead of having to rewrite all the contracts and get clients to execute them, it would appear that everyone just has to draft new disclosures and send them out. Very doable. Pete Swisher is a pension consultant and wholesaler for Unified Trust Company, NA, in Lexington, Kentucky. He is the author of 401(k) Fiduciary Governance: An Advisor s Guide, a textbook for retirement plan advisors. Unified Trust is a full service retirement plan vendor working through independent advisors and TPAs with a transparent, universal investment platform and a unique service offering. Pete can be reached at pete.swisher@unifiedtrust.com. Unified Trust Company, NA Copyright 2010 All Rights Reserved 7

10 Fact Sheet U.S. Department of Labor Employee Benefits Security Administration July 15, 2010 Interim Final Regulation Relating to Improved Fee Disclosure for Pension Plans The Employee Retirement Income Security Act (ERISA) requires plan fiduciaries, when selecting and monitoring service providers and plan investments, to act prudently and solely in the interest of the plan s participants and beneficiaries. Responsible plan fiduciaries also must ensure that arrangements with their service providers are reasonable and that only reasonable compensation is paid for services. Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about the services, the costs, and the service providers. This interim final rule represents a significant step toward ensuring that pension plan fiduciaries are provided the information they need to assess both the reasonableness of the compensation to be paid for plan services and potential conflicts of interest that may affect the performance of those services. Background The Employee Benefits Security Administration (EBSA) is responsible for administering and enforcing the fiduciary, reporting, and disclosure provisions of Title I of the ERISA. The agency oversees approximately 708,000 private pension plans, including 483,000 participantdirected individual account plans such as 401(k)-type plans. In recent years, the way services are provided to employee benefit plans and the way service providers are compensated (e.g., through revenue sharing and other arrangements) have become increasingly complex. Many of these changes may have improved efficiency and reduced the costs of administrative services and benefits for plans and their participants. However, the complexity resulting from these changes also has made it more difficult for many plan sponsors and fiduciaries to understand how and how much service providers are compensated. Although the Department has issued considerable guidance relating to the obligations of plan fiduciaries in selecting and monitoring service providers, this interim final rule establishes, for the first time, a specific disclosure obligation for plan service providers a disclosure obligation designed to ensure that ERISA plan fiduciaries are provided the information they need to make better decisions when selecting and monitoring service providers for their plans. The Department published a notice of proposed rulemaking and related class exemption in December 2007 and held a public hearing on March 31 and April 1, Overview of Interim Final Service Provider Disclosure Regulation The interim final regulation applies only to defined contribution and defined benefit pension plans and focuses on the disclosure of the direct and indirect compensation certain service providers receive. The interim final regulation applies to plan service providers that expect to receive at least $1,000 in compensation in connection with their services and that provide: certain fiduciary or registered investment advisory services; recordkeeping or brokerage services to a participant-directed individual account plan in connection with the investment options made available under the plan; or 1

11 certain other services for which indirect compensation is received. The rule focuses on service providers and compensation arrangements that are most likely to raise questions for plan fiduciaries with respect to the amount of compensation being received by a service provider for plan-related services and potential conflicts of interests that might compromise the quality of those services. The interim final regulation also includes a class exemption from the prohibited transaction provisions of ERISA for a plan fiduciary who enters into a contract without knowing that the service provider has failed to comply with its disclosure obligations. Disclosure Requirements Disclosure of Services and Compensation Information required to be disclosed by plan service providers must be furnished in writing to the plan fiduciary. The rule does not require a formal written contract delineating the disclosure obligations. Information that must be disclosed includes a description of the services to be provided and all direct and indirect compensation to be received by the service provider, its affiliates or subcontractors. Direct compensation is compensation received directly from the plan. Indirect compensation generally is compensation received from any source other than the plan sponsor, the covered service provider, an affiliate, or subcontractor. Because certain services and costs are so significant or present the potential for conflicts of interest, information concerning those services and costs must be disclosed without regard to whether services are furnished as part of a bundle or package. For example, service providers must disclose whether they are providing recordkeeping services and the compensation attributable to such services, even when no explicit charge for recordkeeping is identified as part of the service contract. Service providers must disclose whether they are providing any services as a fiduciary to the plan. Information also must be disclosed about plan investments and investment options. These disclosure obligations are placed on the fiduciaries to investment vehicles that hold plan assets and on recordkeepers and brokers who, through a platform or other mechanism, facilitate the investment in various options by participants in individual account plans, such as 401(k) plans. Ongoing Disclosure Obligations Changes: A service provider generally must disclose a change to the initial information required to be disclosed as soon as practicable, but no later than 60 days from the date on which the covered service provider is informed of such change. Reporting and Disclosure Requirements: Service providers also must, upon request, disclose compensation or other information related to their service arrangements that is requested by the responsible plan fiduciary or plan administrator in order to comply with ERISA s reporting and disclosure requirements. Benefits of Interim Final Regulation The Department estimates that the rule will be economically significant. The non-discounted costs for the first year are estimated to be approximately $153 million. The first year costs are attributable to reviewing and analyzing the regulation, conducting a compliance review to ensure that service providers comply with the regulation, and preparing any new disclosures required by the regulation. Costs in the second and subsequent years are expected to fall to an estimated $37 million. The Department estimates that benefits would result from reduced time and cost for fiduciaries to obtain compensation information needed to fulfill their fiduciary duties, the discouragement of 2

12 harmful conflicts of interest, reduced information gaps, improved decision-making by fiduciaries about plan services, enhanced value for plan participants, and increased ability to redress abuses committed by service providers. Public Notice and Comment on the Interim Final Regulation The interim final regulation will be published in the Federal Register on July 16, The Department invites public comments from interested persons on the regulation by August 30, 2010, and specifically requests input on the feasibility and cost effectiveness of requiring plan service providers furnish to plan fiduciaries a summary disclosure statement as part of the regulation. Public comments can be submitted electronically by to e-ori@dol.gov or by using the Federal erulemaking portal at Persons interested in submitting comments on paper should send or deliver their comments to: Office of Regulations and Interpretations, Employee Benefits Security Administration, Room N-5655, U.S. Department of Labor, 200 Constitution Ave., N.W., Washington, DC 20210, Attention: 408(b)(2) Interim Final Rule. All comments will be available to the public, without charge, online at and and at the EBSA Public Disclosure Room. Effective Date The final regulation is effective for contracts or arrangements between plans and service providers as of July 16, Contact Information For questions about the regulation, contact EBSA s Office of Regulations and Interpretations at (202)