Beyond Benchmarking: An Advisor s Guide to Fee Policy Statements

Understanding fees and how they are properly allocated among one or more service providers stands to receive compensation that participants in defined contribution plans can be a complex and exceeds the value of services provided. 4 At the same time, the disclosures you are required to provide to eligible employees under complicated issue for plan sponsors. Additionally, a combination of new regulations, increased enforcement, and litigation has raised 404(a) may put your plan s participants on notice of inconsistencies in the way fees are allocated to pay for plan expenses. If your the bar in demonstrating compliance with the Employee Retirement Income Security Act (ERISA). Ignoring these challenges in plan has more than 100 participants, then you are now required light of recent developments can prove costly for plan sponsors and to disclose additional detail regarding the allocation and amounts the plan fiduciaries making decisions affecting the management or of plan expenses to the Department of Labor (DOL) in Schedule Since the passage of 408(b)(2), administration fees and expenses of their associated ERISA-covered with advisor retirement guide plans. outlining the process. C of Read Form it 5500. to become 5 comfortable the management of qualified retirement plans have become a central issue with lawmakers, regulators, Plan fiduciaries the courts may and, become in turn, personally your eral liable relevant to restore topics any to losses help you in consulting with a plan sponsor. with the terms and procedure. The guide includes details on sev- plan-sponsor clients and prospects. when The they plan breach sponsor their now duties has to the act prudently Topics include: and solely in the Covered Service Providers fiduciary duty to control and account interest for of plan expenses. participants and beneficiaries. While plan sponsors and fiduciaries have significant flexibility in establishing pol- Required to provide disclosures reasonably in advance of entering PERA (plan expense recapture account) sometimes referred Looking back a decade, very icies few plans for allocating had defined expenses investment to as an ERISA bucket or budget among participants in defined contribution has sponsors into a service contract/agreement. Any changes must be disclosed no This fee policy statement is to illustrate criteria to consider when de- etc.), the Identifying method selected plan expenses must settlor later versus than non-settlor 60 days from expenses the date the service provider is notifi ed policies. 1. Purpose: But as the The fiduciary Company duty plans evolved, the (i.e., 401(k), so Plan has the (as 403(b), marketplace, plan with governed qualified by default the defined above), a qualified retirement comply investment Employee Retirement with alternatives ERISA and (QDIAs), Income Securities Act of 1974, as amended ciding how to allocate the expenses be administered in the manner prescribed and Plan s of such change. of administering an employer-spon-producsored retirement plan. Plan fi ducia-majority of plans now use an investment or ambiguous policy on this statement issue, fiduciaries (IPS) ( ERISA ). enhancements, ERISA regulations, permits the by the plan assets plan governance. to be used document. 1 The for just Fee two equalization purposes: equalizing of revenue sharing among plan Where the plan document is silent participants must select the method or ries should review the plan documents to determine an approach to guide fiduciaries Cover reasonable decisions fees methods on the of administering selection, of allocating monitoring, the plan Plan expenses. and Allocation of excess PERA funds to participant To pay benefits that is appropriate for their plan and replacement of investment options. Pro rata based upon each participant s account value consult with experienced ERISA The Plan s named fiduciaries (the Fiduciaries ) recognize that the decision to pay expenses from This paper is designed to provide you with a framework for determining proposition, decision subject Plan Sponsors counsel if necessary. The fee policy If you wish the Plan s to enhance assets is your a fiduciary value whether your consider to ERISA. plan is helping As such, Per the capita Fiduciaries applied acknowledge equally to all participants statement can be adopted by having a Plan Fiduciary initial and date allocating expenses properly or perhaps a would fee their policy duties your clients they develop must prudently and maintain discharge Must be provided prior benefit statement solely in from incorporating (FPS). the interest Individually of the Plan s based participants upon the and amounts a fee policy statement. If Required contributed to be fi led from This exercise should ensure that to eligible employees annually below on behalf of the plan. beneficiaries and to defray you you the determine play reasonable a critical expenses that role adopting with of decision makers. A proactive approach administering investments the Plan. held by each participant a fee policy statement is a prudent annually and participants quarterly approach, beyond you fee should benchmarking work with will a knowledgeable retirement plan A blank template can be downloaded at www.thornburg.com/fps 2. Fee Policies: The Plan Fiduciaries will periodically ERISA review counsel guide. disclosures to You ensure might provided it is consider compli- by the sending Plan s it in advance of your meeting Once comfortable with the advisor guide, review the plan sponsor help differentiate your services advisor from and/or those of experienced your competitors with both covered clients service and prospects. providers ant ( CSP ) and capable to ensure of being that: followed. or leaving it afterward. The services are necessary for the operation of the Plan Thornburg can assist you in conducting FORM presentations 5500/SCHEDULE to plan C sponsors. Allocation If you would prefer, talk with your Thornburg regional retire- PARTICIPANT DISCLOSURE Next Steps The arrangements are reasonable Adopted by: New Regulations Impacting Fee All fees paid from Plan assets are reasonable, appropriate (paid only for non-settlor services), What are the next steps for engagement with a plan to implement ment consultant and inquire how they can assist you 2013 to prepare Pension for Resource Institute, LLC (G-MAP Compatible) and are permitted by the Plan documents a documentable and prudent process? While new Thornburg regulations, has created such as an amendments your meeting. to ERISA Section Plan Fiduciary: The costs of administering 408(b)(2) the Plan 2 and (i.e., 404(a), recordkeeping, 3 are designed legal, to provide auditing, plan annual sponsors reporting, and etc.) This disclosure framework serves as a roadmap to regulators and will be paid: employees, respectively, with more information to make better would-be plaintiffs, and can result in significant penalties if you Name: informed decisions, the required disclosures have the potential to have not carefully evaluated your plan s fees. Adopting a fee policy o Exclusively by the highlight Company Sales gaps out Ideaof in corporate your current assets fee allocation policies. From the statement is one way to proactively ensure that you are allocating o Partially by the Company plan sponsor s (i.e., net perspective, of any revenue the information sharing received provided from by plan the investments) Initials: plan s expenses properly and not subjecting your plan to a costly DOL o Exclusively by the Collaborate with your Thornburg representative to organize a plan-sponsor workshop covering the various service Plan s participants providers under 408(b)(2) may, for example, reveal that investigation and/or litigation. topics of the fee-policy process. Invite clients and prospects. Perhaps partner with a local ERISA attorney, Date: To the extent any administrative who costs invites are his paid or her by clients the Plan s and prospects participants, and speaks. the Fiduciaries, The four topics after you may want to cover are outlined of various above. This classes is a of great the opportunity Plan s participants to build your and prospective the effects plan of pipeline. var- You can give each attendee weighing competing interests This material is not for distribution to plan participants. ious allocation methods on those a copy interests, of the fee-policy have determined plan sponsor it guide reasonable and follow to allocate up using such the plan costs expense worksheet. Consider based upon the following method: providing some type of CE for plan sponsor fi duciaries. These are relevant topics for which fi duciaries may need training and education. The Department of Labor is beginning to ask plans what type of CE curriculum committee members are utilizing. Provide them with documentable proof they attended the workshop. o Pro rata based upon participants account values o Per capita applied equally to all participants o Hybrid fees will be allocated as follows: Expense Type Pro rata Per capita Individual Recordkeeping/administration For investment professional use only. Trustee/custodial Investment management Investment advisory/consulting Education/communication Auditing/legal Transactions (loans, QDROs, distributions, etc.) Other For investment professional use only. Advisor Guide Beyond Benchmarking: An Advisor s Guide to Fee Policy Statements New regulations, increasing enforcement, and litigation have raised the bar for plan sponsors to manage and administer their plans prudently and in the best interests of participants and beneficiaries. Disclosure and reporting requirements under ERISA 408(b)(2), 404(a)(5) and changes to the required information in Schedule C of Form 5500 put plan fiduciaries, plan participants, and regulators on notice regarding plan expenses. Moreover, the majority of class action cases filed against plan sponsors over the past few years have been predicated upon claims that fiduciaries failed to properly negotiate, allocate and/or monitor fees. This heightened visibility and scrutiny can create significant exposure for plan sponsors that have not carefully considered and documented their decisions relating to the payment of plan expenses. At a minimum, plan fiduciaries must be able to demonstrate that they acted prudently in reviewing the covered service provider (CSP) disclosures, provided under 408(b)(2), and took appropriate action to ensure that fees paid from plan assets are necessary and reasonable. Because ERISA requires plan fiduciaries to hire professional assistance when they lack the expertise to make informed decisions, 1 many are turning to retirement plan advisors. In particular, plan sponsors are increasingly reliant on their advisors for information and guidance in the selection, monitoring and benchmarking of CSPs. Fiduciaries DOL/IRS Schedule C Form 5500 2013 Pension Resource Institute, LLC CSP(s) 408(b)(2) Disclosures Employees/ Participants 408(b)(2) Disclosures While helpful in demonstrating a prudent process, such assistance often also reveals issues involving the payment and allocation of plan expenses that require fiduciaries to make additional decisions. For example, while a benchmark may reveal that a specific service is provided at a reasonable price, how do we know that the compensation is properly paid from plan assets? Alternatively, what happens when a benchmarking report shows that a particular service provider stands to receive more than reasonable compensation? Perhaps there is a more appropriate share class available or a way to recapture and redirect some revenue to pay other service providers? These are just a few of the issues that can be addressed by adopting a fee policy statement (FPS) a document that establishes a process for a plan s payments and allocations of various administrative expenses. This advisor s guide and the following companion materials provide a framework for reviewing plan expenses and working with plan sponsors to develop and implement a FPS: Plan sponsor guide for opening the conversation and explaining how the FPS can help plan fiduciaries manage risk and save time Plan expense worksheet for helping plan fiduciaries evaluate plan expenses Sample fee policy statement a framework for documenting decisions about expenses Plan Sponsor Guide Process & Sales Ideas Fee Policy Statement: Controlling and Allocating Plan Expenses Fee Policy Statement Implementing the Fee Policy Statement Process and Sales Ideas Collectively, these materials should help you deliver an actionable plan to clients and prospects for addressing critical issues involving the payment and allocation of plan expenses. The conversation alone will help solidify your value proposition and differentiate your services. Subsequent assistance with the development and maintenance of the FPS will ensure you play an ongoing role in a plan s fiduciary process. Company: Plan: For investment professional use only.

Procedural Prudence & Department of Labor Guidance Because fiduciaries are judged upon the processes they use to make well-informed decisions, 2 it is critical they reevaluate their policies to incorporate any changes based on new information, regulatory requirements, and/or options available to allocate payment of plan expenses. The new rules combined with the proliferation of new retirement share classes and plan expense recapture accounts (PERAs) are creating more options for plan fiduciaries to consider when evaluating the nature and sources of payments from a plan to its CSPs. However, the availability of more choices requires plan fiduciaries to consider additional information to make informed decisions. Indeed, the Department of Labor (DOL) recently presented its expectations in Advisory Opinion 2013-03A, indicating, among other things, that plan fiduciaries must: Assure that the compensation a plan pays directly or indirectly to a CSP for services is reasonable, including any revenue sharing Act prudently and in the best interests of plan participants and beneficiaries in the negotiation of the specific formula and methodology under which revenue sharing will be credited and paid back to a plan or to a plan s service providers Understand the formula, methodology, and assumptions used by a CSP in arriving at the amounts to return to a plan or to use to pay plan service providers following a CSP s disclosure of all relevant information pertaining to a proposed arrangement Be capable of periodically monitoring a CSP s actions in the performance of its duties to assure, among other things, that any amounts to which a plan may be entitled under the terms of its arrangement are correctly calculated and applied for the benefit of the plan Advisor Fiduciaries With respect to fulfilling a plan sponsor s fiduciary duties, we often hear that, it s all about the process. Fiduciaries are required to follow an objective process to arrive at well-informed decisions regarding all aspects of managing and administering their plans. However, there are three primary areas of fiduciary responsibility for plan sponsors: 1. Selection/monitoring of plan investments 2. Administration and reporting 3. Selection/monitoring of service providers While many plan sponsors have adopted an investment policy statement (IPS) to provide the fiduciaries an objective and repeatable process for selecting, monitoring, and replacing investments, many lack any formal process to guide them in making decisions affecting other areas of fiduciary responsibility, such as plan administration and the management of service providers. These gaps can be problematic as fiduciaries are judged on their procedural prudence, including details of their decision-making process. 3 These areas increasingly present the greatest potential for liability. As new plan designs, product enhancements, regulations and service models over the past decade fueled demand for more formal investment policies, heightened transparency and new choices for plan sponsors are setting the stage for proactive plan advisors who understand how to introduce FPSs in a way that ensures plan sponsors have the requisite process to support the decisions they make in this increasingly scrutinized area of fiduciary responsibility. Action Items Before you introduce the concept of a FPS to your clients or prospects, you should review the companion materials. The plan sponsor guide is designed to help you start the conversation. The plan expense worksheet provides you with an interactive approach to evaluating a plan sponsor s current and preferred method for classifying and allocating common administrative expenses before committing to a particular strategy described in the sample FPS. The plan sponsor guide establishes a five-step decision- making framework for plan fiduciaries to consider: Investments 2013 Pension Resource Institute, LLC Administration CSPs 1. Analyze CSP disclosures to determine the nature and sources of compensation 2. Strategize by examining competing interests of various classes of a plan s participants and the effects of allocation methods on those interests 2 Advisor Guide

3. Formalize by developing a FPS that aligns with the chosen strategy 4. Implement the FPS and incorporate it into plan documents 1 Analyze 5. Monitor plan fees and reconcile payments The remainder of this advisor guide provides a step-by-step approach to help your clients and prospects navigate the information gathering, analysis, and decision making required to adopt an appropriate FPS. 5 4 Monitor Implement Assess 3 2 Formalize Strategize Copyright 2007-2013 3Ethos. Licensed to the Leadership Center for Investment Stewards 1 Analyze Review CSP Disclosures to Determine the Nature and Sources of Compensation Plan fiduciaries should review a CSP s disclosures to ensure that only necessary and reasonable expenses are paid from plan assets. Industry benchmarks are increasingly available to assist with this. But, as noted, a benchmark may reveal that a CSP receives, or stands to receive, compensation in excess of the value of its services. Such a result would require fiduciaries to renegotiate the arrangement, utilize a more appropriate share class, or establish a method (e.g., a PERA) for capturing and redirecting excess revenue to another service provider or back to plan participants. It is critical that fiduciaries investigate these options and take appropriate action. In addition to evaluating the reasonableness of plan expenses, fiduciaries must consider whether a service is necessary to administer the plan or provide benefits to plan participants and beneficiaries (non-settlor services) that are paid from plan assets. Plan assets must be held for the exclusive purpose of providing benefits to plan participants and beneficiaries, and a fiduciary cannot use plan assets for his or her own expenses. Consequently, while an expense may be reasonable (based upon industry benchmarks), paying for it using plan assets may nevertheless be inappropriate or illegal. This rule derives from ERISA s foundation on the basic principles of trust law. The creator of a trust, known as the settlor, decides how to design it and whether to terminate it. The settlor must bear the costs of these expenses and may not deduct them from trust assets. If the expense is a settlor expense, it is not necessary to support the plan and must be paid directly by the plan sponsor. To pay non-settlor expenses from plan assets requires that: 1. Plan documents permit the payment of plan expenses 2. The expense must be reasonable 3. The expense does not pay for services provided by a party in interest ERISA 408(b)(2) requires all CSPs to disclose, among other things, the services provided and all direct and indirect compensation received in connection with them. As for the source of compensation, the CSP disclosures may allow some or all of the fees to be paid indirectly (e.g., from a source other than the plan, plan sponsor or an affiliate/subcontractor of the CSP). Indirect compensation may take the form of 12b-1, Sub-TA, or other forms of revenue sharing with the plan s investment managers. It is critical that plan fiduciaries understand the nature and extent of any indirect compensation received by one or more of the plan s CSPs, as it will factor into both the reasonableness of the compensation and the impact of allocating plan expenses among plan participants, whose investments are the source of the indirect compensation. While you may already assist your clients in benchmarking fees in the CSP disclosures, it is perhaps even more important for fiduciaries to classify the services to determine whether the associated fees are properly paid from plan assets. You can help fiduciaries review CSP disclosures and identify the purpose of services provided (settlor v. non-settlor) and sources (plan assets or otherwise) of any compensation a CSP receives for each service. As discussed, a plan document might also prohibit payment of fees that would otherwise be acceptable. You should help plan fiduciaries review plan documents to ensure that even non-settlor expenses are properly paid from plan assets. The following Advisor Guide 3

The following fees typically are considered non-settlor and may be paid from plan assets: Recordkeeping fees Trustee fees Custodial fees Plan accounting fees Plan audit fees Plan actuarial service fees Reporting fees (Form 5500, etc.) Participant communication fees (SPDs, etc.) Participant education fees Legal fees (related to non-settlor functions, i.e., preparation of legally-required ongoing plan amendments) Investment management fees Plan fidelity bond fee Fees associated with IRS determination letter application Loan administration fees QDRO fees The following fees typically are considered settlor and cannot be paid from plan assets: Plan design or other fees associated with the establishment of the plan Plan termination fees Fees associated with discretionary plan amendments Audit CAP sanctions EPCRS/VCP compliance fee VFC correction fees Amendment of plan for a merger or spin-off activities will help you guide your clients as they analyze their arrangements with CSPs: Identify decision makers responsible for managing fee and expense policies Ensure decision makers are aware of their fiduciary responsibilities involving fee and expense decisions Assist plan fiduciaries gathering information relating to plan fees and expenses Use the plan expense worksheet to identify which fees and expenses are non-settlor expenses (plan expenses), and which are settlor expenses that must be paid by the sponsor Review plan documents to determine whether they prohibit the plan from paying certain fees and expenses 2 Strategize Examine Competing Interests of Plan Participants and Available Allocation Methods Non-settlor expenses may be allocated in a variety of ways among plan participants. However, ERISA requires plan sponsors to follow the terms of a plan document to the extent they are consistent with applicable laws and regulations. If the plan document is silent on how the plan is to pay administrative costs, then fiduciaries have considerable discretion in determining how expenses are allocated among participants and beneficiaries. 4 The DOL Field Assistance Bulletin 2003-03 requires fiduciaries to make such determinations prudently, and through a process that weighs the competing interests of diverse classes of a plan s participants, as well as the effects of various allocation methods on those interests. The method selected must be reasonable, and fiduciaries should be prepared to demonstrate the decision was made solely in the interest of participants. 5 The following are typical ways to allocate plan expenses: Pro rata Under this method, fees are allocated according to the size of a participant s account, in relation to the plan s total assets. The larger the account, the greater the fee. Investment management fees are often based on this method. Per capita Fees are spread out equally among all participants. Fees from third-party administrators are often charged per participant. Hybrid method Fees are allocated using a combined pro rata and per capita approach and are paid through both an assetbased fee and a service-based fee. The fee will increase both as the assets grow and as new participants are added to the plan, presumably compensating the provider for the additional work. Individual charges Certain fees are charged to an individual s account for a specific service (i.e., loan fees, QDRO fees, annual account maintenance charges, etc.). Only those who receive a specific service are charged. 4 Advisor Guide

PERA If a plan s recordkeeper permits this type of account, it can collect revenue sharing payments from the various funds and then use them to offset other plan expenses. Any balance remaining at the end of the year can be allocated to participants accounts. Administration of this type of account can be more complex. But differing fees from a variety of sources can be received without creating a conflict of interest because all participants benefit equally from the payments. According to the DOL, while a pro rata method of allocating expenses among individual accounts would appear in most cases to be an equitable allocation of expenses among participants, a per capita method of allocating expenses among individual accounts may also provide a reasonable approach to allocating certain fixed, administrative expenses of a plan, such as recordkeeping, legal, auditing, annual reporting, claims processing, etc. As discussed, recordkeepers are increasingly offering PERAs to provide fiduciaries with more flexibility in the way a plan pays its service providers. Ultimately, the method used might be based upon the recordkeeper s capabilities and limitations, but it should reflect the fiduciaries determination about fairness and who should bear the expense. Fee Equalization Revenue sharing equalization is an alternative to capturing excess revenue from a plan s investments in a PERA. For years, it has been a common practice for CSPs to receive indirect compensation or revenue sharing payments from mutual fund investment managers based upon the share class and operating expenses of the fund. One perceived shortcoming of the revenue sharing model is that plan participants, who are invested in funds that pay a higher revenue share, can wind up paying disproportionately more of the plan s administrative costs than participants who invest in funds that pay less or no revenue sharing. Recently, plan sponsors and providers have been looking at ways to address this imbalance by distributing administrative expenses more proportionately among a plan s participants. Some recordkeepers now offer fee equalization capabilities that track revenue sharing payments on a participant-by-participant basis. For example, if the plan s recordkeeper prices their services at 40 basis points (bps), the plan can return any revenue sharing amounts paid by participants in excess of 40 bps and charge participants, who are invested in funds that pay less than 40 bps, the difference between the amounts they paid and the 40 bps needed to pay for the recordkeeping services. As an alternative to equalizing revenue sharing payments at the fund level, some plan sponsors are charging participants a flat dollar amount or an equal percent of their account balances to pay for the plan s administrative expenses. Others are replacing revenue sharing funds with lower cost or zero revenue sharing funds and using a pro rata method for charging the expenses back to participants accounts based on a percentage of their account balance. Today, most providers can accommodate fee leveling in some capacity. However, timing the application of revenue sharing credits can vary among providers. Some of the options available are: Daily accrual and daily credit Daily accrual collected at year-end Monthly accrual and monthly credit to participant accounts Quarterly accrual and quarterly credit to participant accounts While plan sponsors may not have a legal obligation to equalize fees, if they elect to do so, there are a number of important issues to consider. 6 For example, if fiduciaries elect to pay expenses on a per capita basis, they must consider the size of their participants accounts because in some cases it may increase the cost for participants with small account balances to a potentially discriminatory degree. Additionally, equalization reimbursements or deductions are typically disclosed as a flat dollar amount on participants quarterly account statements, whereas revenue sharing is disclosed as a percentage on the annual 404(a) disclosures and is not required to be disclosed quarterly or in hard dollars. If a plan is considering a policy that equalizes revenue sharing, it may be prudent to revisit participant education and communications to proactively address any questions that participants raise. When evaluating the impact of allocating fees and administrative expenses, you may want to present various scenarios to help plan fiduciaries understand the impact of adopting one or more of the above-referenced allocation methods on various classes of plan participants, based upon the capabilities of the plan s current recordkeeper. If the fiduciaries adopt a method outside of what the recordkeeper can support, then you may want to help evaluate alternatives. At a minimum, there are two important classifications of participants: highly compensated employees (HCEs); and non-highly compensated employees (NHCEs). When considering the fairness of one method of allocating expenses over another, you should pay particular attention to features and arrangements that may favor the plan s HCEs over its NHCEs. For example, HCEs tend to hold a large percentage of company stock or utilize brokerage or mutual fund windows, versus investing in designated or qualified investment alternatives. If the plan relies upon revenue sharing to pay for all or some of the plan s administrative expenses, then HCEs may unreasonably benefit to the extent their investments do not contribute at the same levels or at all to those expenses. Advisor Guide 5

If a plan is considering fee equalization, you should clarify that plan sponsors are not legally required to equalize administrative fees charged to or deducted from participant accounts and that equalization may result in operational challenges and added costs. You might consider offering to compare the net fund expense between the higher-revenue-paying funds and low-cost index funds, collective investment trusts (CITs), or zero-revenue funds, and pointing out that because a zero-revenue fund s expense ratio is lower than a revenue sharing fund does not necessarily mean it is the best value for the participants. It may be more advantageous to use a fund whose cost after revenue sharing is actually lower than a fund or CIT with no revenue sharing component. For example, let s assume the expense ratio for XYZ International Fund in the R5 share is 1.00% and the revenue-share payment to the recordkeeper is 0.20% for a net cost of 0.80%. The same fund in the no revenue R6 share is 0.85%. The recordkeeper requires 0.60%. In this case using the higherexpense R5 share class results in a net cost that is 5 bps lower than the zero revenue R6. Furthermore, you want to caution your clients that selecting fee equalization could add confusion and affect how plan participants select investments when there is a combination of revenue- and non-revenue-paying funds for them to choose. Additional communication and possibly higher costs may be necessary to educate employees on how fee equalization works to prevent them from making investment decisions on that basis alone. Also, the timing of when the revenue credits or additional fees are made could lead some participants to game the system and switch in and out of a fund to maximize reimbursement or avoid being charged a fee. The sample FPS includes an optional section with sample language for plan sponsors that choose fee equalization. We suggest they should also check with their provider to see if fee equalization is addressed in either the terms of the letter of engagement or recordkeeping services agreement. The following activities will help you guide your clients as they strategize about how to allocate the plan s expenses: Review plan documents to determine whether they prohibit certain fees and expenses being paid from the plan Investigate the capabilities and limitations of a plan s recordkeeper (e.g., tracking and/or capture of revenue sharing payments) Identify sources of revenue that may be allocated to pay expenses (e.g., 12b-1 and Sub-TA fees) Estimate potential revenue generated by HCEs vs. NHCEs Review the impact of discretionary actions (e.g., what could happen if the plan eliminated or reduced any matching contributions) Inquire with the recordkeeper about the timing for applying revenue sharing reimbursement and fees (e.g. daily, monthly, quarterly, or annually) Analyze cost to notify and educate employees of changes in allocating administrative costs of a plan Evaluate the costs/benefits to revenue sharing equalization versus other methods (e.g. flat dollar or using low or no revenue-share funds) Consider replacing funds with higher expenses with low or no revenue mutual funds or CITs Advise fiduciaries regarding their duty to monitor and reconcile expenses and the method for allocating expenses Help align the goals of fiduciaries with available resources Assist in documenting the methods evaluated and the basis for fiduciaries decisions 3 Formalize Develop a Fee Policy Statement that Aligns with the Chosen Strategy Once the fiduciaries understand the effect and availability of various methods for allocating plan expenses, they should document their decision to adopt one method over another. A FPS can serve this purpose and guide fiduciaries in monitoring plan expenses. You should consider using the plan expense worksheet to evaluate plan expenses and to review fiduciaries decisions regarding how expenses are allocated. Once reviewed, turn to the sample FPS that provides the framework for documenting the process going forward. The sample FPS is flexible and allows fiduciaries to customize it based on their unique needs and decisions made in steps 1 and 2. As for a plan s administrative costs, the sample FPS provides that expenses can be paid by one of the following methods: Exclusively by the company out of corporate assets By the company net of any credits received from the plan s CSPs Exclusively by the plan s participants. 6 Advisor Guide

To the extent any fees are paid by plan participants, the sample FPS provides for the following methods to allocate fees among participants: Pro rata Per capita Hybrid If a hybrid method is selected, the sample FPS allows fiduciaries to specify which fees will be allocated pro rata, per capita, or individually. The sample FPS also includes special policies for PERAs. Depending on the plan s available options, the sample FPS allows fiduciaries to specify the PERA type as: An unallocated account of the plan whereby funds held in the PERA are considered plan assets Through an account maintained by the recordkeeper on its books whereby the contract is between the plan and the recordkeeper If the account is maintained by the recordkeeper, the sample FPS allows the fiduciaries to specify whether the contract: Permits the plan to request unused funds be returned to it so that the amounts are considered plan assets Permits the recordkeeper to retain any unused funds so that the amounts are not considered plan assets When the amounts collected in the PERA exceed the costs of administering the plan, then the sample FPS allows the fiduciaries to indicate whether the unused funds will be refunded: Pro rata based on each participant s account value Per capita applied equally to all participants Individually based on the amounts contributed from investments held by each participant The following activities will help you guide your clients as they formalize the plan s FPS: Review plan documents to ensure they allow for fiduciaries preferred methods to allocate plan expenses Ensure fiduciaries have the time, inclination, and knowledge to properly implement and monitor the payments, credits, etc. relating to their chosen method for allocating plan expenses Investigate capabilities and limitations of the recordkeeper and ensure it can accommodate the fiduciaries chosen method Assist fiduciaries in completing the sample FPS Review the time horizon for managing certain fee and expense decisions (e.g., setting up a PERA before year-end) 4 Implement Implement Fee Policy Statement and Incorporate into Plan Documents Because ERISA requires fiduciaries to follow a plan document, it is imperative the FPS is properly implemented. While the sample FPS provides a mechanism for fiduciaries to adopt the completed FPS, it may not automatically become incorporated in the plan document. Additionally, other documents governing the management or administration of the plan (e.g., IPS) may have conflicting provisions regarding methods for allocating and paying plan expenses. To ensure the FPS is properly implemented, fiduciaries should consider engaging experienced ERISA counsel. In addition to helping fiduciaries understand how to use the sample FPS, you can also assist them in streamlining implementation by lending a hand with: Collecting plan documents and reviewing current policies Reviewing contract with recordkeeper regarding capabilities/ limitations for allocating expenses Summarizing the results of the fiduciaries considerations relative to steps 1-3 Preparing a plan for monitoring and reconciling payments for plan expenses Presenting a time horizon for managing certain fee and expense decisions Advisor Guide 7

5 Monitor Monitor Fees and Reconcile Payments As discussed, fiduciaries duties extend to determining whether a plan is operationally consistent with its terms and determining whether plan documents authorize each fee. These duties are ongoing: fiduciaries should continue to monitor whether any fees paid from plan assets are proper (e.g., they relate to non-settlor services), are appropriately accounted for, and any unused funds are credited in a manner consistent with the plan s policies. After the FPS is implemented, you should periodically help fiduciaries review custodial or brokerage statements to confirm that fees have been appropriately accounted for and credited. You may also recommend that fiduciaries revisit steps 1-4 regularly to ensure their decisions remain prudent and solely in the interests of participants and beneficiaries. To facilitate your role in monitoring fees and a plan s FPS, consider the following activities: Collect information from a plan s CSPs regarding the nature, amounts, and sources of plan expenses and payments Periodically reconcile a plan s actual fees and expenses to determine whether CSPs have been properly compensated, and that the compensation remains fair and reasonable for the services rendered Monitor payments to CSPs to ensure payments come from appropriate accounts Periodically assess the reasonableness of a plan s FPS with respect to changes in plan design, participant demographics, investment options, etc. Conclusion Fees and expenses associated with the management of qualified retirement plans have become a central issue with lawmakers, regulators, the courts, and in turn, the plan sponsor community. The plan sponsor has a fiduciary duty to control and account for plan expenses. Very few plans had defined investment policies over the last decade. But over time, the marketplace has evolved with the introduction of new plan designs, product enhancements, regulations, and service models and now the majority of plans use an IPS to guide fiduciaries decisions on the selection, monitoring, and/or replacement of investment options. If you aim to enhance your value proposition, consider assisting your clients in developing and maintaining a FPS. This will help you play a leadership role with decision makers. A proactive approach that goes beyond the benchmarks will help differentiate your services from competitors with both clients and prospects. 1 According to the DOL, The duty to act prudently is one of a fiduciary s central responsibilities under ERISA. It requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions. DOL, Meeting Your Fiduciary Responsibilities, available at: http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html. 2,3 See ERISA Section 404; see also, note iii; see also, Donovan v. Mazzola, 716 F.2d 1226 (9th Cir. 1983), and Leigh v. Engle, 727 F.2d 113 (7th Cir. 1984). Process is critical because fiduciaries are not judged by the results they obtain. They are not guarantors of results, but their performance is measured by the steps they have taken to arrive at well-informed decisions. 4 See DOL Field Assistance Bulletin 2003-03. 5 In this regard, a method of allocating expenses would not fail to be solely in the interest of participants merely because the selected method disfavors one class of participants, provided that a rational basis exists for the selected method. On the other hand, if a method of allocation has no reasonable relationship to the services furnished or available to an individual account, a case might be made that the fiduciary breached his fiduciary duties to act prudently and solely in the interest of participants in selecting the allocation method. Further, in the case where the fiduciary is also a plan participant, the selection of the method of allocation may raise issues under the prohibited transaction provisions of section 406 of ERISA where the benefit to the fiduciary is more than merely incidental. For example, if in anticipation of the plan fiduciary s own divorce, the fiduciary who is also a plan participant decides to change the allocation of expenses related to a determination of whether a domestic relations order constitutes a qualified order from the account incurring the expense to the plan as a whole, such change in allocation by the fiduciary could constitute an act of self-dealing under section 406 of ERISA. 6 See, e.g., DOL Field Assistance Bulletin 2006-1. 2014 Thornburg Investment Management, Inc. This material was developed with the assistance of the law firm of Retirement Law Group, PC and Pension Resource Institute, LLC (PRI) and is provided solely for educational purposes and is not intended to confer any investment, tax or legal advice. PRI G-MAP Compatible. This material is not for distribution to plan participants. Thornburg Funds are distributed by Thornburg Securities Corporation. 5/2/14 2300 North Ridgetop Road Santa Fe, New Mexico 87506 877.215.1330 TH2952