ederated The New Fee Disclosure Rules: What You Need to Do About 408(b)(2)
What You Need to Do About 408(b)(2) Are You Ready? On April 1, 2012, the rules governing every 401(k) and every private pension plan in the United States are going to change. The primary service providers to these plans trustees, advisors, investment managers, recordkeepers and others must provide new fee disclosures to their plan clients, or else their contracts will no longer be reasonable arrangements exempted from ERISA s prohibited transaction rules. Are you ready? Though the Department of Labor (DOL) likely will make some additional changes to these rules, this publication is intended to help you get started by summarizing the basic points of the Interim Final rules, including why DOL issued them, who has to comply, and what needs to be disclosed. While this summary can t take the place of legal advice to ensure compliance with these rules, it can help service providers and plans start thinking about what they need to do. I hope you will find this publication useful as you prepare for the new disclosure requirements, and thank you for all you do to provide for the benefit security of America s workers. Bradford P. Campbell is a nationally recognized figure in employer-sponsored retirement, health and other welfare benefit plans. From 2006 to 2009, he served as the Assistant Secretary of Labor for Employee Benefits, the head of the Employee Benefits Security Administration (EBSA). In this position, he was responsible for overseeing privatesector employee benefit plans covering more than 150 million Americans and holding as much as $6 trillion in assets. As ERISA s former top cop and primary federal regulator, Mr. Campbell provides his clients at Schiff Hardin LLP with insight and knowledge across a broad range of ERISA-plan-related issues. Mr. Campbell held a number of other senior positions in the government, including Deputy Assistant Secretary of Labor for Employee Benefits, Senior Legislative Officer for the Department of Labor, and Senior Legislative Assistant for then-congressman, later SEC Chairman, Christopher Cox. He received his JD, cum laude, from Georgetown, and his AB from Harvard.
Why Did DOL Issue New Fee Disclosure Rules? Under the Employee Retirement Income Security Act (ERISA), a plan fiduciary must engage in a prudent process when selecting service providers to ensure that the plan is paying only reasonable compensation for necessary services. The law does NOT require the plan to select the cheapest service provider (cost is only one of the relevant factors), but it does require the plan fiduciary to have gathered the information necessary to understand all of the compensation the service provider will receive in connection with the plan s business. Some plan fiduciaries expressed concern to the Labor Department that they could not get the information they needed to carry out this duty, primarily because not all service providers clearly identified whether third parties were also paying them or how much revenue they received from third parties. Examples of these indirect payments from third parties include finder s fees, 12b-1 fees, soft dollars, and similar arrangements. The new regulation is intended to make sure plan service providers disclose this fee information before they are hired, making it easier for plan fiduciaries to compare service providers and to comply with their fiduciary duty. What is 408(b)(2) and What Does it Have to Do with Fee Disclosure? To protect participants from having their retirement savings misused, ERISA s prohibited transaction provisions prohibit plans from engaging in a broad range of transactions with parties in interest except when an exemption from these rules applies. These rules are very broad by design, and technically would prohibit most plan service provider agreements because service providers are parties in interest under the law. However, ERISA 408(b)(2) provides an exemption for service providers from the prohibited transaction rules, the exemption for reasonable services. What DOL is doing in the new regulation is adding an additional condition to the exemption for reasonable services the disclosure of fees by service providers. By structuring the regulation this way, a failure to provide the disclosures gives rise to a prohibited transaction, triggering an automatic excise tax under the Internal Revenue Code. 1
Which Service Providers Must Comply with the New 408(b)(2) Disclosures? The new rules apply to certain service providers to covered plans. Covered plans include defined contribution plans such as 401(k)s and ERISA-covered 403(b)s and defined benefit pension plans, but do not include SEPs, SIMPLEs, IRAs, or welfare benefit plans. Unlike the disclosures required in the Form 5500 Schedule C, which are generally completed only by plans with 100 or more participants, the 408(b)(2) disclosures apply to all covered plans regardless of size. The covered service providers who must comply are those reasonably expecting to receive $1,000 or more in total compensation (directly from the plan and/or indirectly from third parties) in connection with the plan and who are: ERISA fiduciaries Registered Investment Advisors Recordkeepers or brokers who make available one or more of the plan s designated investment options (such as by offering a platform) Non-fiduciary service providers in the following areas IF they receive indirect compensation accounting, auditing, actuarial, appraisal, banking, investment consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation. DOL purposefully limited the application of the new 408(b)(2) regulation to those covered service providers that are dealing directly with the plan. Therefore, the affiliates or subcontractors of a covered service provider are not separately subject to the disclosure rules themselves instead, the covered service provider must disclose the compensation it and its affiliates and subcontractors will receive. What Must Be Disclosed? Covered service providers will need to provide the following information to plans reasonably in advance of their service arrangement: A description of the services to be provided Whether the service provider will be an ERISA fiduciary or an RIA A description of the direct payments the service provider (and its affiliates and subcontractors) expect to receive from the plan A description of the indirect payments the service provider (and its affiliates and subcontractors) expect to receive in connection with the arrangement, who will pay the indirect compensation, and for which services it will be received 2
A description of any compensation exchanged among related parties (such as within a bundled services arrangement) that is transaction-based or charged against a plan s investment and reflected in its net value A description of any compensation expected to be received in connection with termination of the service agreement A description of how the service provider will receive its compensation. DOL also inserted into the regulation a provision that service providers must provide to the plan within 30 days of its request any compensation information necessary for the plan to comply with its reporting and disclosure obligations (Form 5500, etc.). In addition to these general disclosures, certain service providers must also provide additional information: Recordkeepers or brokers that make investment options available (such as through a platform) must also provide information about the fees and expenses of each investment option, including: o The annual operating expenses (such as the expense ratio) if the return is not fixed o Amounts charged against the investment due to the sale, transfer or withdrawal from the investment (such as sales loads, redemption fees, surrender charges, exchange fees, etc.) o Other ongoing fees such as wrap or mortality fees Recordkeepers must disclose their fees for recordkeeping services as a specific line item if the actual amount can t be determined, recordkeepers can disclose a good-faith estimate along with the assumptions and methodology used to produce the estimate ERISA fiduciaries to investment options that hold plan assets must also provide information about the fees and expenses of the investment option. Service providers must inform plans of changes to this information within 60 days of the change. Under the Interim Final rule, the information does not have to be provided in a single document the disclosures can be provided via multiple sources. (Please note, however, that DOL is considering changing this provision. See Will DOL Make Any Changes in the Final Regulation? on the following page.) The disclosures must be made for all existing arrangements by April 1, 2012, as well as for all future arrangements. 3
What Does This Mean for Plan Sponsors and Service Providers? Plan sponsors and service providers will both need to change their existing processes to ensure the appropriate disclosures have been requested and received. This will require significant changes for some service providers, particularly recordkeepers and brokers offering investment platforms. The degree of compliance complexity will depend in part on the type of compensation arrangements each service provider has. Service providers responsible for providing investment option fee information to the plan may comply by passing on materials containing the required information prepared by the investment issuer (such as a prospectus) as long as the investment issuer is not an affiliate of the service provider and the materials are regulated by a state or federal agency. DOL allows service providers to correct an inadvertent error before a prohibited transaction is deemed to have occurred covered service providers have 30 days to correct good faith errors or omissions from the time they become aware of the error. DOL also provides a means for a plan fiduciary to avoid a prohibited transaction for a failure by the service provider to make the required disclosures. If the plan fiduciary discovers a disclosure failure on the part of the service provider, the plan fiduciary must request the missing information in writing, and if no answer is received in 90 days, the plan fiduciary must notify DOL. The plan fiduciary must then decide whether to terminate the service provider. Will DOL Make Any Changes in the Final Regulation? DOL issued the 408(b)(2) regulation as an Interim Final regulation. This means that if DOL does nothing else, the new rules described above will apply on April 1, 2012. However, DOL officials say they will issue a final regulation in September or October 2011 that will make a number of changes to the Interim Final regulation. This complicates service provider compliance efforts, because though it is likely the bulk of the rule will be the same, we do anticipate some material changes. Based on the comments DOL received on the Interim Final regulation, it appears that the most significant issue that could change is whether service providers must give plan fiduciaries a summary disclosure. The Interim Final rule allows the disclosures to be provided in a variety of documents, but some comments suggested that DOL s goal of assisting plan fiduciaries would be best served if fiduciaries received as least an index showing where to find the relevant disclosure information among those documents. If DOL adds a summary disclosure requirement, this will increase the burden on service providers, though we won t know the extent of the burden until the details of the requirement are published in the final regulation. 4
Getting Ready Despite the possibility of some change to the rules described above, service providers and plan fiduciaries are well-advised to begin seeking legal counsel to ensure their compliance. The good news for many service providers is that those following best practices likely already collect and disclose much of the relevant data, making it easier to comply. Getting started early to take the necessary steps will make compliance much easier for service providers and plans alike.
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