Introduction

On February 11, 2011, the Department of Labor (DOL) announced that the applicability date for the new service provider fee disclosure rules would be extended to January 1, 2012. Once applicable, covered service providers will be required to make specific fee disclosures to retirement plan fiduciaries in order to qualify for the prohibited transaction exemption for reasonable services under Section 408(b)(2) of the Employee Retirement Income Security Act of 1974 (ERISA), as amended.

General

On July 16, 2010, the DOL published an interim final regulation (the “Regulation”) under Section 408(b)(2) of ERISA requiring covered service providers of ERISA retirement plans to make specific fee disclosures in order to assist the fiduciaries of such plans in understanding the reasonableness of the fees being charged for plan services and assessing potential conflicts of interest that might affect the quality of those services. Compliance with the disclosure requirements of the Regulation is necessary in order to qualify for the prohibited transaction exemption under Section 408(b)(2) of ERISA (and the parallel provisions of Section 4975 of the Internal Revenue Code) for service contracts and arrangements between a plan and a party in interest. In general, such contracts and arrangements are exempt under Section 408(b)(2) of ERISA if the contract or arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable compensation is paid for the services. Under the Regulation, no service contract or arrangement with a covered service provider will be considered “reasonable” unless the new disclosure requirements are satisfied.

Extended Applicability Date; No “Grandfather Relief”

The new disclosure requirements apply to all covered service contracts and arrangements in existence on or after January 1, 2012. The Regulation was originally scheduled to become effective on July 16, 2011. This date was extended, however, to provide the DOL with additional time to evaluate comments received on the interim final regulation and to ensure that plans and service providers have sufficient time to undertake orderly and efficient compliance efforts following the publication of final rules.

The Regulation does not contain “grandfather relief” for service contracts or arrangements entered into prior to January 1, 2012. Therefore, the new disclosure requirements for pre-existing contracts and arrangements must be satisfied no later than January 1, 2012.

Covered Plans

The Regulation applies only to defined contribution plans (including 401(k) plans) and defined benefit pension plans. Health and welfare benefit plans, individual retirement accounts (IRAs) and annuities, simplified employee pensions (SEPs) and simple retirement accounts are excluded from coverage (although the DOL is considering the adoption of separate fee disclosure rules for welfare benefits plans).

Covered Service Providers A “covered service provider” is any service provider that enters into a contract or arrangement with a covered plan and reasonably expects to receive at least $1,000 in direct or indirect compensation in connection with providing one or more of the following types of services (regardless of whether the services will be performed by, or the compensation is received by, the covered service provider or an affiliate or subcontractor of the covered service provider):

  • Service as a Fiduciary of a Covered Plan. Services provided directly to a covered plan as an ERISA fiduciary.  
  • Service as a Fiduciary to a “First Tier” Plan Asset Vehicle in Which a Covered Plan Has a Direct Equity Investment. Services provided as an ERISA fiduciary with respect to an investment contract, product or entity that holds plan assets and in which a covered plan has a “direct equity investment.” A “direct equity investment” does not include the underlying investments made by an investment contract, product or entity that holds plan assets. Thus, for this purpose, the Regulation does not “look through” to “second tier” investments that hold plan assets.
    • For example, if the managers of a hedge fund or private equity fund are ERISA fiduciaries because the fund is an ERISA plan asset vehicle and a covered plan has a direct equity investment in the fund, the managers would be covered service providers. By contrast, if that same fund invested in another fund (i.e., a “fund of funds” investment), the managers of the second fund would not be a covered service provider with respect to a covered plan that has a direct equity investment in the first fund (assuming the plan does not also have a direct equity investment in the second fund), regardless of whether the managers of the second fund are ERISA fiduciaries.  
  • Service as a Registered Investment Adviser to a Covered Plan. Services provided directly to a covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any state law.  
  • Recordkeeping or Brokerage Services Involving Participant-Directed Plans to Which Investment Alternatives are Made Available. Recordkeeping services or brokerage services provided to an individual account plan (such as a 401(k) plan) that permit participants or beneficiaries to direct the investment of their accounts, if one or more designated investment alternatives will be made available (e.g., through a platform or similar mechanism) in connection with such recordkeeping services or brokerage services. Brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants and beneficiaries to select investments beyond those specifically designated are not designated investment alternatives.
    • For example, a broker that makes available, as part of its contract or arrangement, a menu of specific proprietary or nonproprietary mutual funds into which participants may direct the investment of their individual plan accounts would be a covered service provider.  
  • Certain Other Services for Indirect Compensation. Accounting, auditing, actuarial, appraisal, banking, consulting (i.e., consulting related to the development or implementation of investment policies or objectives, or the selection or monitoring of service providers or plan investments), custodial, insurance, investment advisory (for plan or participants), legal, recordkeeping, securities or other investment brokerage, thirdparty administration, or valuation services provided to the covered plan, for which the covered service provider, an affiliate or a subcontractor reasonably expects to receive indirect compensation or payments from related parties.

Importantly, no person or entity will be considered a covered service provider under the Regulation solely by reason of providing services, other than fiduciary services, with respect to an investment contract, product or entity in which a covered plan invests, regardless of whether the contract, product or entity holds plan assets. Thus, a record keeper servicing a collective investment fund is not a covered service provider to a plan investing in the fund merely because the fund holds plan assets.

In addition, the Regulation makes clear that an affiliate or a subcontractor that performs services under a contract or arrangement between a covered service provider and a covered plan is not a covered service provider.

Initial Disclosure Requirements

A covered service provider must disclose the following information1 to a responsible plan fiduciary (i.e., a fiduciary with authority to cause the covered plan to enter into, or extend or renew, a service contract or arrangement) in writing:

  • Description of Services. A description of the services to be provided pursuant to the contract or arrangement.  
  • Status. If applicable, a statement that the covered service provider, an affiliate or subcontractor will provide, or expects to provide, pursuant to the contract or arrangement: (i) services as a fiduciary, either directly to a covered plan or to an investment contract, product or entity holding plan assets, and in which the covered plan has a direct equity investment; or (ii) services directly to a covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any state law.  
  • Compensation.
    • Direct Compensation. A description of all direct compensation, either in the aggregate or by service, that the covered service provider, an affiliate or a subcontractor reasonably expects to receive from the covered plan in connection with the services.  
    • Indirect Compensation. A description of all indirect compensation that the covered service provider, an affiliate or a subcontractor reasonably expects to receive in connection with the services, including identification of the services for which the indirect compensation will be received and the payer of the indirect compensation. Indirect compensation is defined as compensation received from any source other than the covered plan, the plan sponsor, the covered service provider, an affiliate or a subcontractor (if the subcontractor receives the compensation for services performed under the contract or arrangement). For example, a covered service provider that provides multiple services to a covered plan pursuant to a “bundled” service arrangement would be required to disclose any compensation received from third parties in connection with the services.  
    • Related Party Compensation. A description of any compensation that will be paid among the covered service provider, an affiliate or a subcontractor in connection with the services if it is set on a transaction basis (e.g., commissions, soft dollars, finder’s fees or other similar incentive compensation based on business placed or retained) or is charged directly against the covered plan’s investment and reflected in the net value of the investment (e.g., rule 12b-1 fees), including identification of the services for which the compensation will be paid and the payers and recipients of such compensation.  
  • Termination Payments. A description of any compensation that the covered service provider, an affiliate or a subcontractor reasonably expects to receive in connection with termination of the contract or arrangement and how any prepaid amounts will be calculated and refunded upon such termination.  
  • Recordkeeping Services. If recordkeeping services will be provided to the covered plan:
    • A description of all direct and indirect compensation that the covered service provider, an affiliate or a subcontractor reasonably expects to receive in connection with such recordkeeping services; and  
    • If the covered service provider reasonably expects recordkeeping services to be provided, in whole or in part, without explicit compensation for such recordkeeping services, or when compensation for recordkeeping services is offset or rebated based on other compensation received by the covered service provider, an affiliate or a subcontractor, a reasonable and good faith estimate of the cost to the covered plan of such recordkeeping services, including an explanation of the methodology and assumptions used to prepare the estimate and a detailed explanation of the recordkeeping services that will be provided to the covered plan.2  
  • Manner of Receipt. A description of the manner in which the compensation will be received, such as whether the covered plan will be billed or the compensation will be deducted directly from the covered plan’s account(s) or investments.

Additional Investment Disclosures

Fiduciary Services to a Plan Asset Vehicle in Which a Covered Plan Has a Direct Equity Investment. A covered service provider that provides fiduciary services with respect to an investment contract, product or entity that holds plan assets and in which a covered plan has a direct equity interest is required to disclose the following additional information with respect to such contract, product or entity:

  • A description of any compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer of or withdrawal from the investment contract, product or entity (e.g., sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees and purchase fees);
  • If the return is not fixed, a description of the annual operating expenses (e.g., expense ratio); and  
  • A description of any ongoing expenses in addition to annual operating expenses (e.g., wrap fees, mortality and expense fees).  

Recordkeeping and Brokerage Services. A covered service provider that provides recordkeeping or brokerage services to a participant-directed individual account plan is required to disclose the additional information listed in the preceding paragraph with respect to each designated investment alternative for which recordkeeping services or brokerage services will be provided. This requirement may be satisfied by providing current disclosure materials of the issuer of the designated investment alternative that include the information described in such paragraph, as long as the issuer is not an affiliate, the disclosure materials are regulated by a state or federal agency, and the covered service provider does not know that the materials are incomplete or inaccurate.

Timing of Disclosure

A covered service provider is generally required to make the disclosures required by the Regulation to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into, extended or renewed. As noted above, for contracts or arrangements entered into prior to January 1, 2012, the required disclosures must be made no later than January 1, 2012. Changes to such information generally must be disclosed as soon as practicable, but not more than sixty days after the date on which the covered service provider is informed of such change.

In addition, upon request of a responsible plan fiduciary or a covered plan administrator, a covered service provider must furnish (generally, within thirty days) any other information relating to the compensation received in connection with the contract or arrangement that is required for the covered plan to comply with the reporting and disclosure requirements of Title I of ERISA.

Disclosure Errors

No contract or arrangement will fail to be reasonable solely because the covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the information required by the Regulation, provided that the covered service provider discloses the correct information to the responsible plan fiduciary as soon as practicable, but not later than thirty days from the date on which the covered service provider knows of such error or omission.

Class Exemption for Responsible Plan Fiduciary

The Regulation contains a final class exemption that provides prohibited transaction relief for responsible plan fiduciaries where a covered service provider fails to disclose information required by the Regulation and the applicable fiduciary did not know of such failure and reasonably believed that the covered service provider satisfied the disclosure requirement. This relief is subject to the following conditions:

  • The responsible plan fiduciary, upon discovering that the covered service provider failed to disclose the required information, requests in writing that the covered service provider furnish such information; and  
  • If the covered service provider fails to comply with such written request within ninety days, the responsible plan fiduciary notifies the DOL of the covered service provider’s failure in accordance with the notice procedures set forth in the Regulation.  

The class exemption does not, however, provide prohibited transaction relief to covered service providers for disclosure failures. Accordingly, a covered service provider’s failure to comply with the Regulation will result in excise tax exposure under Section 4975 of the Internal Revenue Code.

Action Items

Notwithstanding the extended applicability date of the Regulation, plan fiduciaries and covered service providers should be taking steps to ensure that the disclosure requirements will be satisfied with respect to all their service contracts and arrangements by January 1, 2012. Action items include (i) identifying covered plans and covered service providers, (ii) determining the types of covered services provided, (iii) updating existing and/or developing new disclosures, and (iv) monitoring any changes in the Regulation adopted by the DOL. In addition, plan fiduciaries should seek confirmation from their covered service providers that all required disclosures will be made by the January 1, 2012 deadline.

Conclusion

The Regulation requires covered service providers to provide detailed fee disclosures to retirement plan fiduciaries in order to qualify for the prohibited transaction exemption for reasonable services under Section 408(b)(2) ERISA. Both plan fiduciaries and covered service providers should take appropriate action to ensure that all required disclosures will be made with respect to their plan service contracts and arrangements.