The Department of Labor (DOL) recently released its final fee disclosure regulation, 29 C.F.R. 2550.404a-5. The regulation is the third issuance in the DOL's ongoing effort to improve clarity with respect to fees and expenses incurred by employee benefit plans. The release also modifies existing regulations under Internal Revenue Code (Code) Section 404(c) to conform those rules to the newly adopted regulation. In general, the new regulation requires detailed advance disclosures as well as regular updates on actual expenses to participants in employee benefit plans that provide participants with investment discretion (generally 401(k) and 403(b) plans). The new regulation outlines, in detail, notice content as well as the form and timing of disclosures. The new rule takes effect for plan years beginning after November 1, 2011 — thus, January 1, 2012 for most participants.
The new regulation requires two types of disclosures: disclosures related to the plan itself and disclosures related to investment options within the plan.
Information that must be disclosed about the plan is broken into three categories: general information, administrative expenses, and individual expenses. The regulation includes extensive detail on what must be included in each section, but in general, the following must be included:
General information that must be disclosed includes: (1) an explanation as to when participants and beneficiaries may give investment instructions, (2) an explanation of any specific limits on investment instructions, including transfers between investment options, (3) a description of or reference to plan provisions relating to voting, tender, and similar rights for investment options, (4) identification of the "designated investment alternatives" available under the plan, (5) identification of any investment managers, and (6) a description of a brokerage window or similar arrangement, if any.
Information about plan administrative expenses (e.g., legal, accounting, recordkeeping, and so forth) that may be charged to a participant's account must be disclosed as well as how such charges will be allocated (e.g., pro rata or per capita). In addition to the annual disclosure, actual administrative expenses, including a description of the actual expense, must be disclosed to participants quarterly. For plans with revenue-sharing arrangements that might make overall administrative expenses appear lower than they may actually be, the disclosure must include explicit language noting the existence of a revenue-sharing arrangement.
Information about expenses that result from individual actions that may be charged to a participant's account (e.g., plan loans, qualified domestic relations orders, investment advice, and so forth) must also be disclosed. As is required for administrative expenses, actual individual expenses must be disclosed at least quarterly along with a description of the actual individual expense.
Disclosure Timing and Updating
In addition to the quarterly updates required for administrative and individual expenses, appropriate notices must be disclosed on or before the date a participant can direct his or her investments and at least annually thereafter. Disclosures may be provided in an SPD or pension benefits statement, but only if those documents are provided on a schedule that meets the disclosure regulation's annual timing requirement. In addition to the obligation to provide an annual disclosure (as well as the quarterly updates for administrative and individual expenses described above), a plan must keep its participants abreast of any changes to the plan-related information. Updates must be provided at least 90 days, but no more than 30 days before a change becomes effective. There is a reasonableness exception to the 90/30 day window for events that could not be anticipated (e.g., the need to quickly change an investment option under the plan).
A few items that practitioners and benefits professionals should be aware of include:
- The updating requirement is not subject to a materiality exception. That is, the DOL believes that any change in plan or expense information is, in general, material.
- Unlike other disclosure requirements that may be waived for plans with few participants or small total balances, the new regulation applies to all plans, regardless of size.
- The new regulation makes clear that these rules, which are premised on ERISA fiduciary duty obligations, apply to the plan administrator (and not all fiduciaries as was in the proposed rule). Plan administrators may, however, reasonably rely on information provided by service providers and investment issuers in making the disclosures.
- Notices must be distributed to all eligible employees (not just those already participating in the plan). This requirement makes sense given that the purpose of the information is to help participants choose whether to participate in the plan as well as to choose and monitor specific investment selections.
The new regulation requires that certain information be disclosed automatically (to all eligible participants), other information be disclosed only subsequent to a participant's actual investment, and finally, other information be disclosed only upon participant request. As with plan-related disclosures, the regulation includes explicit detail about the disclosure content.
The new regulation requires that certain investment-related information be disclosed automatically (i.e., regardless of whether a participant invests in the product). Because of the extremely varied nature of investment products available to employee benefit plans today, and the related difficulty of effectively comparing such products, the regulation requires that the automatic disclosures be made in the form of a comparative chart. The chart must prominently display the name of the plan administrator, the date of the information provided, as well as a statement that more current information is available at a listed Web site. While any chart can be used, the new regulation includes a model chart that, if used, will constitute compliance with the new regulation.
Automatic information required to be disclosed includes: (1) identifying information for the investment product (e.g., name and type of investment); (2) investment product performance data with fixed-return products disclosing the fixed rate of return and the term of the investment and investment products without a fixed rate of return disclosing the average annual return, if available, for the most recent one-year, five-year, and 10-year periods; (3) relevant benchmarks that must be broad based and not related to investment product provider; (4) fee and expense information, including shareholder-type fees (in other words, fees billed directly against a participant's investment such as sales loads), total annual operating expenses expressed as a percentage with a specific requirement that an example of the total annual operating expense ratio be given using a hypothetical $1000 investment, as well as a requirement that specific statements on the impact of fees on performance be included; (5) a Web site for obtaining additional information that, among other things, must include information on a description of the investment's goals and objectives, principle strategies and attendant risks, portfolio turnover rates (i.e., how frequently the investment product buys and sells securities), and quarterly performance updates, among other things; and (6) a glossary of terms to assist participants in understanding the investment alternatives or a Web site that provides such a glossary. There also are special rules for employer stock fund and annuity investment alternatives.
Information that must be disclosed subsequent to a participant's investment includes any materials provided to the plan relating to the exercise of voting, tender, and similar rights that pass through to the plan participant. Upon request, a participant must be provided various governing documents (e.g., prospectus, financial statements, or reports).
Disclosure Timing and Updating
As with plan-related information described above, investment-related disclosures must be made on or before the date a participant can direct his or her investments and at least annually thereafter. Also, the same updating requirements apply for changes in investment related information.
A few notes that practitioners and benefits professionals should be aware of include:
- Disclosures made pursuant to the new regulation may be made using existing distribution methods. This, of course, includes electronic media. However, in the preamble to the new regulation, the DOL notes its interest in elaborating on electronic disclosures at some future date. It is possible that we will see more lenient electronic distribution rules under the new regulation, but for now plan administrators should undertake interim compliance with existing ERISA distribution methods.
- Plan administrators are free to provide additional information so long as it is not misleading. For example, this may include development of more appropriate benchmarks for investment alternatives composed of blended securities.
- With respect to investment-related disclosures, we expect there to be a great deal of discussion between plan administrators and investment alternative issuers and/or service providers. While the regulation clearly places responsibility for compliance on the plan administrator, much of the information will come from other sources. For example, who will maintain a Web site for bank collective investment funds, insurance products, employer stock funds, or other investment alternatives that do not already maintain a dedicated Web site? Reviewing your plan's current investment alternatives and plan communication calendar against the new disclosure regulation's detailed requirements will give you a sense of where you should start asking for support from investment alternative issuers and/or your service providers.
While the new disclosure regulations will not become effective for most plans until January 2012, compliance with the new regulation will be a large undertaking. We recommend that plan administrators start a dialogue with service providers soon and develop a detailed timeline to work toward compliance. Finally, note that while the new regulation is perhaps the largest undertaking with respect to plan fees and expenses to date, it is not likely the last word on the topic. The DOL has indicated that it is working on its next piece of the fee disclosure puzzle — guidance with respect to individual benefit statements.