On July 16, 2010, the Department of Labor’s Employee Benefits Security Administration (EBSA) issued interim final regulations that require initial information disclosures to be made by certain service providers to plan fiduciaries. The primary purpose of these final regulations is to assist plan fiduciaries in fulfilling their responsibility of assessing the reasonableness of the compensation paid for services and any potential conflicts of interest that may affect the service provider’s performance of service. The final regulations will become effective on July 16, 2011. In the interim, EBSA has requested that any public comments on the regulations be submitted in writing by August 30, 2010.

In general, ERISA §406(a)(1) prohibits a fiduciary from causing a plan to engage in a transaction between the plan and a “party in interest.” Specifically, a fiduciary is prohibited from causing a plan to engage in a transaction that constitutes a direct or indirect furnishing of goods, services or facilities between the plan and a “party in interest.” Transactions prohibited under ERISA §406(a)(1) are commonly referred to as Prohibited Transactions. A “party in interest” as to an employee benefit plan includes a person providing services to such plan. Based on this definition of “party in interest,” a transaction between a plan and a person providing services to such plan involving the furnishing of goods, services or facilities is considered a prohibited transaction unless such transaction qualifies for an exemption provided under ERISA §408. ERISA §408(b)(2) specifically exempts from classification as a prohibited transaction an arrangement between plans and service providers where: (1) the contract or arrangement is reasonable, (2) the services are necessary for the plan’s establishment or operation, and (3) no more than reasonable compensation is paid for the services.

The prior regulations issued by EBSA under ERISA §408(b)(2) provided that a contract or arrangement was reasonable, if it permitted the plan to terminate the contract or arrangement without penalty and with reasonably short notice. The new interim final regulations impose more stringent information disclosure requirements whereby covered service providers must provide specified information to a “responsible plan fiduciary” for certain plans. If the required information disclosures are not made by the service provider, the contract or arrangement will fail to be reasonable, and thus, will not be exempt from the prohibited transaction rules.

The interim final regulations apply only to “covered plans,” which include pension plans but not SEPs, SIMPLE plans or IRAs (or welfare plans). Although EBSA excluded welfare plans from these interim final regulations, it indicated, in its preamble to the regulations, that it plans to issue a comprehensive disclosure framework for “reasonable” service contracts or arrangements to welfare plans. Accordingly, the issued interim final regulations reserve a section for welfare plan disclosure. However, even without regulations for welfare plan disclosure, ERISA §404(a) obligates fiduciaries of welfare plans to obtain and consider information relating to the cost of plan services and potential conflicts of interest presented by such service arrangements.  

A “covered service provider” under the final regulations is a service provider that enters into a contract or arrangement with the covered plan and reasonably expects to receive $1,000 or more in compensation, directly or indirectly, in exchange for providing certain services. Specifically, covered service providers include those who:

  1. provide services as an ERISA fiduciary or as a registered investment adviser;  
  2. provide recordkeeping services or brokerage services to a covered plan that is an individual account plan and permits participants to direct the investment of their accounts, if one or more designated investment alternatives will be made available in connection with such recordkeeping services or brokerage services; and  
  3. provide specified services to the covered plan and reasonably expect to receive “indirect” compensation or certain payments from related parties.  

A person or entity, however, is not a covered service provider solely by providing services:

  1. as an affiliate or a subcontractor performing one or more services as a fiduciary or registered investment adviser, certain recordkeeping or brokerage services or other services for indirect compensation under the contract or arrangement with the covered plan, or  
  2. to an investment contract, product or entity in which the covered plan invests other than services as a fiduciary.  

The interim final regulations require a covered service provider submit to the plan fiduciary the requisite initial disclosure information in writing. These final regulations, however, do not set out a particular manner or format for which the initial disclosures must be made by the covered service providers. Unlike the proposed regulations issued by the Department of Labor on December 13, 2007, the interim final regulations do not require that any formal contract or arrangement itself be in writing or that any representations concerning the specific obligations of the covered service provider be included in a written contract or arrangement. Based on the preamble to the interim final regulations, EBSA has tentatively adopted this flexible approach because it was persuaded that, given the varying relationships between plans and their service providers, requiring formal contracts or arrangements in every instance may result in unnecessary burdens, complexity and costs. However, should it be convinced that the benefits of formal contracts and arrangements outweigh the costs, the final regulations may be revised to require covered service providers to furnish a “summary” disclosure statement that provides an overview of the requisite information.

The interim final regulations currently require a covered service provider to submit the following initial disclosure information to the plan fiduciary:

  • A description of the services to be provided to the covered plan, other than non-fiduciary services;  
  • A statement that the covered service providers, affiliates and subcontractors will provide, or reasonably expect to provide, services pursuant to the contract or arrangement directly to the covered plan as a fiduciary or registered investment adviser;  
  • A description of all direct (either in the aggregate or by service) and indirect compensation;  
  • If applicable, a description of any compensation that will be paid among the covered service provider, an affiliate and/or a subcontractor, in connection with services, if on a transaction basis (e.g., 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;  
  • A description of any compensation in connection with the termination of a contract or arrangement;  
  • In the case of covered service providers providing recordkeeping services:  
  1. A description of all direct and indirect compensation expected to be received in connection with recordkeeping services, and  
  2. A statement of whether the covered service provider reasonably expects recordkeeping services to be provided without explicit compensation, or whether compensation for recordkeeping services is offset or rebated based on other compensation received,  
  • A description of the manner in which compensation will be received, and  
  • In the case of fiduciaries for investment vehicles holding plan assets, a description of:  
  1. Any compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer or withdrawal from the investment contract, etc.,  
  2. The annual operating expenses if the return is not fixed, and  
  3. Any ongoing expenses in addition to annual operating expenses.  

The initial disclosure information must be provided by the covered service provider to the plan fiduciary within a reasonable period of time before the contract or arrangement is entered into, extended or renewed. Any changes to the initially disclosed information must be submitted to the responsible plan fiduciary as soon as practicable, but in no event later than 60 days from the date the covered service provider is informed of such changes. In addition to providing the requisite initial disclosure information, covered service providers are required to provide, upon request by the plan fiduciary or plan administrator, any other information required for the covered plan to comply with the reporting and disclosure requirements of Title I of ERISA and its regulations. Notwithstanding the disclosure requirements imposed by the interim final regulations, 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 required information so long as the covered service provider discloses the correct information to the responsible plan fiduciary no later than 30 days from the date on which such service provider knows of the error or omission.