The United States Department of Labor (the “DOL”) has been active recently in adopting new reporting and disclosures requirements for service providers to employee benefit plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). The broad purpose of these requirements is to allow plan sponsors to review and monitor plan fees and expenses by increasing transparency. Another objective is to inform plan sponsors of indirect or nonmonetary compensation received by service providers in connection with services provided to plans that may not have been previously disclosed or clearly disclosed. This article is intended to provide a highlevel summary of the requirements applicable to the managers of private equity funds.1 Specifically, we discuss two of the DOL’s recently issued reporting and disclosure initiatives likely to affect private equity funds and managers:2 (i) the Form 5500 Schedule C and (ii) the “service provider” disclosure regulations (or, in ERISA-speak, the “Section 408(b)(2)” regulations).
Form 5500 Schedule C
Form 5500 is the annual report filed with the DOL, the Internal Revenue Service and the Pension Benefit Guaranty Corporation by employee benefit plans. The newly revised Schedule C became effective for the 2009 plan year, which means that the first newly revised Schedule C’s were generally filed in the fall of 2010.
Since many plan sponsors are currently preparing to file the 2010 Form 5500, now would be an opportune time to review the requirements.
Schedule C requires that plans disclose all direct and indirect compensation, including both monetary and non-monetary compensation, paid to service providers that received compensation for services to the plan in excess of $5,000 for the plan year. If a service provider to a plan fails to provide the plan with the necessary information, the plan must identify that non-compliant service provider on Schedule C.
Of particular interest to private equity fund managers, Schedule C also requires disclosure of compensation paid to a service provider by a fund in which an ERISA plan is invested. So, for example, if an investment manager receives its management fee and/ or performance allocation from a fund, those amounts must be included on the plan’s Schedule C, even though the compensation was not paid by the plan directly, but rather by the fund. Schedule C is a publicly available document.
There is an exception to this reporting requirement, however, for funds that qualify as venture capital operating companies (“VCOCs”) or real estate operating companies (“REOCs”). As a result, a management fee paid to an investment manager by a VCOC or REOC need not be reported on a plan investor’s Schedule C while one paid by a fund that is owned less than 25% by “benefit plan investors” would need to be reported on the Schedule C. Neither fund would be a “plan assets” fund, yet one would be subject to the Schedule C reporting and the other would not.17 Thus, managers structuring new funds may wish to consider the benefits of avoiding the Schedule C disclosure obligations when weighing the pros and cons of VCOC/REOC status versus the 25% limit.
For private equity funds that rely on the 25% limit (or, less commonly, private equity funds that are plan assets funds), the Schedule C rules allow for an abbreviated form of reporting when the only compensation the manager receives for services to the plan is “eligible indirect compensation.” Eligible indirect compensation is fees and expenses charged to the fund and reflected in the value of the investment or return on investment of the investing plan. For example, a management fee or performance allocation charged to the fund and reflected in the value of the plan’s interest in the fund would be eligible indirect compensation. If that is the only compensation that the manager receives in connection with services provided to the plan, then the actual amounts of the indirect compensation need not be disclosed on Schedule C. Rather, only the identity of the party providing the eligible indirect compensation disclosure to the plan must be disclosed.
A service provider relying on the shorter form of reporting for eligible indirect compensation must make certain general disclosures to the plan, including a description of the services provided for the indirect compensation and a description of the amount (or the formula used to determine the amount) of the indirect compensation. Many managers find that the fund’s offering memorandum already includes the information required to be disclosed for this purpose.
Service Provider Regulations
More recently, the DOL has issued regulations that govern what information plan service providers must disclose to plan fiduciaries. These rules are also sometimes referred to as the “408(b)(2)” regulations, referring to the section of ERISA that allows plans to pay reasonable compensation for services. These rules are currently in “interim final” form and expected to be finalized in the near future in advance of an April 1, 2012 effective date. Failure to make the required disclosures would be a “prohibited transaction” under ERISA, resulting in excise taxes and other adverse consequences to the service provider.
Similar to the Schedule C rules, the 408(b)(2) regulations require service provides to disclose to plan fiduciaries the direct and indirect compensation received for services provided to a plan, as well as other information. Among the differences from the Schedule C requirements is that the reporting is made to the plan fiduciary, rather than the government, and is a one-time disclosure that must be updated only when the information changes, rather than annually. Additionally, a service provider to a fund that is not a plan assets fund, regardless of why it is not a “plan assets” fund, is not subject to these disclosure requirements.
“Of particular interest to private equity fund managers, Schedule C also requires disclosure of compensation paid to a service provider by a fund in which an ERISA plan is invested.”
Thus, the manager of a private equity fund that is a VCOC, REOC or below the 25% limit need not be concerned with these regulations in connection with the fund. If, however, the fund is a plan assets fund, then the manager would be required to disclose to the plan fiduciary not only its direct and indirect compensation for services provided to the plan, but also information about the annual operating expenses of the fund.
Investment managers who manage private equity portfolios for plans (such as a “manager of managers”) would be subject to these rules because they would provide fiduciary services directly to the plan.
Understanding the reporting and disclosure requirements will benefit private equity managers both with respect to their own ERISA compliance efforts and with respect to meeting the needs of their ERISA clients. As disclosure has become an increasing focus of the DOL, it can be expected to be an increasing focus of plan sponsors as well. We would be happy to assist with any ERISA reporting and disclosures questions or issues.