Tax-qualified retirement plan fee disclosure has received significant recent attention from the media and the government. In fact, three different bills relating to 401(k) tax-qualified retirement plan fees have been introduced in Congress this year; namely, the 401(k) Fair Disclosure for Retirement Security Act of 2009 ("the Fair Disclosure Act"), the Defined Contribution Plan Fee Transparency Act of 2009 (the "Fee Transparency Act") and the Defined Contribution Fee Disclosure Act of 2009 (the "Fee Disclosure Act"). Each of these Acts is designed to assist plan participants in selecting cost-efficient investment options and, thus, each would impose new reporting and disclosure requirements, including new disclosures from service providers to plan sponsors and from plan sponsors to plan participants. (Of the three Acts, the Fair Disclosure Act seems to have the most momentum, so this article will focus its discussion primarily upon it.) In addition, the United States Department of Labor ("DOL") issued proposed regulations in December 2007 and July 2008 that would govern disclosures by tax-qualified retirement plan sponsors.
Plan Sponsor's Obligations
Employers who provide benefits to their employees under a tax-qualified retirement plan are required to operate such plans for the exclusive purpose of providing benefits to participants and defraying reasonable expenses of administering the plan. This requires plan sponsors to ensure that any fees paid with plan assets are reasonable. Notably, within the past couple of years, the plaintiff's bar has initiated countless lawsuits aimed at plan sponsors alleging breaches of fiduciary duty related to plan fees. A number of these lawsuits have alleged that plan sponsors overpaid for services from service providers. In light of these fiduciary requirements, the general inability of plan sponsors to receive detailed information on investment fees and the resulting wave of fee-based lawsuits, the requirement that service providers provide information under the fee disclosure legislation and/or regulations would seemingly improve the ability of plan fiduciaries to meet their fiduciary duty to ensure that fees paid with plan assets are reasonable. However, such legislation and/or regulations would also impose additional compliance obligations on plan fiduciaries and would potentially subject them to financial penalties and increased liability exposure in the event of non-compliance.
Summary of Key Provisions of the Acts
Plan Sponsor Disclosures
Under each of the Acts, tax-qualified retirement plan sponsors must issue periodic statements showing all retirement plan fees displayed as a total and allocated among fee categories, as well as detailed participant account balance and investment performance information.
Under the Fair Disclosure Act, plan sponsors would have to provide a disclosure statement to participants within a reasonable period prior to (a) the earliest date under the plan for a participant's initial investment and (b) the effective date of any material change in investment options. With respect to the issue of what constitutes a "reasonable period," the Secretary of the Treasury is directed to issue regulations defining certain safe harbor periods of not less than 10 days, but plans with immediate eligibility or automatic enrollment would have to provide the disclosure statement before the first investment of contributions. In addition to the enrollment disclosure rules, quarterly disclosure statements would have to be provided to plan participants and would be required to include certain key information for each investment option elected, such as any fees in connection with the option, a history of returns, net of fees and expenses, and a fee comparison chart disclosing fees by category. The quarterly disclosure statement must also explain that investment options should not be selected on the basis of fees.
Under the Fee Transparency Act, plan sponsors would have to provide plan participants with two separate disclosures regarding plan investments and fees; a disclosure statement at the time of enrollment and quarterly disclosure statements. Such disclosure statements would be required to contain detailed participant level information about each participant's investment performance under the plan and the fees applicable to such participant's accounts. The disclosure statement to be provided at the time of enrollment must inform the recipient of each plan investment alternative, along with its annual operating fees, whether such fees pay for services beyond investment management (such as plan administration), and whether there are additional charges for buying or selling the particular alternative (such as redemption fees). (Notably, the disclosure statement to be provided at the time of enrollment would need to be provided to all plan participants annually as well.) The quarterly disclosure statements must inform participants about the fees associated with the investments they have selected, including the operating expenses for each investment alternative, any sales charges for the alternatives selected, any separate charges for plan administration and any deductions for participant-initiated services (e.g., fees on plan loans taken against a participant's account balance). The quarterly disclosure statement must also tell participants how to obtain further information regarding fees for investment alternatives in which they are not invested, in order to assist them in deciding whether to make investment changes.
The Fee Transparency Act and the Fee Disclosure Act include a penalty provision whereby failing to provide the requisite disclosure statements to plan participants carries a $100 a day per failure per participant penalty. The Fee Transparency Act provides that the maximum annual exposure is capped at the lesser of $500,000 or 10% of the assets of the Plan, but the Fair Disclosure Act does not include such a cap.
Service Provider Disclosures
Under each of the Acts, services providers must provide detailed information about proposed fees and service offerings to plan administrators in advance of entering into a contract for plan services. Specifically, service providers must give the employer an estimate of total fees, a detailed and itemized list of all the services to be provided under the contact, and a schedule of any transaction charges that participants may face. Service providers would have to update disclosure statements reflecting such fee information annually and within a reasonable period prior to any material modification of the contract. Employers would be required to make these disclosure statements available to plan participants. Under the Fair Disclosure Act, service providers would not have to disclose fees reasonably expected in a plan year to be less than $5,000.
Under each of the Acts, service providers are required to disclose any financial or personal relationship with the plan, the sponsor of the plan or any other service provider to the plan and must disclose any amounts that will be paid to or from other third-parties in connection with the provision of services to the plan.
Under the Fee Transparency Act, service providers that fail to provide statements disclosing their fees to plan administrators would face a penalty of $1,000 a day per failure, with annual exposure capped at the lesser of $1,000,000 or 10% of the assets in the plan. Under the Fair Disclosure Act, service providers face a similar penalty of $1,000 per day, per plan, subject to a maximum penalty of 10% of the amount involved.
Under each of the Acts, retirement plan fees, to the extent they are required to be disclosed, must be categorized as investment management, administration and record-keeping, transaction-based (Fair Disclosure Act only), sales charges (Fee Disclosure Act and Fee Transparency Act only) or other. Total charges must be presented in the written disclosure statements in aggregate total dollar amount, as well as on a category basis.
Under the Fair Disclosure Act and the Fee Disclosure Act, the disclosure of retirement plan fees must be "unbundled" (i.e., set forth individually by service, as opposed to aggregated and disclosed as a single fee by service provider for all services performed) and allocated among four fee categories, which would require all service providers to break out "free" or discounted bundled services. Under the Fee Transparency Act, fees must be allocated between the investment management and administration and record-keeping fee categories.
Index Fund Requirement
Under the Fair Disclosure Act, in order to qualify for fiduciary liability protection under Section 404(c) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), tax-qualified retirement plan sponsors must offer a broad-based securities market index fund as an investment alternative to plan participants. Seemingly, the rationale underlying the inclusion of this provision of the Fair Disclosure Act is that index funds are a relatively low-fee investment option that participants will be able to utilize. Neither of the other two Acts contain this requirement and, it is our understanding that this proposal has received a lot of negative feedback from the service provider community. In our experience, however, index funds are a very common investment alternative utilized by plan sponsors, such that the "requirement" to add one should not place any additional burdens on most plan sponsors.
All of the Acts provide limited fiduciary protection for tax-qualified retirement plan sponsors that receive incomplete or erroneous information from service providers. However, the retirement plan community is seeking further protections, such as a broader ability to rely on the information provided by service providers and protections from lawsuits if the fees disclosed in participant notices contain negligible errors.
Department of Labor Audit
The Fair Disclosure Act would direct the Department of Labor to annually audit a sample of plans to check for compliance with the Fair Disclosure Act's disclosure requirements and to impose penalties for violations.
Department of Labor Regulations
In addition to the three Acts summarized above, the United States Department of Labor ("DOL") issued proposed regulations in December 2007 and July 2008 that would govern disclosures of plan fees by service providers to tax-qualified retirement plan sponsors and by such sponsors to plan participants, respectively.
Generally speaking, the proposed regulations would require certain plan service providers to disclose, in writing to the plan fiduciary who engages them, the services that are to be provided to the plan, the direct and indirect compensation related to the services to be provided by the service provider and any conflicts of interest that could adversely affect the service provider's performance under the service contract (which, for these purposes, are defined quite broadly), if any. Where fee information must be disclosed, the level of detail is quite significant. In general, the proposed regulations accommodate alternative means of providing the required fee disclosure information (including electronic) and, where actual amounts are not available, estimates may be used. The proposed regulations also include an obligation upon the service providers to update the applicable written disclosures on a timely basis. Notably, unlike the Acts, which require all providers to break out "free" or discounted bundled services, the proposed regulations would require disclosure of only the gross price of the bundled services.
Under the proposed regulations, if the service provider contract fails to require disclosure of the requisite information, or if the service provider fails to disclose such information, the services will not be considered "reasonable" and provision of the services will not qualify for relief from ERISA's so-called "prohibited transaction" rules. In this regard, a resulting prohibited transaction could have negative consequences for both the service provider and the plan fiduciary who hires the service provider, although the proposed regulations do include relief for a plan fiduciary when, unbeknownst to the plan fiduciary, a service provider fails to comply with the disclosure requirements.
With respect to disclosures to plan participants, the proposed regulations require disclosure of fee information to each plan participant on or before the date of eligibility and at least annually thereafter. In addition, a plan's expenses must be disclosed quarterly to each participant, which disclosure must specify the fees charged to such participant's plan account in the previous quarter and include a description of each type of fee, such as redemption fees, surrender charges, sales loads and expense fees. As with the service provider disclosure rules, failure to disclose requisite information to plan participants could result in the services not being considered "reasonable," which could result in a violation of ERISA's prohibited transaction rules by the plan fiduciary failing to make adequate disclosure.
Notably, the Department of Labor has recently indicated that it intends to finalize its fee disclosure regulations by the early part of 2010.
Although it is uncertain whether any of the Acts will be enacted into law and/or the DOL Regulations will be finalized, and legislative commentators have indicated that they do not expect any final plan fee rules to be enacted in 2009, it seems likely that plan fee legislation and/or regulation is likely to become a reality at some point in the near future. Because of the increased duties and obligations such rules would place on plan fiduciaries and plan sponsors, and the related potential for increased liability exposure to the extent a plan fiduciary fails to act on information provided to it by service providers, White & Case LLP will continue to monitor the progress of these proposed fee disclosure requirements.