Since at least 2006, the U.S. Department of Labor (DOL) has had fee disclosure on its mind. Now DOL is done worrying about making the rules — at least for the time being — and is shifting all the worries to retirement plan providers and plan fiduciaries. After several years of proposed rules and regulations, comments, final rules, interim final regulations and more comments, the Department of Labor has completed its three-part masterpiece on the disclosure of retirement plan fees and expenses.
Part 1 of the fee disclosure triptych focused on government reporting, using Schedule C of each plan's Form 5500 annual report. Those enhanced reporting requirements became generally effective in 2009.
After some delays, Parts 2 and 3 are ready for market in 2012. Part 2 governs provider-level disclosure — disclosures by covered service providers to retirement plan fiduciaries. These regulations, the 408(b)(2) regulations, become effective on July 1, 2012, for new and existing service arrangements.
Part 3, which controls plan-level disclosure — fee (and other investment-related) disclosures by plan fiduciaries to participants who direct their retirement plan investments — generally goes effective 60 days later, on August 30, 2012.
To date, service providers have carried most of the load, studying the new fee-disclosure rules and preparing their own disclosure forms, but that is beginning to change. Retirement plan fiduciaries are starting to receive fee disclosures from their service providers, and in their capacity as plan fiduciaries, they have their own legal duties to review and understand the disclosures, object to those that don't comply, take the disclosures into account as they evaluate providers, and possibly replace providers. And once that Part 2 process is complete, the plan fiduciaries must turn to Part 3, ensuring that their plan participants also receive appropriate disclosures about fees and other investment-related information.
To assist plan fiduciaries in carrying out their fee disclosure duties, we are compiling, and responding to, a running list of questions as our clients ask them. We encourage you to review the list as it develops and to submit your own questions about how to comply with these duties that have real legal and financial significance.
Q – Which of our plans do we need to worry about?
A – The service provider fee disclosure regulations under ERISA § 408(b)(2) apply to "covered plans." Covered plans include your retirement plans, such as defined benefit plans, as well as 401(k) plans, profit sharing plans, money purchase plans and 403(b) plans, unless an exemption applies. If you sponsor SEP IRAs, SIMPLE IRAs or previously sponsored certain orphaned 403(b) plans, those plans are exempt from the 408(b)(2) disclosure requirements. In addition, if you sponsor pension plans that are not subject to Title I of ERISA, such as governmental plans, non-electing church plans or plans covering only a self-employed person and his/her spouse, those plans are exempt from these regulations as well.
Note that the participant fee disclosure regulations only apply if you sponsor participant-directed individual account plans, such as 401(k) plans. We'll discuss the participant fee disclosure regulations in future "frequently asked questions."
Q – Are our welfare plans covered by these rules?
A – Welfare plans are not covered by the current ERISA § 408(b)(2) regulations. However, the Department of Labor is also concerned about fee-transparency for welfare plans. The DOL has held public hearings about welfare plan disclosures and reserved a section in the 408(b)(2) regulations for future welfare plan disclosure requirements.
Q – So what? Why should I care about the service provider fee disclosure requirements?
A – Because you want to avoid claims that you have caused the plan to engage in a prohibited transaction. This comes about as follows:
A service provider is a "party in interest" for purposes of the ERISA prohibited transaction rules, which means that a service relationship between a plan and a service provider is a prohibited transaction unless an applicable exemption is available. ERISA § 408(b)(2) provides an exemption if the service 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. DOL regulations clarify each of these conditions to the exemption. Compliance with the new disclosure requirements are among the conditions for a service arrangement to be reasonable.
In the DOL's view, if all of the requirements of the regulation are not satisfied, and if no other statutory or administrative exemption applies, the fiduciary responsible for causing the plan to enter the relationship will have caused the plan to engage in a prohibited transaction. ERISA § 406(a)(1) imposes a duty on each fiduciary not to cause the plan to engage in a prohibited transaction. Under ERISA § 409, the fiduciary may be held liable to make good any losses to the plan resulting from the violation and may be subject to such other equitable or remedial relief as a court may deem appropriate, including removal of the fiduciary.
In a case where the fiduciary has not followed all of the technical requirements of the regulations, but where the fiduciary can establish that the plan did not pay more than reasonable compensation for the services, it is not clear what liability a court might impose on the fiduciary (because arguably there were no losses to the plan as a result of the prohibited transaction). Precedent from past court decisions is mixed. But even if no liability is imposed, the time and expense of defending against such claims can be significant.
It appears that the fiduciary causing the transaction would not be subject to excise taxes under Internal Revenue Code § 4975, which imposes an excise tax on "disqualified persons" engaging in a prohibited transaction under rules similar to the ERISA prohibited transaction rules. Under Code § 4975(a), those excise taxes would be imposed on the service provider, and not the "fiduciary acting as such."
Employers should also keep in mind that the plan administrator will need some of the information required to be disclosed by service providers in order to prepare the participant disclosures required under the 404a-5 regulations.
Finally, criminal penalties (including fines and imprisonment) can be imposed under ERISA § 501 upon conviction for willful violation of ERISA. Although it has rarely occurred in this context, the DOL could initiate criminal proceedings if a fiduciary blatantly disregards ERISA requirements.
Q – Who should we expect to receive disclosures from?
A – That depends on who you hired to service your plans and how those providers are paid. The ERISA § 408(b)(2) disclosure requirements apply only to "covered service providers." This would include, for example, a plan's investment advisor, certain investment managers and the plan's recordkeeper. Services providers that provide other enumerated services for indirect compensation — that is, compensation from sources other than the plan or plan sponsor — are also covered service providers. The threshold for the disclosure requirements is if the covered service provider reasonably expects to receive at least $1,000 in compensation over the life of a contract or arrangement with a covered plan.
Q – When do our covered service providers need to provide the disclosures to us?
A – July 1, 2012. The deadline for providing the initial disclosures for existing contracts or arrangements is July 1, 2012. For contracts entered into after July 1, 2012, the initial disclosure must be provided reasonably in advance of when the contract is entered into, extended or renewed.
Q – Do the disclosures have to be in a particular form?
A – No particular form is required, but the disclosures must be in writing. Your provider may reference your existing documents or existing disclosures. Further, the DOL provided a model "guide" to cross-reference existing documents. Existing documents may include your provider contracts, and existing disclosures may include your investment advisor's Form ADV.
Q – How do we know that our providers have given us everything they need to?
A – You, or your legal counsel, should review the disclosures received and compare them to the disclosure requirements. If you conclude that additional information is required, you may want to make a written request of your provider. Your provider should deliver requested information required by 408(b)(2) within 90 days of the request and generally provide additional information generally reasonably in advance of your disclosure deadline.
Q – We are really busy right now, can we wait to review the disclosures?
A – The DOL hasn't set a deadline by which you must review the disclosures, but you should do so as expeditiously as possible after you receive the disclosures from your service providers and within a time frame that would be considered prudent for an experienced fiduciary under similar circumstances. Remember, the requirement to have reasonable contracts in place with your service providers isn't new; the new disclosure requirements are intended to help you make sure that your contracts are reasonable. The disclosures could bring to light new information that makes you re-evaluate your current arrangements. Accordingly, you or your legal counsel should review the disclosures promptly after you receive them to make sure the information matches what you know about the arrangements and to address any inconsistencies, discrepancies or missing pieces.
Q – We don't understand a service provider's disclosure and we have questions, now what?
A – It's very important that you understand the information that you receive from each service provider. The first step in most cases will be to reach out directly to the service provider that gave you the disclosure and ask questions about the portions you don't understand. You may want to document the questions that you have and the process that you are taking to get the questions answered. Depending on the questions that you have, you may also want to involve your legal counsel.