five years in the making, the Department of Labor (DOL) has published
its long-awaited plan sponsor fee disclosure regulations under ERISA
section 408(b)(2). With these new regulations taking effect on July 1,
2012, plan sponsors and service providers alike will be scrambling to
Why is Fee Disclosure such a Big Deal?
The Employee Retirement Income Security Act (ERISA) is one of the
main federal laws that govern the operation of employer-sponsored
retirement plans. Among the many topics it covers, ERISA sets forth
the rules that apply to plan fiduciaries. Generally speaking, plan
fiduciaries include those who have discretion over the administration
or assets of a plan as well as those who provide investment advice to
a plan for a fee. Since its passage in 1974, ERISA has included a
requirement that a plan can only pay reasonable fees for required
services such as recordkeeping, compliance or government reporting. If
a plan pays fees that are not reasonable, such payments are prohibited
transactions subject to penalties by the DOL and IRS.
While this requirement may seem, well… reasonable, service
providers have not been legally obligated to disclose their
compensation. That was not as much of a challenge in 1974 when the
predominant type of retirement plan was the defined benefit plan.
However, as the retirement plan world shifted from defined benefit to
defined contribution daily-valued, participant-directed 401(k), the
platforms and financial products became more sophisticated and
complex. Service providers began receiving compensation via expenses
built into plan investments rather than by directly billing plan
sponsors. Some providers began marketing their services as no- or
low-cost since their fees were being subsidized by the investments
rather than being billed to the plan or the plan sponsor.
Having a plan automatically pay to operate itself might be
convenient, but it may result in plan fiduciaries who are unable to
dissect complex fee structures to determine how much each service
provider is being paid. If fiduciaries do not know the amount of the
fees, there is no way they can determine whether those fees are
reasonable. With fee structures differing from provider to provider,
it has also become difficult for fiduciaries to compare the fees and
services of multiple vendors to determine which offers the best value.
What is the Solution?
Recognizing this growing disconnect, the DOL embarked on a
three-pronged initiative to help ensure that fiduciaries have access
to information they need to fulfill the reasonableness requirement.
First is the expanded fee reporting on Form 5500, Schedule C, which
was effective for plan years beginning in 2009 and is generally
required for plans with more than 100 participants. The second prong
is the required disclosure to plan participants at various times
throughout the year.
Third is the requirement for service providers to disclose fee and
service information to plan sponsors. Regulations implementing this
requirement were first proposed in December 2007. After being revoked,
re-proposed and semi-finalized, the sponsor-level fee disclosure
regulations were finalized in February of this year.
Are all Service Providers Required to Comply?
The short answer is "No." The regulations coin a new term "Covered
Service Provider" (CSP) to describe those subject to the rules. CSPs
fall into three general categories:
Registered Investment Advisors and other fiduciary advisors;
Those who provide a plan investment platform; and
Service providers who receive indirect compensation, e.g.
revenue sharing, commissions, etc.
These might seem straightforward, but the devil is in the details.
Let's consider several examples to help clarify.
The first category clearly indicates that Registered Investment
Advisors and other fiduciary advisors are CSPs. But, what about those
who are non-fiduciary brokers? Such individuals do not fit into the
first category; however, since they typically receive commissions,
they are CSPs under the third category.
This group seems relatively clear-cut. Any vendor, regardless of
how it is compensated, that provides the investment platform to a
participant-directed, defined contribution plan is a CSP. However,
there are some nuances. Assume an investment professional provides the
investment platform and partners with a separate firm who provides
recordkeeping. In this case, the investment professional, not the
recordkeeper, is likely the platform provider; therefore, the
recordkeeper would probably not be a category 2 CSP. However, since
most recordkeepers receive revenue sharing payments, they will
typically be category 3 CSPs.
Third Party Administrators
TPAs cannot be classified as a group because their services and
compensation arrangements can vary widely. Consider a TPA that
provides annual compliance testing and government reporting services
but does not provide recordkeeping. If all fees are paid by the plan
sponsor or directly from the plan, that TPA is not a CSP and is not
subject to the new fee disclosure requirements. This is due to the
fact that all fees are being paid directly and are, presumably,
However, assume that the same firm regularly partners with an
insurance company for recordkeeping services. The insurance company
pays the TPA a marketing allowance based on the combined assets of all
mutual clients. That marketing allowance is indirect compensation,
making the TPA a category 3 CSP.
Whether other providers are CSPs depends largely on how they are
compensated. Attorneys and accountants generally will not be CSPs
since their typical compensation structures do not include indirect
compensation. The regulations require that the fees paid to affiliates
or subcontractors of a CSP must also be disclosed, so it is important
to consider the relationships service providers may have with other
companies. Since those affiliates often have no direct relationship
with the plan, the CSP must include their compensation with its
Regardless of the category, a service provider must have a
reasonable expectation that its fees will be $1,000 or more under the
life of its contract with the plan in order for it to be a CSP.
What must be Disclosed?
There is quite a list of information a CSP must provide to a
covered plan. It is all designed to help plan fiduciaries understand
the fees being paid and the services to which they relate. In
addition, full disclosure of all compensation will help highlight any
potential conflicts of interest in the recommendations that service
providers make to their clients.
Who: The CSP must identify itself
and, if applicable, provide a written statement that it will provide
services as a fiduciary or a Registered Investment Advisor.
What: The CSP must identify the
services it provides to a plan under the contract or arrangement.
How: The CSP must describe how it
will receive each category of compensation. For example, some fees may
be directly billed to the plan, while others may be deducted from
investment returns or paid via revenue sharing.
How Much: The CSP must report all
direct and indirect compensation paid to itself and/or any affiliates
and should include anything of monetary value, e.g. gifts, trips, etc.
The fees should be tied to the services to which they relate, and for
indirect compensation, the payer must also be identified. If
recordkeeping is part of a bundle of services and the CSP is unable to
determine the portion of total compensation related to that service,
the CSP must provide a reasonable, good-faith estimate or use the
prevailing market rate for similar services. If there are any fees
related to the termination of the agreement, the CSP must disclose
those in addition to providing a description of how any pre-paid
amounts will be pro-rated and refunded.
In addition to the above, fiduciary CSPs are required to provide
general information about the investment options offered under the
plan, including expense ratios, wrap fees, historical rates of return,
comparisons to benchmarks, etc.
When must the Information be Disclosed?
The goal of the regulations is to ensure plan fiduciaries have the
information to determine if a service provider's fees are reasonable
in advance of making the hiring decision. If a plan has already hired
a service provider that is a CSP, the CSP must provide the initial
disclosures no later than July 1, 2012. For all future arrangements,
the CSP must disclose "reasonably in advance of the date the contract
is entered into, extended or renewed." The inclusion of the words
"extended or renewed" can present a trap for the unwary. It is not
uncommon for a contract to expire (after one or two plan years) and
automatically renew each year thereafter. In those instances, the
disclosures must be provided each year prior to the renewal date.
In many situations, the investment menu is not determined until
after the contract is signed. How can the CSP provide all the
investment disclosures in advance? If this circumstance occurs, the
investment information must be provided no later than 30 days after
the CSP knows which platform, funds, etc., will be used.
When any of the previously disclosed information changes, the CSP
must communicate those changes as soon as possible but no later than
60 days after becoming aware of the change.
What are the Consequences of
The DOL has made compliance an integral part of the reasonable fee
requirement; therefore, if there is no disclosure, the fees are
automatically deemed unreasonable. That means there is a prohibited
transaction. The non-disclosing CSP is subject to an excise tax equal
to 15% of the amount involved and may be required to unwind the
arrangement by returning the fees collected.
Prohibited transaction penalties usually apply to all parties
involved, which means the plan representative making the hiring
decision (the responsible plan fiduciary) may also be on the hook.
However, the regulations provide some relief if the responsible plan
fiduciary did not know the CSP was non-compliant and, immediately upon
discovering the failure, made a written request to the CSP for the
required disclosures. If the CSP does not respond to the request
within 90 days, in order to avoid liability for the prohibited
transaction, the responsible plan fiduciary must notify the DOL in
writing of the CSP's failure and may be required to fire the CSP.
When are the New Rules Effective?
The service provider fee disclosure rules are effective on July 1,
2012. In addition, since the participant-level fee disclosure rules
are so closely linked, their effective date has also been pushed back
to July 1st. For existing service provider arrangements, plan sponsors
should expect to receive the required disclosure information no later
than that date. The initial annual participant disclosure is due
August 30, 2012 (60 days after the effective date) and the initial
quarterly participant disclosure is due November 14, 2012 (45 days
after the close of the first quarter after the effective date).
It will be interesting to see how these new rules unfold. But one
thing is for sure… plan sponsors and participants will not have any
shortage of reading material by the end of this year.
This newsletter is intended to provide general
information on matters of interest in the area of qualified retirement
plans and is distributed with the understanding that the publisher and
distributor are not rendering legal, tax or other professional advice.
Readers should not act or rely on any information in this newsletter
without first seeking the advice of an independent tax advisor such as
an attorney or CPA.