The U.S. Department of Labor (“DOL”) has adopted two regulations that add significant new disclosure requirements that affect the operation of plans subject to the Employee Retirement Income Security Act (“ERISA”). The first regulation (the “Service Provider Regulation”) requires certain persons or entities that provide services to retirement plans subject to ERISA (“Plans”) to disclose to relevant Plan fiduciaries information regarding (among other things) the compensation they receive in connection with those services. The second regulation (the “Participant Disclosure Regulation”) applies to Plans that permit participants to direct investments and requires that specific disclosures be made to participants concerning Plan expenses and various aspects of the designated investment alternatives under the Plan.
The Service Provider Regulation becomes effective July 1, 2012. The Participant Disclosure Regulation will require action by Plans no later than August 30, 2012 (in cases where the plan year is the calendar year). Sponsors, administrators and other fiduciaries of Plans (“Plan Fiduciaries”) will need to take steps to monitor compliance with the Service Provider Regulation and (if applicable) to ensure that the disclosures required by the Participant Disclosure Regulation are made.
These two regulations are detailed and complex. This Employee Benefits Update provides only a general overview that highlights many of the key provisions of the regulations.
Service Provider Regulation
The Service Provider Regulation generally applies to ERISA Plans that provide deferred compensation or retirement income (including defined benefit pension plans and defined contribution retirement plans (e.g., 401(k) plans)); however, individual retirement accounts, certain types of “SIMPLE” plans and accounts, and certain frozen Section 403(b) annuity contracts and custodial accounts are not subject to the regulation. The Service Provider Regulation also does not apply to ERISA health plans or other welfare benefit plans.
This regulation relates to an ERISA exemption which states that it is not a “prohibited transaction” for a Plan service provider to receive compensation so long as both the compensation received by the service provider and the arrangement between the service provider and the Plan are reasonable. The regulation essentially provides that arrangements between Plans and certain service providers will not be considered “reasonable” – and will not qualify for the exemption – unless the service provider discloses to the relevant Plan Fiduciaries specified information regarding its compensation. For existing arrangements covered by the regulation, those disclosures must be delivered to the relevant Plan Fiduciary prior to July 1, 2012.
While the disclosure obligations under the Service Provider Regulation are imposed on service providers, the relevant Plan Fiduciaries also need to take action to ensure compliance – e.g., by determining which persons and entities providing services to their Plan are covered by the regulation (“Covered Service Providers,” defined below), and by confirming they have received the required disclosures from those Covered Service Providers.
“Compensation” – Different Types DefinedUnder the Service Provider Regulation, “Compensation” is broadly defined to include money or any other thing of value. In addition, certain types of Compensation have special definitions under the regulation:
- “Direct Compensation” means any Compensation received directly from the Plan.
- “Indirect Compensation” is defined as all Compensation received from any source other than the Plan, the Plan sponsor or the Covered Service Provider (or its affiliates or subcontractors).
- “Related-Party Compensation” includes any Compensation paid among the Covered Service Provider, an affiliate, or a subcontractor if it is set on a transaction basis (e.g., commissions, soft dollars or incentive compensation) or is charged directly against the Plan’s investment and reflected in the investment’s net value (e.g., so-called “Section 12b-1 fees”).
Covered Service ProvidersThe regulation’s disclosure obligations apply to the following categories of service providers if it is reasonably expected that the service provider (including its affiliates and subcontractors) will receive $1,000 or more in Direct or Indirect Compensation in connection with its services arrangement under the Plan.
- ERISA Fiduciaries and Registered Investment Advisers. This category of Covered Service Provider includes persons or entities that provide services to the Plan as an ERISA fiduciary or as an investment adviser registered under applicable federal or state law. This category also includes persons or entities that provide ERISA fiduciary services to an investment fund that is considered (under DOL rules) to hold assets of the Plan (e.g., a bank collective fund), if the Plan holds a direct ownership interest in that fund.
- Recordkeepers and Brokers That Are “Platform Providers.” This category of Covered Service Provider includes providers of recordkeeping or securities brokerage services to a self-directed individual account Plan (e.g., most 401(k) plans) if any investment alternative designated by the Plan (a “Designated Investment Alternative”) is made available in connection with those services (e.g., through a platform). “Designated Investment Alternatives” do not include brokerage windows, self-directed brokerage accounts or similar arrangements.
- Certain Service Providers Receiving Indirect Compensation or Related-Party Compensation. This category of Covered Service Provider includes persons or entities that provide accounting, actuarial, appraisal, auditing, banking, custodial, insurance, investment advisory (Plan or participant), legal, recordkeeping, securities brokerage, third-party administration, valuation and/or certain types of consulting services to a Plan, but only if it is reasonably expected that the service provider (or its affiliate or subcontractor) will receive Indirect Compensation or certain Related-Party Compensation.
Required Initial Disclosures
The Service Provider Regulation requires Covered Service Providers to provide certain initial disclosures in writing to the relevant Plan Fiduciaries regarding their Compensation arrangements. The regulation does not require that these disclosures be provided in any specific format.
In general, the initial disclosures should be received from the Covered Service Provider in writing reasonably in advance of the date the service arrangement is entered into, extended, or renewed; however, as explained above, for existing arrangements, the initial disclosures must be received by the relevant Plan Fiduciaries prior to July 1, 2012.The initial disclosures include the following:
- Services. A description of all services to be provided under the arrangement (the “Services”).
- Statement of Fiduciary or Registered Adviser Status. A statement, if applicable, that the Covered Service Provider (or any affiliate or subcontractor) reasonably expects to provide the Services as a fiduciary under ERISA and/or as an investment adviser registered under applicable law.
- Direct Compensation. A description of all Direct Compensation that the Covered Service Provider, an affiliate or subcontractor reasonably expects to receive in connection with the Services.
- Indirect Compensation. A description of all Indirect Compensation that the Covered Service Provider (or its affiliate or subcontractor) reasonably expects to receive in connection with the Services, including: (i) identification of the Services provided for the Indirect Compensation; (ii) the payer of the Indirect Compensation; and (iii) a description of the arrangement between the Covered Service Provider and the payer of the Indirect Compensation
- Related-Party Compensation. A description of any Related-Party Compensation, including identification of the services provided for, and the payer and payee of, that Compensation, even if this Related-Party Compensation is otherwise disclosed.
- Termination Fees. A description of any other Compensation that the Covered Service Provider, an affiliate or subcontractor reasonably expects to receive in connection with the termination of the arrangement, including how any prepaid amounts will be calculated and refunded.
- Method of Payment of Compensation. A description of how each type of Compensation will be received (e.g., billed to the Plan or deducted from the Plan’s account).
Where the Covered Service Provider is not able to describe the Compensation in a specific monetary amount, it may provide a formula, percentage of Plan assets or per capita charge, provided that the disclosure permits a reasonable Plan Fiduciary to evaluate the reasonableness of the Compensation.
Special Disclosure RequirementsThere are additional specific disclosure requirements for certain types of Covered Service Providers, as follows:
- Recordkeeping Services. If it is reasonably expected that there will be no explicit Compensation for recordkeeping services, or that Compensation for those services will be offset or rebated based on other Compensation, a reasonable good faith estimate must be provided of the implicit cost of the recordkeeping services to the Plan, including a detailed explanation of the services and a description of how the Compensation will be received.
- Fiduciary Services. If a Covered Service Provider is a fiduciary to an investment contract, product or entity that holds assets of the Plan (as determined under DOL rules) and in which a Plan has a direct ownership investment, the disclosures must include a description of any Compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer of or withdrawal from the contract, product or entity (e.g., sales loads and redemption fees); the annual operating expenses (e.g., expense ratio) of the contract, product or entity; and any on-going expenses in addition to annual operating expenses (e.g., wrap fees), unless those amounts are otherwise disclosed by the platform provider.
- Investment Disclosure for Designated Investment Alternatives. If recordkeeping or brokerage services are provided to a self-directed individual account Plan and Designated Investment Alternatives are made available (e.g., through a platform) in connection with those services, the disclosures detailed above regarding fiduciary services must be provided by the platform provider for each of those Designated Investment Alternatives. This requirement may be satisfied by the Covered Service Provider passing through current disclosures of the issuer if certain conditions are satisfied. This disclosure must comply with the requirements applicable to the Plan administrator’s investment-related disclosures to participants under the Participant Disclosure Regulation discussed below.
In general, the Covered Service Provider must disclose any material changes in the required disclosures as soon as practicable, but not later than 60 days after acquiring knowledge of the material change. Changes to investment-related information with respect to Designated Investment Alternatives may be updated on an annual basis.
Requests for Additional Information
In some circumstances, a Plan administrator or other relevant Plan Fiduciary may need information from a Covered Service Provider to comply with ERISA reporting or disclosure requirements – e.g., the Plan’s Form 5500 filing requirements. Under the Service Provider Regulation, if the relevant Plan Fiduciary makes a written request for that information, the Covered Service Provider generally must provide the information to the Plan Fiduciary reasonably in advance of the deadline for satisfying the ERISA requirement (e.g., reasonably in advance of the Form 5500 filing deadline).
Consequences of Non-Compliance
If the requirements of the Service Provider Regulation are not satisfied, the statutory prohibited transaction exemption noted above will not apply and the arrangement under which the Covered Service Provider provides services to the Plan could be considered a “prohibited transaction” under ERISA. In that case, the relevant Plan Fiduciary could become liable to the Plan – e.g., if the Plan paid unreasonable Compensation for the Services of the Covered Service Provider.
However, in connection with the Service Provider Regulation, the DOL has issued an administrative prohibited transaction exemption applicable to Plan Fiduciaries for situations where, unbeknownst to the Plan Fiduciary, the Covered Service Provider fails to provide the disclosure required by the regulation. In order for the relief under the administrative exemption to be available, the Plan Fiduciary must have reasonably believed that the disclosure requirements of the regulation were satisfied and must not have known that the Covered Service Provider failed to comply with the disclosure requirements. To qualify for the administrative exemption, the responsible Plan Fiduciary, upon discovering the disclosure failure, must request in writing that the Covered Service Provider provide the disclosures and, if the relevant disclosures are not made within 90 days, notify the DOL of the Covered Service Provider’s failure within 30 days following the end of that 90-day period. The Plan Fiduciary must also terminate the arrangement with the Covered Service Provider if the requested information relates to future services and the information is not promptly provided after the 90-day period. The DOL has developed a model notice that Plan Fiduciaries may use for this purpose.
Participant Disclosure Regulation
The Participant Disclosure Regulation applies only to defined contribution Plans (e.g., 401(k) Plans) that permit participants to direct the investment of their accounts. (In this Update, references to “participants” include Plan beneficiaries.) Certain Plans involving individual retirement accounts and certain frozen Section 403(b) annuity contracts or custodial account are not subject to this regulation.
The regulation requires Plan administrators to make two types of disclosures to Plan participants who have the right to direct investment of their accounts: (i) disclosures relating to the Plan; and (ii) disclosures regarding the Plan’s investments. In this regard, the “administrator” of a Plan is typically the Plan sponsor, or a person or committee identified as administrator in the Plan document.
While the regulation imposes disclosure obligations on the Plan administrator, as a practical matter it is likely that Plan administrators will look to (and should be contacting) service providers (e.g., the Plan’s recordkeeper or platform provider) and/or the issuers of Designated Investment Alternatives to arrange for disclosure of much of the required information. In satisfying the requirements of the regulation, a Plan administrator is permitted to rely on information provided by Plan service providers or the issuers of Designated Investment Alternatives, so long as the administrator acts reasonably and in good faith.
Plan-Related DisclosuresThe regulation requires Plan administrators to disclose to participants general Plan information, administrative expenses information and individual expenses information. These disclosures must be based on the latest information available to the Plan.
- General Plan Information. The general Plan information includes (i) an identification of any Designated Investment Alternative offered under the Plan; (ii) an explanation of the circumstances under which participants may give investment instructions; (iii) an explanation of any specified limitations on instructions under the terms of the Plan, including any restrictions on transfer to or from a Designated Investment Alternative; (iv) a description of or reference to Plan provisions relating to the exercise of voting, tender and similar rights related to an investment in a Designated Investment Alternative as well as any restrictions on such rights; (v) an identification of any designated investment managers; and (vi) a description of any brokerage windows, self-directed brokerage accounts or similar plan arrangements that enable participants to select investments beyond those designated by the Plan.
Administrative Expenses Information. The administrative expenses information includes explanation of any fees and expenses for general Plan administrative services (e.g., legal, accounting, recordkeeping) that may be charged against the individual accounts of participants (whether by liquidating shares or deducting dollars) and that are not reflected in the total annual operating expenses of any Designated Investment Alternative, and the basis on which such charges will be allocated to each individual account (e.g., pro rata or per capita).In addition, Plan administrators must disclose, at least quarterly: (i) the dollar amount of the fees and expenses described above that are actually charged during the preceding quarter to the participant’s account for the applicable Plan administrative services; (ii) a description of the services to which the charges relate; and (iii) if applicable, an explanation that, in addition to the fees and expenses disclosed, some or all of the Plan’s administrative expenses for the preceding quarter were paid from the total annual operating expenses of one or more of the Plan’s Designated Investment Alternatives (e.g., through revenue sharing arrangements, Rule 12b-1 fees or sub-transfer agent fees).
Individual Expenses Information. This information includes an explanation of any fees and expenses (i) that may be charged against the individual account of a participant on an individual, rather than on a plan-wide, basis (e.g., fees related to processing Plan loans or qualified domestic relations orders, fees for investment advice, fees for brokerage accounts, commissions, redemption fees and optional rider charges in annuity contracts) and (ii) that are not reflected in the total annual operating expenses of any Designated Investment Alternative.In addition, Plan administrators must disclose, at least quarterly, (i) the dollar amount of the individual fees and expenses that are actually charged during the preceding quarter to the participant’s account, and (ii) a description of the services to which the charges relate (e.g., loan processing fee).
Investment-Related DisclosuresThe regulation requires Plan administrators to disclose the following information with respect to each of the Plan’s Designated Investment Alternatives. As noted above, the “Designated Investment Alternatives” are the investment options designated by the Plan, and do not include the specific investments available under brokerage windows and similar arrangements. In this regard, recently issued guidance suggests that, in the DOL’s view, a Plan that permits participant direction of investments should generally have at least three Designated Investment Alternatives.
Information to be Presented in a Comparative ChartThe regulation requires that the following investment-related disclosures be provided with regard to each Designated Investment Alternative in a comparative format and include a safe harbor comparative chart that may be used for this purpose.
- The name of the Designated Investment Alternative and the type or category of the investment (e.g., money market fund, balanced fund (stocks and bonds), large-cap stock fund, international equity fund or employer stock fund of that alternative).
- Performance data such as (i) the average annual total return of the Designated Investment Alternative for 1-, 5- and 10-calendar year periods (or for the life of the Designated Investment Alternative, if shorter) ending on the date of the most recently completed calendar year or (ii) if applicable, the fixed or stated annual rate of return and term of the Designated Investment Alternative.
- The name of an appropriate broad-based securities market index for the Designated Investment Alternative and its returns over the same periods for which the Designated Investment Alternative’s performance is shown.
- For Designated Investment Alternatives without a fixed return:
- The amount and a description of each shareholder-type fee and a description of any restriction or limitation that may be applicable to a purchase, transfer or withdrawal of the investment in whole or in part (such as round trip, equity wash or other restrictions);
- The total annual operating expenses of the investment expressed as a percentage (i.e., expense ratio);
- The total annual operating expenses of the investment for a one-year period expressed as a dollar amount for a $1,000 investment; and
- A statement indicating that fees and expenses are only one of several factors that participants should consider when making investment decisions, and that the cumulative effect of fees and expenses can substantially reduce the growth of a participant’s retirement account in whole or in part.
- For Designated Investment Alternatives with a fixed return: the term of the investment, the amount and a description of any shareholder-type fees and a description of any restrictions on purchases, transfers or withdrawals.
WebsiteFor each Designated Investment Alternative, an Internet website address must be provided where participants can find the following information with regard to the alternative: name; objectives or goals; principal strategies (including a general description of the types of assets held by the investment) and principal risks; portfolio turnover rate; performance data; and fee and expense information.
General GlossaryA general glossary of terms must be provided to assist participants in understanding Designated Investment Alternatives (or a website that provides specific access to such a glossary).
Other InformationA Plan administrator must provide certain information upon request by a participant– e.g., prospectuses, financial reports or similar documents relating to Designated Investment Alternatives that have been provided to the Plan; a statement of the unit value of a Designated Investment Alternative (as well as the date of valuation); and a list of assets comprising the portfolio of each Designated Investment Alternative that is considered to hold assets of the Plan (under DOL rules). A Plan administrator also must provide information concerning the exercise of voting and similar rights relating to a Designated Investment Alternative in which the participant is invested (to the extent such rights are passed through to participants), upon the Plan’s receipt of that information.
Timing and Manner of Disclosures
Unless otherwise indicated above, the plan-related and investment-related disclosures required by the Participant Disclosure Regulation must be provided on or before the date on which a participant can first direct his or her investments, and at least annually thereafter. If there is a change to this information, the Plan generally must furnish each participant a description of the change at least 30 days, but not more than 90 days, in advance of the effective date of such change. Disclosures relating to administrative expenses and individual expenses that are actually charged to the account of a participant must be provided on a quarterly basis within 45 days after the end of the quarter.
For calendar-year Plans, the initial disclosures of plan-related and investment-related expenses must be furnished by August 30, 2012 and the first quarterly statement must be furnished by November 14, 2012 (i.e., 45 days after the end of the third quarter). This first quarterly statement need only reflect the fees and expenses deducted from a participant’s account during the July through September quarter to which the statement relates.
As noted above, under the regulation certain information must be furnished through a website. Other disclosures required by the regulation may be provided electronically under DOL rules applicable to ERISA disclosures generally (e.g., in furnishing summary plan descriptions), or consistent with guidance provided by the DOL specifically for purposes of the Participant Disclosure Regulation.
Consequences of Non-Compliance
Under ERISA, Plan Fiduciaries are required to act prudently and for the exclusive benefit of Plan participants. In the DOL’s view, the Plan administrator of a Plan that permits participants to direct investments will be in compliance with these ERISA fiduciary duties only if the requirements of the Participant Disclosure Regulation are satisfied. If those requirements are not satisfied, the Plan administrator could become liable for, e.g., investment losses incurred by a participant as a result of that noncompliance.