New Regulations for Service Providers

On July 16, 2010, the U.S. Department of Labor (DOL) issued interim final regulations under ERISA Section 408(b)(2) that impose new disclosure requirements on “covered service providers” providing services to specified pension plans subject to ERISA. Additionally, on Oct. 20, 2010, the DOL issued more final regulations under ERISA Section 404(a) that require the disclosure of certain plan and investment-related information, including fee and expense information, to participants and beneficiaries in participant-directed individual account plans (e.g., 401(k) plans). These regulations, viewed in connection with the requirement, which became effective in 2009, to report actual fee information on the Schedule C of the Form 5500, demonstrate a clear policy shift by the DOL toward disclosure as a principal means of assisting plan fiduciaries to “satisfy” their duties and ensuring that participants have the information necessary to make informed decisions about the management and investment of their retirement savings. This article focuses exclusively on the new fee disclosure requirements imposed on covered service providers to ERISA pension plans under the interim final regulations issued in July of 2010 (the “Regulation”). Section I briefly describes the relevant law; Section II describes the Regulation; and Section III discusses the impact of the new requirements on plan fiduciaries and provides practical advice regarding steps to take in advance of their effective date.

I. Background

Section 404(a) of ERISA sets forth an ERISA fiduciary's duties to plan participants and beneficiaries. Among other things, a plan fiduciary must act solely in the interest of the plan's participants and beneficiaries for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan.

Section 406(a)(1)(C) of ERISA generally prohibits the furnishing of services by a “party in interest” to a plan. However, Section 408(b)(2) provides a commonly-used exemption to this general prohibition, exempting service contracts or arrangements if: 1) the contract or arrangement is reasonable; 2) the services are necessary for the establishment or operation of the plan; and 3) no more than reasonable compensation is paid for the services.

The Regulation clarifies the scope of disclosure with respect to compensation that the DOL views is necessary in order for a plan fiduciary to determine whether a contract or arrangement for services by a party in interest to a plan is “reasonable” under Section 408(b)(2) of ERISA.

II. The Regulations

Coverage

The Regulation applies only to contracts or arrangements for services between a covered plan and a covered service provider. For this purpose, a “covered plan” is generally a defined benefit or defined contribution plan covered by ERISA, with certain exceptions. A “covered service provider” is one that reasonably expects $1,000 or more in direct or indirect compensation to be received in connection with providing one or more specified services, including: 1) services provided directly to the plan as a fiduciary or investment adviser; 2) services provided as a fiduciary to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment; 3) certain record-keeping or brokerage services provided to a participant-directed individual account plan (e.g., a 401(k) plan); and 4) other services for which the covered service provider, affiliate, or subcontractor reasonably expects to receive indirect compensation, including accounting, auditing, actuarial, appraisal, banking, consulting, custodial, insurance, investment advisory, legal, record-keeping, securities or other investment brokerage, third party administration, or valuation services.

Disclosure Requirements

With respect to a contract or arrangement covered by the Regulation, a covered service provider must disclose to the plan fiduciary, in writing, the following information:

• a description of all services it will provide to the covered plan (excluding non-fiduciary services provided to an investment entity);
• if applicable, a statement that the covered service provider, an affiliate, or subcontractor will, or reasonably expects to, provide services to the covered plan (or investment entity) as a fiduciary or registered investment adviser;
• a description of all direct compensation, either in the aggregate or by service, that the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with the services;
• a description of all indirect compensation that the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with the services;
• a description of any compensation that will be paid among the covered service provider, any affiliate, or subcontractor if (i) set on a transaction basis ( e.g., commissions, soft dollars, finder's fees or similar incentive compensation based on business placed or retained) or (ii) charged directly against the covered plan's investment and reflected in the net value of the investment;
• a description of compensation that a covered service provider, affiliate, or subcontractor reasonably expects to receive upon termination of the contract or arrangement and how prepaid amounts will be calculated and refunded upon such termination; and
• a description of the manner in which the compensation will be received, such as whether the covered plan will be billed or the compensation will be deducted directly from the covered plan's account(s) or investments.

In addition to the seven classes of disclosure obligations that apply to all covered service providers, the Regulation imposes specific disclosure obligations on certain recordkeepers, brokers and fiduciaries to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment.

Timing of Disclosures

In general, a covered service provider must disclose the required information to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into. Additionally, a covered service provider must disclose a change to the required information no later than 60 days from the date on which the covered service provider is informed of the change, absent certain extraordinary circumstances. Upon request of a plan fiduciary or covered plan administrator, a covered service provider must furnish any information relating to the compensation received in connection with the contract or arrangement that is required for the covered plan to comply with Title 1 of ERISA, such as the Form 5500 Annual Report.

Disclosure Errors

No contract or arrangement will fail to be “reasonable” solely because a covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in its disclosure, provided the service provider discloses the correct information no later than 30 days from the date the covered service provider knows of such error or omission.

Class Exemption for Responsible Plan Fiduciary

If certain conditions are met, a plan fiduciary will not be deemed to have engaged in a prohibited transaction under Section 406(a)(1) of ERISA solely because a covered service provider failed to provide the required disclosures. This class exemption protects a plan fiduciary from being deemed to cause the plan to engage in a prohibited transaction due to the failure by a covered service provider to satisfy its disclosure obligations under the Regulation.

Effective Date

On Feb. 11, 2011, the DOL delayed the date on which covered service providers must begin to comply with the Regulation from July 16, 2011, to Jan. 1, 2012.

III. Practical Implications for Plan Fiduciaries

Even though the Regulation imposes disclosure obligations on covered service providers, prudent plan fiduciaries should act quickly to educate themselves on these requirements in order to protect themselves and act in the interest of the plan by ensuring these requirements are timely satisfied by all plan service providers. Plan fiduciaries should draft checklists and implement procedures to ensure that each covered service provider to the plan satisfies its disclosure obligations. Steps taken by plan fiduciaries could include the following:

Identify Covered Service Providers. Plan fiduciaries should identify all covered service providers and notify each of them of the fiduciary's expectations of receipt of the information required by the Regulation. Prudent covered service providers should already be preparing to make this disclosure, so fiduciaries should begin communication as early as possible.

Ensure Compliance with Disclosure Rules. As a matter of prudence, plan fiduciaries should strive to understand the fees and expenses that are being charged by all service providers. Ensuring that covered service providers comply with the new disclosure obligations is a critical first step in this process.

Revise Contracts. Plan fiduciaries should undertake a comprehensive review of all service contracts and, where applicable, update contracts to ensure conformity with the Regulation.

Revise RFP Process. Plan fiduciaries should revise the employer's form request for proposal (RFP), if applicable, to request a description of a prospective service provider's internal procedures to ensure compliance with the Regulation.

Ensure Compliance with Class Exemption. Plan fiduciaries should implement a process to ensure they satisfy the conditions for the class exemption for responsible plan fiduciaries in the event a covered service provider fails to provide the required disclosures. Compliance with this class exemption is essential in protecting plan fiduciaries from potential personal liability due to the actions ' or inactions ' of covered service providers.

Understand the Disclosure. Plan fiduciaries should train themselves and appropriate personnel to review and interpret the required disclosures upon receipt from a covered service provider and implement procedures whereby the information is utilized by the plan fiduciaries in selecting, reviewing and administering service contracts.

Disclose to Participants. Once fiduciaries educate themselves about the fees and expenses associated with plan investments and administration, they should work to educate participants regarding the same. In addition to exercising best practices, this will assist plan fiduciaries in complying with the final regulations recently issued under ERISA Section 404(a).

Document. Plan fiduciaries should diligently document their review and evaluation of plan investments, as well as their continued monitoring of those investments. This documentation process should include receipt and utilization of the required disclosures from covered service providers. The more robust the documentary record, the better equipped a fiduciary will be to demonstrate fidelity to ERISA's fiduciary standards. The absence of such documentation will be readily seized upon as indicia of a lack of prudence by plan fiduciaries.

Act Quickly. Even though the Regulation does not take effect until Jan. 1, 2012, many service providers already have the ability to provide the information required by the Regulation. Plan fiduciaries should request service providers to provide the new fee disclosure information for plan years prior to the 2012 effective date. In other words, undertaking a “dry run” for 2011 could enable plan fiduciaries to identify and eliminate wasteful spending earlier, and resolve any administrative issues necessary to realize the full benefit to the plan of the newly required disclosures in advance of the 2012 effective date.

John L. Brown is an attorney with Arnall Golden Gregory LLP in Atlanta, where he is a member of the firm's Tax and Employee Benefits Practice Group. Brown's practice covers virtually all aspects of tax and employee benefits and has a particular focus on the Patient Protection and Affordable Care Act. He can be reached at 404-873-8788 or at [email protected].

On July 16, 2010, the U.S. Department of Labor (DOL) issued interim final regulations under ERISA Section 408(b)(2) that impose new disclosure requirements on “covered service providers” providing services to specified pension plans subject to ERISA. Additionally, on Oct. 20, 2010, the DOL issued more final regulations under ERISA Section 404(a) that require the disclosure of certain plan and investment-related information, including fee and expense information, to participants and beneficiaries in participant-directed individual account plans (e.g., 401(k) plans). These regulations, viewed in connection with the requirement, which became effective in 2009, to report actual fee information on the Schedule C of the Form 5500, demonstrate a clear policy shift by the DOL toward disclosure as a principal means of assisting plan fiduciaries to “satisfy” their duties and ensuring that participants have the information necessary to make informed decisions about the management and investment of their retirement savings. This article focuses exclusively on the new fee disclosure requirements imposed on covered service providers to ERISA pension plans under the interim final regulations issued in July of 2010 (the “Regulation”). Section I briefly describes the relevant law; Section II describes the Regulation; and Section III discusses the impact of the new requirements on plan fiduciaries and provides practical advice regarding steps to take in advance of their effective date.

I. Background

Section 404(a) of ERISA sets forth an ERISA fiduciary's duties to plan participants and beneficiaries. Among other things, a plan fiduciary must act solely in the interest of the plan's participants and beneficiaries for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan.

Section 406(a)(1)(C) of ERISA generally prohibits the furnishing of services by a “party in interest” to a plan. However, Section 408(b)(2) provides a commonly-used exemption to this general prohibition, exempting service contracts or arrangements if: 1) the contract or arrangement is reasonable; 2) the services are necessary for the establishment or operation of the plan; and 3) no more than reasonable compensation is paid for the services.

The Regulation clarifies the scope of disclosure with respect to compensation that the DOL views is necessary in order for a plan fiduciary to determine whether a contract or arrangement for services by a party in interest to a plan is “reasonable” under Section 408(b)(2) of ERISA.

II. The Regulations

Coverage

The Regulation applies only to contracts or arrangements for services between a covered plan and a covered service provider. For this purpose, a “covered plan” is generally a defined benefit or defined contribution plan covered by ERISA, with certain exceptions. A “covered service provider” is one that reasonably expects $1,000 or more in direct or indirect compensation to be received in connection with providing one or more specified services, including: 1) services provided directly to the plan as a fiduciary or investment adviser; 2) services provided as a fiduciary to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment; 3) certain record-keeping or brokerage services provided to a participant-directed individual account plan (e.g., a 401(k) plan); and 4) other services for which the covered service provider, affiliate, or subcontractor reasonably expects to receive indirect compensation, including accounting, auditing, actuarial, appraisal, banking, consulting, custodial, insurance, investment advisory, legal, record-keeping, securities or other investment brokerage, third party administration, or valuation services.

Disclosure Requirements

With respect to a contract or arrangement covered by the Regulation, a covered service provider must disclose to the plan fiduciary, in writing, the following information:

• a description of all services it will provide to the covered plan (excluding non-fiduciary services provided to an investment entity);
• if applicable, a statement that the covered service provider, an affiliate, or subcontractor will, or reasonably expects to, provide services to the covered plan (or investment entity) as a fiduciary or registered investment adviser;
• a description of all direct compensation, either in the aggregate or by service, that the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with the services;
• a description of all indirect compensation that the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with the services;
• a description of any compensation that will be paid among the covered service provider, any affiliate, or subcontractor if (i) set on a transaction basis ( e.g., commissions, soft dollars, finder's fees or similar incentive compensation based on business placed or retained) or (ii) charged directly against the covered plan's investment and reflected in the net value of the investment;
• a description of compensation that a covered service provider, affiliate, or subcontractor reasonably expects to receive upon termination of the contract or arrangement and how prepaid amounts will be calculated and refunded upon such termination; and
• a description of the manner in which the compensation will be received, such as whether the covered plan will be billed or the compensation will be deducted directly from the covered plan's account(s) or investments.

In addition to the seven classes of disclosure obligations that apply to all covered service providers, the Regulation imposes specific disclosure obligations on certain recordkeepers, brokers and fiduciaries to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment.

Timing of Disclosures

In general, a covered service provider must disclose the required information to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into. Additionally, a covered service provider must disclose a change to the required information no later than 60 days from the date on which the covered service provider is informed of the change, absent certain extraordinary circumstances. Upon request of a plan fiduciary or covered plan administrator, a covered service provider must furnish any information relating to the compensation received in connection with the contract or arrangement that is required for the covered plan to comply with Title 1 of ERISA, such as the Form 5500 Annual Report.

Disclosure Errors

No contract or arrangement will fail to be “reasonable” solely because a covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in its disclosure, provided the service provider discloses the correct information no later than 30 days from the date the covered service provider knows of such error or omission.

Class Exemption for Responsible Plan Fiduciary

If certain conditions are met, a plan fiduciary will not be deemed to have engaged in a prohibited transaction under Section 406(a)(1) of ERISA solely because a covered service provider failed to provide the required disclosures. This class exemption protects a plan fiduciary from being deemed to cause the plan to engage in a prohibited transaction due to the failure by a covered service provider to satisfy its disclosure obligations under the Regulation.

Effective Date

On Feb. 11, 2011, the DOL delayed the date on which covered service providers must begin to comply with the Regulation from July 16, 2011, to Jan. 1, 2012.

III. Practical Implications for Plan Fiduciaries

Even though the Regulation imposes disclosure obligations on covered service providers, prudent plan fiduciaries should act quickly to educate themselves on these requirements in order to protect themselves and act in the interest of the plan by ensuring these requirements are timely satisfied by all plan service providers. Plan fiduciaries should draft checklists and implement procedures to ensure that each covered service provider to the plan satisfies its disclosure obligations. Steps taken by plan fiduciaries could include the following:

Identify Covered Service Providers. Plan fiduciaries should identify all covered service providers and notify each of them of the fiduciary's expectations of receipt of the information required by the Regulation. Prudent covered service providers should already be preparing to make this disclosure, so fiduciaries should begin communication as early as possible.

Ensure Compliance with Disclosure Rules. As a matter of prudence, plan fiduciaries should strive to understand the fees and expenses that are being charged by all service providers. Ensuring that covered service providers comply with the new disclosure obligations is a critical first step in this process.

Revise Contracts. Plan fiduciaries should undertake a comprehensive review of all service contracts and, where applicable, update contracts to ensure conformity with the Regulation.

Revise RFP Process. Plan fiduciaries should revise the employer's form request for proposal (RFP), if applicable, to request a description of a prospective service provider's internal procedures to ensure compliance with the Regulation.

Ensure Compliance with Class Exemption. Plan fiduciaries should implement a process to ensure they satisfy the conditions for the class exemption for responsible plan fiduciaries in the event a covered service provider fails to provide the required disclosures. Compliance with this class exemption is essential in protecting plan fiduciaries from potential personal liability due to the actions ' or inactions ' of covered service providers.

Understand the Disclosure. Plan fiduciaries should train themselves and appropriate personnel to review and interpret the required disclosures upon receipt from a covered service provider and implement procedures whereby the information is utilized by the plan fiduciaries in selecting, reviewing and administering service contracts.

Disclose to Participants. Once fiduciaries educate themselves about the fees and expenses associated with plan investments and administration, they should work to educate participants regarding the same. In addition to exercising best practices, this will assist plan fiduciaries in complying with the final regulations recently issued under ERISA Section 404(a).

Document. Plan fiduciaries should diligently document their review and evaluation of plan investments, as well as their continued monitoring of those investments. This documentation process should include receipt and utilization of the required disclosures from covered service providers. The more robust the documentary record, the better equipped a fiduciary will be to demonstrate fidelity to ERISA's fiduciary standards. The absence of such documentation will be readily seized upon as indicia of a lack of prudence by plan fiduciaries.

Act Quickly. Even though the Regulation does not take effect until Jan. 1, 2012, many service providers already have the ability to provide the information required by the Regulation. Plan fiduciaries should request service providers to provide the new fee disclosure information for plan years prior to the 2012 effective date. In other words, undertaking a “dry run” for 2011 could enable plan fiduciaries to identify and eliminate wasteful spending earlier, and resolve any administrative issues necessary to realize the full benefit to the plan of the newly required disclosures in advance of the 2012 effective date.

John L. Brown is an attorney with Arnall Golden Gregory LLP in Atlanta, where he is a member of the firm's Tax and Employee Benefits Practice Group. Brown's practice covers virtually all aspects of tax and employee benefits and has a particular focus on the Patient Protection and Affordable Care Act. He can be reached at 404-873-8788 or at [email protected].