Plan Fiduciaries Should “Welcome” Final Regulations Regarding Service Provider Disclosures

Last week the U.S. Department of Labor published Final Regulations dealing with service provider disclosures under Section 408(b)(2) of ERISA. This is the latest in a series of regulatory initiatives undertaken by the DOL to ensure that plan fiduciaries, as well as plan participants and beneficiaries, obtain meaningful information about the services that are provided to their employee benefit plans and the cost of those services. The DOL began by revising Schedule C of Form 5500 to expand the disclosures regarding service providers. Then came new regulations under Section 404(a) of ERISA requiring plan administrators to disclose specified plan and investment-related information, including fee and expense information, to participants and beneficiaries in 401(k) and other individual account plans. The Section 408(b)(2) Final Regulations represent another significant component of the disclosure regime since, in the view of the DOL, plan fiduciaries need the information called for in the Final Regulations in order to satisfy the fiduciary standards of ERISA when selecting and monitoring service providers. Plan fiduciaries need to be familiar with these important new rules, understand and apply the disclosures they receive from service providers, and be aware of certain new obligations they have regarding service arrangements.

Key Terms

The Final Regulations under Section 408(b)(2) of ERISA require “covered service providers” to provide “responsible plan fiduciaries” with the information they need to: (1) assess the reasonableness of compensation received by the covered service provider, directly and indirectly, for the services being provided; (2) identify potential conflicts of interest with respect to covered service providers; and (3) satisfy the reporting and disclosure requirements with which they must comply, including the important participant-level disclosure requirements under Section 404(a) of ERISA.

Affected Plans. The disclosure requirements apply to defined benefit plans and defined contribution plans that are subject to ERISA. The requirements do not apply to SIMPLE retirement accounts, SEPs, IRAs, or welfare benefit plans. The Final Regulations also confirm that the disclosures need not be provided with respect to non-ERISA tax sheltered annuity contracts issued before January 1, 2009 for which all contributions have ceased and all accounts are fully vested.

Covered Service Providers. “Covered service providers” (CSPs) that are subject to the disclosure requirements are those expecting to receive at least $1,000 in compensation for services, who fall into the following categories:

• Providers of fiduciary services with respect to a covered plan or investment vehicle in which a covered plan invests;
• Registered investment advisers;
• Recordkeepers or brokers who make investment alternatives available to a covered plan (sometimes referred to as “platform providers”); and
• Providers of the following types of services IF they reasonably expect to receive “indirect compensation” in connection with the services: accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, TPA or valuation services.

The requirement that service providers in the final category also receive “indirect compensation” for their services appears to be targeted both at bundled arrangements and arrangements in which service providers may receive additional fees from other service providers as part of the arrangement (such as a recordkeeping firm that may provide support services to a brokerage firm in addition to plan-related services). Therefore, the “typical” direct relationship between an employer and a service provider (such as the accounting firm that audits the employer’s 401(k) plan in exchange for a fee) should not be implicated by the new rules.

Responsible Plan Fiduciary. A “responsible plan fiduciary” (RPF) is a fiduciary with authority to cause the covered plan to enter into, or extend or renew, the contract or arrangement. Consistent with the broadly applicable fiduciary standards of ERISA, this is a functional definition. In most cases, the RPF is likely to be (or at least include) the person or persons designated to serve as the plan administrator of the covered plan.

Direct and Indirect Compensation. “Direct compensation” is compensation received directly from the covered plan. “Indirect compensation” is compensation received from any source other than the plan sponsor, the CSP, or an affiliate of the CSP.

Required Disclosures Regarding Services and Compensation

To comply with new disclosure requirements, a CSP must provide written disclosure to the RPF regarding a variety of service and expense-related information including:

• The services to be provided and all direct and indirect compensation to be received by the CSP, its affiliates and subcontractors;
• In the case of a CSP that expects to receive indirect compensation, the arrangement between the CSP and the payer of the indirect compensation (including the sources of the indirect compensation and the services for which it will be paid). This disclosure is intended to allow the RPF to assess potential conflicts of interest;
• Whether recordkeeping services are being provided and the compensation attributable to the recordkeeping services, even if the recordkeeping services are part of a package of services and there is no explicit charge for those services; and
• The expense ratio of any investment-related services (including ongoing operating expenses) together with the specific expense data for inclusion in the participant-level disclosure that must be provided in the case of participant-directed individual account plans.

The required disclosures can be provided electronically, so long as the electronic information can be readily accessed by the RPF and clear notification is given to the RPF about how to access the information. The Final Regulations preserve the “Sample Guide to Initial Disclosures” that was included in the earlier Interim Final Regulations to assist CSP in designing their disclosures.

Timing of Required Disclosures

CSPs must provide an initial disclosure of services and compensation reasonably in advance of the date the contract or service arrangement is entered into. (No prudent fiduciary would engage a plan service provider without having received and assessed an initial disclosure!) Ongoing disclosures must be made upon the request of the RPF, reasonably in advance of the date upon which the fiduciary states that it must comply the applicable reporting and disclosure requirement of ERISA. Any changes to previously disclosed information must be disclosed by the CSP as soon as practicable but no later than 60 days from the time the CSP learns of the change. Changes to investment-related information must be disclosed at least annually.

Extended Effective Date

Importantly, the Final Regulations extend the effective date of the requirements from April 1, 2012 (the effective date of the Interim Final Regulations) to July 1, 2012. Note that this delay also affects the timing of the participant level disclosures that plan administrators are required to make under Section 404(a) of ERISA and DOL Regulations Section 2550.404a-5. Under the transitional rule published last summer, that disclosure is to be provided 60 days after the effective date of the Final Regulations under Section 408(b)(2) of ERISA, so August 30, 2012 for calendar year plans.

Somewhat Serious Implications for RPFs (Plan Administrators)

The enhanced disclosures mandated by the Final Regulations under Section 408(b)(2) of ERISA may be received by RPFs (in most cases, plan administrators) as a mixed blessing. Clearly, the disclosures will arm the fiduciaries with the information they need to make prudent choices solely in the interests of the plan participants and beneficiaries. And the detailed disclosures will directly support the efforts of plan administrators to meet their obligations under the reporting and disclosure requirements of ERISA, especially the participant-level disclosures required under Section 404(a). At the same time, the disclosures will add to the burden already borne by plan administrators by requiring them to scrutinize disclosures from CSPs and invest a little more time in fulfilling their duties in light of those disclosures.

Notably, the Final Regulations essentially impose new obligations upon a fiduciary if it discovers that a CSP failed to disclose required information. If an RPF discovers that a required disclosure has not been made, it must request in writing that the CSP provide the missing information. (It could be an entire notice that was not provided or it could be information that was omitted from a notice.) If the CSP fails to comply within 90 days, the RPF is to notify the DOL in a written notice that contains information specified in the Final Regulations. Moreover, if the CSP fails to provide the required disclosure within 90 days, the RPF is to determine whether to terminate or continue the service arrangement “consistent with its duty of prudence” under Section 404 of ERISA. But the Final Regulations go even further. If the requested information relates to future services and it is not disclosed promptly after the 90-day period, the regulations require the RPF to terminate the arrangement as expeditiously as possible (consistent with the duty of prudence). Woe betide the CSP that fails to make a required disclosure, and pity the RPF that fails to take action to remedy the problem!