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Proposed Regulations Outline Fee and Conflict Disclosure Requirements for ERISA-Governed Service Providers

The Department of Labor (DOL) has added its voice to the ongoing debate on the immediate and long-term corrosive effect that fees can have on retirement income and savings. The Department proposed regulations on December 13 that require service providers for all Employee Retirement Income Security Act (ERISA)-governed plans to disclose fees and potential conflicts of interest before a contract or agreement is entered, extended, or renewed with the plan fiduciary.

The proposed regulations are important because they provide transparency to what can be an opaque and arcane area. They focus on direct and indirect compensation and potential conflict-of-interest issues. The proposed regulations also closely follow the framework of Congressional legislation that requires more 401(k) fee disclosure and new reporting requirements for the Department's 5500 filings. The proposed regulations will likely become a de facto industry standard for disclosure for all fee information from service providers to ERISA plans and an influence on plan-participant fee disclosure.

Clearly, the proposed regulations are momentous for ERISA-governed service providers. Compliance responsibility falls squarely upon their shoulders. The Department strictly enforces the prohibited transaction rules and imposes penalties for fiduciary self-dealing and conflicts of interest. Plus, plan fiduciaries can always terminate service providers who fail to comply with the proposed regulations.

Service Providers
The proposed regulations apply to all contracts or arrangements between a plan and

• Fiduciary service providers under ERISA and the Investment Advisers Act of 1940;
• Providers of banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping, securities or other investment brokerage, or third-party administration services; and
• Providers who receive indirect compensation in connection with accounting, actuarial, appraisal and auditing, legal, or valuation services.

Disclosure of Fees and Compensation
The proposed regulations impose a common business practice that, while generally followed, is not mandated in ERISA. The rules require that the terms of the contract must be in writing. This includes services to be performed and all compensation that will be received either directly from the plan or indirectly from parties other than the plan or plan sponsor, including how such compensation will be paid. Compensation and fees include money or anything else of monetary value, including gifts, awards, finder's fees, commissions, 12b-1 fees, soft dollars, and float income as well as indirect compensation received from a party other than the plan, the plan sponsor, or service provider. The Department will permit compensation to be disclosed as a specific dollar amount, formula, asset charge, or per capita charge so long as the description permits a plan fiduciary to evaluate the reasonableness of the compensation or fee. Additionally, the disclosure of fees includes fees paid to the service provider and affiliates, which include entities controlled by or under common control with the service provider, as well as its officers, directors, agents, and employees.

• Some Plan Investments Included
  Entities that are treated as providing covered categories of services to plans as a result of plan investments under the plan assets rules are also covered by the proposed regulations. For example, the Department's plan asset rules extend the proposed regulations to bank collective investment funds and private funds that receive 25 percent or more of their investments from ERISA.
• Rules for Bundled Services
  For bundled arrangements, the bundled service provider must disclose all of the services and the aggregate compensation or fees received directly or indirectly by the service provider, its affiliate or subcontractor, or any other party. The new Form 5500 filing also has this requirement. However, the bundled service provider must break out fees that are a separate charge directly against the plan's investment reflected in the net value of the investment, such as management fees paid by mutual funds to their investment advisers, float revenue, other asset-based fees, and compensation that is set on a transaction basis such as finders fees, brokerage commissions, and soft dollars.

Conflict- of-Interest Disclosure
Service providers must disclose information about relationships or interest that may raise conflicts of interest for the service provider in performing plan services. They must describe

• Any participation or interest of the service provider in transactions to be entered into by the plan in connection with the contract;
• Any material financial, referral or other relationship with a money manager, broker, other client of the service provider, other service provider to the plan, or any other entity that does or may create a conflict of interest for the service, provider in performing its duties;
• Any direct or indirect compensation that it may receive without prior approval of an independent plan fiduciary in connection with the performance of the service, and a description of the nature of the compensation; and
• Any policies or procedures designed to prevent the above compensation or fees, relationships, or conflicts from adversely affecting its services to the plans, such as procedures for offsetting fees received from third parties against amounts it would otherwise charge the plan.

General Compliance Requirements
Service providers are required to give these disclosures in writing and to the best of their knowledge. Additionally, this information must be made available with enough lead time before the contract is entered, renewed, or extended that the plan fiduciary can prudently make an informed decision. The Department does not prescribe a specific format for the required disclosures but does say the disclosures can be in an electronic format and may be in multiple documents from multiple sources.

The proposed regulations also require a service provider to notify a plan fiduciary within 30 days of acquiring knowledge of any material modification to the disclosures previously provided. Material is defined by the DOL as any change that a reasonable plan fiduciary would view as significantly altering the total mix of information or significantly affecting a reasonable plan fiduciary's decision to hire or retain the service provider. Additionally, a service provider must provide all information necessary for a plan fiduciary to comply with the new 5500 form filing requirements.

Class Exemption for Plan Fiduciary
Because a failure by the service provider to comply with the proposed regulations will result in a prohibited transaction under ERISA affecting both the service provider and the plan fiduciary that entered the contract, the Department has proposed a prohibited transaction class exemption for plan fiduciaries that meet certain conditions. The Department will give relief to a fiduciary if three conditions were met:

• Based on the information available at the time, the plan fiduciary reasonably believed the service provider had complied with the regulations' requirements and did not know or have reason to know that the service provider failed to comply.
• Once aware of the failure, the fiduciary demanded in writing that the service provider comply with the disclosure obligations and then notified the Department if the service provider did not comply within 90 days.
• The plan fiduciary considered terminating the service provider or continued the contract by evaluating the failure and assessed the availability, qualifications, and costs of potential replacements and their responsiveness in furnishing the information that the service provider should have disclosed.

Prohibition against Termination Penalties
The proposed regulations continue to require that service providers permit termination of their contract on reasonably short notice without penalty. However, the Department asks if there are problems with the current regulatory framework and if interpretative guidance is needed.

Effective Date
The proposed regulations are scheduled to take effect 90 days after final regulations are published in the Federal Register.

SVIA Comments
Like many others, the Stable Value Investment Association (SVIA) has submitted comments to the DOL. While SVIA supports disclosure, it has asked for some changes and additional clarification on the proposed regulations. For example, the proposed rules require disclosure of all fees paid for all services performed for an ERISA-governed plan. This requirement may result in voluminous listing of services and their respective fees. SVIA suggests that the Department permit disclosure in major categories that are reflective of the services performed for the plan and that a standard of materiality be incorporated to guide this disclosure. SVIA asks the Department to provide illustrations of the types of conflicts that the Department wants service providers to disclose since ERISA prohibits service providers that have conflicts of interest and views such conflicts as a violation. Additionally, the SVIA requests that the Department extend the effective date to a year for new contracts and agreements, and up to three years for current contracts to minimize costs and permit an orderly update of contractual agreements. To learn more about SVIA's comments, please go to www.stablevalue.org.

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