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DOL Retirement Plan Fee and Expense Disclosures: Tackling Complex 408(b)(2) Questions

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WEDNESDAY, SEPTEMBER 12, 2012

Presenting a live 90-minute webinar with interactive Q&A

Sarah E. Downie, Partner, Orrick Herrington & Sutcliffe, New York Jeffrey Lieberman, Partner, Clifford Chance, New York Adrienne A. Scerbak, Of Counsel, Winston & Strawn, New York

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LOOK-BACK AT THE FIRST ROUND OF 408(b)(2) DISCLOSURES AND RELATED RULES

Sarah E. Downie Jeffrey Lieberman Adrienne Ann Scerbak

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Introduction

• Brief Recap of DOL’s disclosure scheme
• Section 408(b)(2) Disclosures
• The Obligations of Responsible Plan

Fiduciaries after July 1

• Benchmarking Considerations
• Disclosure Issues

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Recap of DOL Disclosure Scheme

• DOL’s intent has been to increase transparency

regarding the fees that plans (or participants and beneficiaries) pay for management of plan assets and the provision of services by various service providers

• First foray into new disclosure requirements

– 2009 – first year amended Form 5500 Schedule C issued – Requires reporting of “direct and indirect” compensation received by service providers – Only specific obligation on Plan administrators is to include disclosure (and in certain circumstances to inform government if provider refused to give information)

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Recap of DOL Disclosure Scheme

• Second piece of disclosure requirements – issuance of regulations under

ERISA Section 408(b)(2) – The prohibited transaction rules of 408(b)(2) permit: “Contracting or making reasonable arrangements with a party in interest for . . . services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.” – Also, see DOL Advisory Opinions 97-15A and 97-16A – Regulations regard disclosure as integral to determining if fee is reasonable

• Third disclosure requirements – issuance of ERISA Section 404(a)

regulations requiring disclosures to plan participants and beneficiaries when plan allocates investment responsibilities to participants or beneficiaries, the plan administrator is responsible for providing information to participants regarding the plan's investment options, including fee and expense information.

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Section 408(b)(2) Disclosures

• Section 408(b)(2) regulations provide detailed

guidance on how a “responsible plan fiduciary” (“RPF”) can fulfill its statutory duty

• Initial disclosures from covered service providers

(“CSP”) to responsible plan fiduciaries were due July 1, 2012

• The preamble to the regulation notes:

– The availability of information sufficient to enable the plan fiduciary to make informed decisions about the costs of recordkeeping is fundamental to a responsible plan fiduciary’s ability to satisfy its ERISA obligations.

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Section 408(b)(2) Disclosures

• Who are primary CSPs to plans?

– Fiduciaries, investment advisers, recordkeepers, and broker-dealers to individual account plans, third party administrators and certain other service providers if receiving indirect compensation

10

Section 408(b)(2) Disclosures

• What type of information must CSPs provide?
• Disclosure of Compensation

– “Compensation” may be described or estimated as a monetary amount, formula, percentage of assets, or a per capita charge or, if the compensation cannot reasonably be expressed in such terms, by any other reasonable method. Any description or estimate must contain sufficient information to permit evaluation of the reasonableness of the compensation.

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Section 408(b)(2) Disclosures

• Compensation
• Direct vs. Indirect Compensation:
• 408(b)(2) Regulations generally define indirect

compensation as paid from a person or entity

• ther than the plan or the plan sponsor
• Disclosure of compensation to be paid among

related parties (subcontractors)

• Termination compensation

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Section 408(b)(2) Disclosures

• Disclosure of services to be provided
• Express statement if a fiduciary or registered

investment advisor

13

Recordkeeper Disclosures

• Under the 408(b)(2) Regulations,

recordkeepers must disclose:

– All revenue sharing amounts received (credits or use of proprietary investment options); and – The charges that recordkeepers make to the plan for recordkeeping services (direct charges)

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After July 1 – Responsible Plan Fiduciary Responsibilities

• RPFs must engage in prudent process to evaluate

reasonableness of fees and conflicts of interest highlighted in the disclosures

• Establish a process. Who is primarily responsible

for review? Who has needed skills?

• Engage consultant and other service providers to

provide analysis?

• Need to review and ask questions.
• Contact service providers for additional

information.

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After July 1 – Responsible Plan Fiduciary Responsibilities cont’d

• Questions to consider:

– Are the services provided appropriate? – Are the services provided adequate to meet plan needs? – Is the compensation for the services reasonable? How is this determined? – Are the expenses reasonable? – Are there any conflicts of interest? Are they manageable? – Are there termination costs? – Do the disclosures conform to existing agreements with service providers? – Are the disclosures in correct or incomplete?

• In the first round of disclosures, some RPFs may not have been prepared

because they do not understand the importance of hiring an outside consultant and/or benchmarker – if they do not understand the materials, RPFs may be in a position of not being able to correctly complete the participant disclosures or identify 408(b)(2) disclosures that are incorrect

• r incomplete

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Concerns of Responsible Plan Fiduciaries

• Prudent Process may include:

– Allocate costs to compensation – Calculate dollar amounts – Benchmark amounts – Potentially need to negotiate/renegotiate based

• n benchmarking
• 408(b)(2) Regulations expressly do not
• verride 404(a) fiduciary responsibilities;

prudence rules continue to apply

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Benchmarking

• Why Benchmark?

– Benchmarking may provide RPF with competitive pricing information to help determine reasonableness of fees and expenses as compared to the market – Help RPF find all plan fees, including indirect compensation that may be “hidden” – Provide RPF with monitoring tool to use on

• ngoing basis as part of ordinary prudent review

process

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Benchmarking cont’d

• Can RPF do Benchmarking itself?

– ERISA’s prudent expert rule effectively requires that where fiduciaries are unsure of their expertise, prudence calls for the fiduciary to seek the advice of experts – If RPF is not expert in benchmarking, it should hire an outside expert

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Benchmarking cont’d

• How should RPF choose benchmarking

expert?

• Choosing benchmarking experts presents

various challenges

• If not independent, raises issue of whether plan

fiduciary has met obligation to plan

• can be significant variations in scope, cost and quality
• f benchmarking reports

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Benchmarking – Scope of Analysis

• What should benchmarking report/analysis look

like?

– Should look at and benchmark fees, including plan design input and participant success measures

• success measures are statistics that measure how well a plan

helps participants prepare for retirement and include:

– participation rate – number of participants maximizing match – number of participants using plan advice program

• success measures provide perspective on fees – are

participants getting the most out of what they pay for the plan?

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Benchmarking – Scope of Analysis

• Typical benchmarking process

– identify similar plans for benchmark group – identify all fees – look at plan design and plan complexity and what services are provided

• more complex plans can cost more to administer
• benchmark group should be similar in design and complexity

– identify success measures with respect to recordkeeping services analysis – compare plan to benchmark group on “apples to apples” basis to get a clear picture of where plan stacks up on fees and success measures – make sure plan demographics and statistics match

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Benchmarking – Scope of Analysis cont’d

• Fee comparison
• Look at total plan fees v. benchmark group:

– recordkeeper – investment consultant – managed account provider, if any – investment manager, if any – other service provider

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Benchmarking – Scope of Analysis cont’d

• Look at individual CSP fees v. benchmark

group:

– recordkeeper

• investment fees, managed account fees, ERISA

spending account credit

– investment consultant

• any indirect compensation? commissions?

– investment manager

• investment fees

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Benchmarking – Scope of Analysis cont’d

• Look at investment lineup:

– obtain high-level comparison of fees v. benchmark group – look at how expense ratios of investment options compare to benchmark group – look at how total participant investment expense compares to benchmark group – remember that cost is not everything – fees assessed in combination with investment performance and total services provided

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Benchmarking – Duty to Monitor

• RPF must also monitor benchmarking service

– What is scope of duty to monitor? Same as scope

• f duty to monitor any service provider, such as

recordkeeper, investment manager, etc. – Arrangement must be “reasonable” – look at qualifications of provider, quality of services, reasonableness of fees in light of services

• Benchmarking the benchmarkers

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Benchmarking – Who Pays?

• The fiduciary responsibility rule in ERISA §404(a)(1)(A)

provides:

“A fiduciary shall discharge his duties . . . for the exclusive purpose

• f:

(i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan. . . .”

• Consider whether benchmarking or similar evaluation

services is a “reasonable expense” of administering the plan

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Benchmarking – How will it affect CSP Arrangements?

• Market expectation that benchmarking focus

may potentially drive plans to unbundling recordkeeping services

• Advisers: potentially fixed fees or per service

fees

• Investment options could change: lower-cost

share classes, indexed funds, collective trusts

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Participant Disclosures

• Section 404 of ERISA requires plan fiduciaries to

use the “prudent man standard of care” in carrying out plan duties.

• Final regulation provides that the investment of

plan assets is a fiduciary act governed by ERISA section 404(a)(1)(A) and (B).

• For participant-directed plans such as 401(k)

plans, the plan administrator is responsible for providing information to participants regarding the plan's investment options, including fee and expense information.

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Participant Disclosures

• The 408(b)(2) disclosures are necessary for

preparation of the participant disclosures, but

• nly are useful to the extent that the 408(b)(2)

disclosures are understood by the plan fiduciaries

• The deadline for the initial participant

disclosures was August 31, 2012

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Issues and Challenges

• Under the 408(b)(2) regulations, any number of

entities can be CSPs by acting, by way of example, as an investment manager, recordkeeper, bookkeeper, auditor or attorney

• When services are “bundled”, because one entity

provides, for example, the investment funds platform, recordkeeping and other administrative services, the entity will comprise one CSP and the disclosure to the RPF and participants is relatively straightforward

• A bundled arrangement is relatively common for

participant-directed plans such as 401(k) plans

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Issues and Challenges cont’d.

• However, defined benefit plans may not do “one-stop shopping”

and may have one or more investment managers managing different pockets of the plan assets

• Each such investment manager, might in turn, invest the plan assets

in vehicles such as venture funds or hedge funds

• Because the investment manager is managing plan assets, the

regulation raises the question as to whether the investment manager is not only a CSP but also a RPF because the investment manager has the authority to cause the covered plan to enter into,

• r extend or renew, the contract or arrangement in the underlying

investment vehicles

• If the investment manager is an RPF, should it require 408(b)(2)

disclosures from the funds in which it has invested plan assets?

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Issues and Challenges cont’d.

• If the investment fund does not agree that it is a CSP

because of the investment manager’s intermediary position, the investment manager is still in the position of having to gather enough information to make its own disclosure

• If RPF requests disclosures that RPF believes the

investment manager should have received, what should investment manager do?

• Is it responsible for following process for obtaining

delinquent disclosures (discussed below)?

33

Issues and Challenges cont’d

• 408(b)(2) Regulations provide that “affiliates” include
• fficers, directors and employees of the CSP.
• Rules require that CSP say whether it, an affiliate or

subcontractor will provide fiduciary services.

• Does this mean that CSP must explicitly disclose the

name of the employee working on an account because employee is technically an “affiliate”?

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Issues and Challenges cont’d

• CSP and RPF confusion between disclosure required on Schedule C of a plan’s annual Form

5500 and 408(b)(2) disclosures – Many similarities between disclosure requirements and CSPs have become used to Schedule C items. Arguably less risk with respect to Schedule C because the result of a service provider’s refusal to provide the necessary information is required to be reported to the DOL while the refusal by a service provider to make complete 408(b)(2) disclosures to the RFP results in the arrangement between the plan and the service provider being considered a prohibited transaction for which both the plan administrator and the service provider can be liable (if fiduciary follows certain procedures, only service provider will have liability for prohibited transaction – see below) – On Schedule C, a plan administrator reports compensation paid to plan service providers for that year; the information that a covered service provider must disclose to a plan administrator under 408(b)(2) must be provided before the parties enter into an agreement, upon the renewal of the agreement and upon a modification of the agreement – On Schedule C, a plan administrator reports compensation to a service provider if the compensation equals or exceeds $5,000; under 408(b)(2), compensation threshold is $1,000 or more – Often impossible to allocate to plans

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Issues and Challenges cont’d

• General guidance regarding what CSPs should do if they

simply have not provided timely disclosure and have not yet heard from RPF

– RFP must request disclosure from CSP and give CSP 90 days to respond; if CSP does not respond, RPF must report CSP to DOL, and consistent with its duty of prudence, consider termination of (or terminate) contract or arrangement – Following these steps will exempt RFP from any fiduciary liability but CSP will remain liable for fiduciary lapses

36

Understanding Service Provider Disclosures

• Understanding Fees – the Devil is in the Details

– RPFs need to understand how the fees are calculated – If disclosures are too complicated; for example, if fees are found in the body of the disclosure, but not in the totals, will fiduciaries be able to understand them – If not, RPFs are responsible for requesting additional information from CSPs – Consultants should be able to assist RPFs in wading through the documents to help RPFs make appropriate comparisons

37

Understanding Service Provider Disclosures (cont.)

– Is information set forth in other documents (e.g., an investment management agreement) that have already been provided?

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How to Obtain Delinquent Disclosures

• RPF has not received service provider disclosure or disclosure

is incomplete and needs information for completion of participant disclosure, must contact provider in a “timely” fashion; CSP has 90 days in which to respond,

• If provider does not respond to request within 90 days, then

RPF is obligated to notify the DOL of the provider's failure, and

• CSP’s failure requires RPF to determine, in accordance with its

fiduciary duties, whether it should terminate the contract with the CSP; further, the CSP will be required to terminate contract as soon as possible after the 90-day period if the missing information is related to future services and the CSP has not complied with the request after the 90 day period.

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What Lies Ahead?

• Possibilities include:

– Increased use of benchmarkers and consultants – Decrease in use of “bundled” fees, perhaps leading to lower fees – More frequent changes in plan providers as benchmarking increases – Increased communication between participants and plan administrators – Need to train plan administrators and HR personnel on responding to participant questions and requests

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Sarah E. Downie (212) 506-5234 sdownie@orrick.com Jeffrey Lieberman (212) 878-8013 jeffrey.lieberman@cliffordchance.com Adrienne Ann Scerbak (212) 294-6746 ascerbak@winston.com

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