The Department of Labor (DOL) has issued new rules requiring disclosure of
information in connection with services provided to ERISA-covered employee
benefit plans. The rules consist of new regulations that interpret Section
408(b)(2) of ERISA and include a new prohibited transaction exemption.
Section 408(b)(2) requires that a service provider arrangement and the
compensation payable under the arrangement be reasonable in order for the
arrangement not to violate ERISA’s prohibited transaction rules. The new
regulations impose disclosure obligations that a service provider must meet for
the Section 408(b)(2) exemption to apply. The prohibited transaction exemption
provides relief for plan fiduciaries who are responsible for engaging service
providers (responsible fiduciaries), if they unknowingly fail to receive all of
the information required to be disclosed under the regulations. This WorkCite
provides an overview of the new regulations and the prohibited transaction
exemption from the perspective of their impact on responsible fiduciaries and
What is the Importance of Section 408(b)(2) for Responsible Fiduciaries?
ERISA Section 406(a)(1)(C) prohibits the furnishing of goods, services or
facilities between a plan and a party in interest to the plan. Because a “party
in interest” includes any party that provides services to a plan, service
arrangements generally are prohibited unless they qualify for an exemption.
Section 408(b)(2) provides such an exemption by permitting plans to arrange
for a party in interest to provide office space, legal, accounting or “other
- the contract or arrangement is reasonable,
- the services are necessary for the establishment or operation of the
- no more than reasonable compensation is paid for the services.
The new regulations revise existing Section 408(b)(2) regulations that
describe conditions which must be met for a services contract or arrangement to
be “reasonable.” Other provisions of existing regulations continue to apply,
such as standards for determining when a service is “necessary,” what is
“reasonable compensation,” and special considerations for arrangements that
involve conflicts of interest for plan fiduciaries. In addition, the new
regulations do not affect other prohibited transaction exemptions that may be
available for certain services, such as exemptions for specific types of
services provided by a bank or an insurance company.
What Do the New Regulations Generally Require?
The regulations impose information disclosure requirements on providers of
certain types of services to certain types of ERISA plans. The regulations also
explain what are reasonable termination provisions for services contracts.
What Plans are Subject to the New Regulations?
The new regulations apply to all ERISA “employee pension benefit plans.” This
includes Section 401(k) plans and other types of retirement plans, such as
defined benefit pension plans, employee stock ownership plans, profit sharing
plans, and ERISA-covered Section 403(b) plans. SEPs, SIMPLE plans and IRAs are
not subject to these regulations.
The new regulations also do not apply to welfare benefit plans. The DOL has
reserved the possibility of expanding the rules to cover welfare benefit plans
in the future. Until further guidance is issued, responsible fiduciaries of
welfare benefit plans must continue to comply with the other requirements of
existing regulations and must generally determine whether a service provider
arrangement is “reasonable,” but are not required to obtain the new information
that covered service providers must disclose to fiduciaries of retirement plans.
Which Service Providers are Covered by the New Regulations?
The regulations apply to arrangements for services rendered on behalf of a
plan for compensation. Compensation means money and other forms of payment for
services, other than a non-monetary payment that is less than $250 in value. In
addition, only arrangements under which the service provider is expected to
receive $1,000 or more in compensation are covered by the new requirements.
General Categories of Service-Provider Relationships Covered by the
- Fiduciaries and investment advisors. The new regulations
apply to any arrangement where a provider renders services either as an
ERISA fiduciary, or as an investment advisor registered under state law or
the Investment Advisors Act of 1940. The fiduciary category includes persons
who provide services directly to the plan, or who provide fiduciary services
to an investment contract, product or entity in which a plan makes a direct
equity investment. This would include, for example, a discretionary
investment manager who is hired by a plan to invest its assets, as well as
an investment manager who has discretionary investment authority over an
investment account in which the plan makes a direct investment. This
category does not include a provider of investment management services to
asset pools that do not consist of ERISA “plan assets,” such as mutual funds
registered under the Investment Company Act of 1940. Investment advisers are
covered in this category by the new regulations only if they provide
services directly to the plan. Therefore, an adviser retained by a
participant to invest only the participant’s account for a fee would not be
- Certain providers of recordkeeping or brokerage services.
Providers of recordkeeping or brokerage services to individual account plans
(such as Section 401(k) plans) that permit participants to direct the
investment of their plan accounts are subject to the new regulations if the
service provider also arranged for one or more of the investment
alternatives available under the plan. For this purpose, “recordkeeping”
includes a broad array of services, including enrollment, payroll deductions
and contributions, offering plan investment options, processing of loans,
withdrawals and distributions, as well as maintaining participant accounts,
records and statements. Therefore, a bank, brokerage firm or mutual fund
company that provides an administrative platform for a Section 401(k) plan
will generally be required to comply with the new regulations. However, a
firm that solely provides recordkeeping services to a plan but does not
provide plan investment options (either directly or through an affiliate or
subcontractor), generally would not be a covered service provider in this
- Providers of certain services who receive indirect compensation.
Providers of certain other specified services are included as
covered service providers if they reasonably expect to receive indirect
compensation from the plan or receive certain types of payments from
related parties. For this purpose, indirect compensation means compensation
received from a source other than the plan, the plan sponsor, the covered
service provider, an affiliate or a subcontractor, or compensation paid by a
related party. The categories of included services are accounting, auditing,
actuarial, appraisal, banking, custodial, insurance, investment advice (to
the plan or participants), legal, recordkeeping, brokerage, plan
administration or valuation services. Covered services also include
consulting services related to the development or implementation of
investment policies or objectives, or the selection or monitoring of service
providers or plan investments. As a result, a firm that provides actuarial
services to a plan and which is paid directly by the sponsor of the plan for
those services would not be subject to the new information disclosure
requirements, so long as the firm does not receive any other compensation
from other parties with respect to the plan.
What Information Must Covered Service Providers Disclose?
The following items of information must be provided by a covered service
- Description of the services to be provided. The
regulations provide flexibility in determining how specific the description
must be. However, the DOL has cautioned that responsible fiduciaries have a
duty to determine whether the description is sufficiently detailed to enable
them to determine whether the compensation payable for the services is
reasonable. As a result, responsible fiduciaries will need to determine
whether a services description is sufficiently detailed, and may need to
request additional information in some cases.
- Statement of service provider’s status. Covered service
providers must disclose their status to the plan, specifically status as a
fiduciary or registered investment advisor.
- Compensation to be paid. The regulations require that
all compensation, whether direct or indirect, be disclosed to the plan
fiduciary. Covered service providers must disclose the services to which any
indirect compensation relates and from whom they receive such compensation.
This requirement also applies to indirect compensation paid among covered
service providers and their affiliates and subcontractors, such as
commissions, soft dollars, finder’s fees and Rule 12b-1 fees. The
regulations require specific identification of the services for which such
fees are paid, and the payers and recipients of such compensation. Finally,
the regulations also require disclosure of any compensation that the service
provider, an affiliate or a subcontractor reasonably expects to receive in
connection with the termination of the contract or arrangement, and how any
amounts that were prepaid by the plan will be calculated and refunded at the
time the contract is terminated.
- Manner of payment. The disclosure must describe whether
the plan will be billed directly or plan participants’ accounts will be
charged by the provider.
- Investment-related information. Any covered service
providers who are fiduciaries of investment vehicles which hold plan assets
must disclose to the responsible fiduciary of an investing plan any
compensation which will be charged against the invested amounts (e.g., sales
loads, redemption fees, surrender charges and account fees), the annual
operating expenses if the return is not fixed (e.g., expense ratio), and any
ongoing expenses, aside from the annual operating expenses (e.g., wrap fees,
mortality and expense fees).
What Additional Disclosures Must Recordkeepers and Brokers Provide?
In addition to the general disclosure requirements described above, covered
providers of recordkeeping services must describe all direct compensation (i.e.,
plan-paid) and indirect compensation that the provider, an affiliate or a
subcontractor reasonably expects to receive under the recordkeeping arrangement.
In addition, if the provider of recordkeeping services is not expected to
receive explicit compensation for its services, or if its compensation will be
offset or rebated based on other compensation it will receive (or that an
affiliate or subcontractor will receive), the disclosure must include a “good
faith estimate” of the cost of those recordkeeping services. The DOL’s stated
intent behind this requirement is to provide responsible fiduciaries with more
complete and meaningful information to evaluate recordkeeping services,
especially in cases where these services are “bundled” with other services.
Covered providers of recordkeeping and brokerage services must also furnish
the specific investment disclosures described above for each of the investment
alternatives that they provide under the plan. This obligation can be satisfied
by providing current disclosure materials from those investment providers, such
as prospectuses for registered mutual funds.
When Must the Disclosures be Made?
The disclosures must be made “reasonably in advance” of the date
on which the contract or arrangement is first entered into. Disclosure must
again be provided when the contract or arrangement is extended or renewed.
Special timing rules apply for disclosures that must be provided if an
investment vehicle which did not previously hold ERISA “plan assets” later holds
plan assets, and when new investment alternatives are added to a plan under a
recordkeeping or brokerage arrangement.
If there is a change in any of the information required to be disclosed, the
covered service provider must report such change to the plan fiduciary as soon
as practicable, but generally not later than 60 days after the covered service
provider is informed of the change. The regulations do not limit this obligation
to instances of “material” changes.
How are the Disclosures to be Made?
The disclosures must be provided in writing. The DOL has not developed any
model format for making the disclosures. However, the DOL has indicated that it
is considering adding a requirement that covered service providers provide a
one- or two-page summary of the key information required to be disclosed, with
instructions as to where the responsible fiduciary can locate more detailed
What Other Requirements Apply under the Regulations?
As was required under prior law, a plan must have the ability to terminate
the arrangement without penalty on reasonably short notice in order for the
exemption to apply. The new regulations did not make any changes to this
How Do the Rules Impact a Plan’s Reporting Obligations?
Responsible plan fiduciaries and plan administrators may receive upon request
from covered service providers any other information relating to the
compensation received under a contract or arrangement for services, to the
extent that information would be required for the covered plan to comply with
ERISA’s reporting and disclosure rules. This requirement is designed in part to
help plans complete Schedule C of Form 5500, which requires disclosure of
certain compensation received by service providers. The requirement is also
designed to allow responsible fiduciaries to respond to participants’ requests
for additional information, which may be necessary for a plan to meet the
requirements of ERISA Section 404(c). Covered service providers must generally
respond to these requests within 30 days.
Is There Any Relief Available for Errors Made in the Disclosure?
Assuming that good faith efforts and reasonable diligence was used by the
covered service provider in making the disclosures, the regulations provide that
the contract will not fail to be reasonable as a result of an error or omission
in the disclosure, as long as the covered service provider provides the correct
information to the plan fiduciary as soon as practicable, but no later than 30
days after the covered service provider knows of the error or omission.
What Relief Does the Prohibited Transaction Exemption Provide?
The regulations include a limited class exemption from ERISA’s prohibited
transaction rules where the requirements of the regulation are not met due to a
covered service provider’s failure to make the proper disclosures. The class
exemption protects a responsible plan fiduciary if the fiduciary did not know of
the disclosure failure, the plan fiduciary makes a formal request to the covered
service provider for the necessary information, and if the covered service
provider does not furnish the requested disclosures within 90 days, the plan
fiduciary notifies the DOL of the failure. The regulations provide that specific
information, such as the covered service provider’s contact information and
details of the plan fiduciary’s formal request for information, be provided in
the notice to the DOL.
When are the Regulations Effective?
The regulations are effective July 16, 2011, and will apply to contracts and
arrangements in place prior to the effective date, as well as those signed on
and after that date. The DOL has solicited comments on these regulations and may
modify them prior to next year. As a result, plan sponsors and fiduciaries
should continue to monitor developments in this area.
What Other Issues Must Responsible Fiduciaries Consider when Contracting
for Plan Services?
In addition to considering the requirements of the new regulations,
responsible fiduciaries must also act prudently and in the sole interest of
participants and beneficiaries when entering into service provider arrangements.
Compliance with the requirements of the Section 408(b)(2) prohibited transaction
exemption does not itself establish that responsible fiduciaries have fulfilled
these duties. Instead, responsible fiduciaries must generally show that they
obtained and carefully considered information necessary to evaluate the services
of a proposed provider, the reasonableness of the fees for that provider’s
services, and whether there are any potential conflicts of interest that could
affect the quality of those services. This may be accomplished by showing that
responsible fiduciaries engaged in a selection process that took into
consideration these and other pertinent factors.