A Plan Fiduciary’s Guide to the Service Provider Disclosure Rules

February 9, 2012

The Department of Labor (DOL) has finalized rules under which certain retirement plan service providers (“covered service providers”) must disclose fee and other information to the plan fiduciaries responsible for retaining those covered service providers (“responsible fiduciaries”). The disclosure rules take effect on July 1, 2012, and apply to all arrangements with covered service providers that are in place on that date or that are entered into after that date. There is no grandfathering of existing covered service provider arrangements or contracts.

Meeting the requirements of the disclosure rules will now be necessary in order for many types of service provider arrangements to comply with ERISA’s prohibited transaction restrictions. A responsible fiduciary who causes a plan to enter into an arrangement with a covered service provider without obtaining the disclosures required under the rules can be subject to fiduciary liability under ERISA for permitting the plan to engage in a prohibited transaction. In addition, responsible fiduciaries have an obligation to consider the information contained in the disclosure when selecting and monitoring covered service providers. If a responsible fiduciary fails to obtain and adequately consider information relevant to the selection or retention of a service provider, that failure may constitute a breach of its fiduciary duties under ERISA.

The following summarizes the requirements of the disclosure rules and highlights key issues that responsible plan fiduciaries will need to address.

How do the New Rules Change Existing ERISA Requirements?

ERISA Section 406(a)(1)(C) prohibits a plan from paying a party in interest to provide goods, services or facilities to the plan. Because the term “party in interest” includes any party that provides services to a plan, an exemption from this prohibition is necessary for most service provider arrangements with a plan. The most commonly used exemption allows a party in interest to provide office space, legal, accounting or “other services” to a plan if each of the following conditions is met:

  • the contract or arrangement is reasonable;
  • the services are necessary for the establishment or operation of the plan; and
  • the plan pays no more than reasonable compensation for the services.

Beginning on July 1, 2012, an arrangement with a covered service provider will not be a “reasonable contract or arrangement” for purposes of the exemption unless the covered service provider timely furnishes to the responsible fiduciary the information required under the new disclosure rules. If an existing covered service provider does not comply with the disclosure rules, the responsible fiduciary must take specific actions under a special prohibited transaction exemption that the DOL has established to address such non-compliance (as discussed more fully below).

Which Plans are Subject to the New Rules?

The new rules apply to a broad range of retirement plans, including Code Section 401(k) plans, defined benefit pension plans, employee stock ownership plans, profit sharing plans, cash balance plans, money purchase plans or other retirement plans subject to ERISA. For these purposes, Code Section 403(b) plans that are subject to ERISA are also considered covered plans. However, a Section 403(b) annuity contract or custodial account that is otherwise subject to ERISA is excluded from the disclosure requirements where: (1) the annuity contract or custodial account was issued to employees before Jan. 1, 2009; (2) the plan sponsor has ceased making contributions to the contract or account (including ceased contributing employee deferrals); (3) the individual employees can enforce the contract or account without the plan sponsor’s involvement; and (4) the employees are fully vested in the amounts in the contract or account.

The new rules do not apply to simplified employee pension plans (SEPs), SIMPLE plans, IRAs or welfare benefit plans. Responsible fiduciaries of these plans must continue to comply with the other requirements of existing rules and must generally determine whether a service provider arrangement is “reasonable,” but are not required to receive the disclosures required under the new rules. The DOL has held hearings on extending the disclosure rules to providers of services to welfare benefit plans, but has not yet taken action to do so.

Who are Covered Service Providers?

The rules apply to arrangements for services rendered on behalf of a plan where the covered service provider reasonably expects to receive, directly or indirectly, $1,000 or more in compensation in connection with providing the services specified under the arrangement. Compensation for this purpose means money and other forms of payment for services, other than a non-monetary payment that is valued at $250 or less in the aggregate during the term of the contract. A service provider who is otherwise subject to the rules must meet the disclosure requirements even if the services will be performed, or the compensation will be received, by an affiliate or subcontractor of the service provider.

If the compensation threshold is met, the following types of service providers are covered service providers subject to the disclosure rules:

  1. Fiduciaries and investment advisers. This category includes any provider that renders services either as an ERISA fiduciary, or as an investment adviser registered under state law or the Investment Advisers Act of 1940. Covered fiduciaries include persons or entities that provide fiduciary 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. 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, would each be covered service providers. 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 service providers only if they provide services directly to the plan. Therefore, an adviser retained by a participant solely to invest the participant’s account for a fee would not be a covered service provider.
  2. 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 rules 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 rules. 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 category.
  3. Direct providers of certain services who receive indirect compensation. Providers of certain other specified services are included as covered service providers if they (or their affiliates or subcontractors) reasonably expect to receive “indirect compensation.” 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. For example, 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 (and its affiliates and subcontractors) does not receive any other compensation from other parties with respect to the plan.

What Must be Disclosed to Responsible Fiduciaries?

The following items of information must be disclosed by a covered service provider to the responsible fiduciary.

Description of the services to be provided. The rules provide flexibility in determining how specific the description must be. However, the DOL has cautioned that the responsible fiduciary has a duty to determine whether the description is sufficiently detailed to enable it 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 with respect to the plan (as well as the status of their affiliates or subcontractors), as a fiduciary and/or registered investment adviser.

Compensation to be paid. The rules require that all compensation that the service provider will receive in connection with the contract or arrangement, whether direct or indirect, be disclosed to the plan fiduciary. Direct compensation is defined as compensation received directly from the covered plan, and also includes compensation that is initially paid by the plan sponsor and then is reimbursed from the plan. Indirect compensation is compensation from any source other than the covered plan and is usually fees paid among covered service providers and their affiliates and subcontractors, such as commissions, soft dollars, finder’s fees, Rule 12b-1 fees and other incentive pay based on placing or retaining business. The rules require specific identification of the services for which such fees are paid, the payers and recipients of such compensation and a description of the arrangement between the payer and the recipient of the compensation. The DOL has clarified in the final rules that whether indirect compensation is received “in connection with” the contract or arrangement is to be broadly interpreted. By example, the DOL indicates that subsidies that a plan investment consultant receives from investment managers to host a conference for its plan clients would need to be disclosed by the consultant to such clients. Covered service providers must also disclose any compensation that they, 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.

Investment-related information. Any covered service providers who are fiduciaries of investment vehicles that hold plan assets must disclose to the responsible fiduciary any compensation that 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). Also, recordkeepers and brokers that provide platforms to plans for participant investment direction must provide an array of information about the investment options that they will make available within the plan. As discussed below, this information is required to be passed through to participants by the plan administrator under the participant-level disclosure rules that also become effective during 2012.

Manner of payment. The disclosure must describe whether the plan will be billed directly or plan participants’ accounts will be charged by the covered service provider.

What Additional Disclosures Must Recordkeepers 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 good faith estimate must include an explanation of the methodology and assumptions used to prepare the estimate and a detailed explanation of the recordkeeping services to be provided. 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 offered by the plan for which recordkeeping or brokerage services will be provided. This obligation can be satisfied by providing current disclosure materials from the investment issuers, such as prospectuses for registered mutual funds or information replicated from such materials, as long as (1) the investment issuer is a regulated entity that is not an affiliate of the covered provider, and (2) the covered provider represents truthfully and in writing to the responsible plan fiduciary that it has acted in good faith in the provision of such materials and has no knowledge that the materials are incomplete or inaccurate.

When Must the Disclosures be Provided?

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 that 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, other than investment-related information, 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 rules do not limit this obligation to instances of “material” changes. The covered service provider must disclose changes in investment-related information at least annually.

How Must the Disclosures be Provided?

The disclosures must be provided in writing, but may be provided electronically as long as the electronic information is readily accessible to responsible plan fiduciaries who have received clear notification on how to gain such access.

The DOL has not yet required that the disclosures be provided in any uniform format. However, the DOL has indicated that it is considering adding a requirement that covered service providers provide a uniform guide or other similar tool along with the required disclosures. The DOL has developed a sample guide for how the initial required disclosures might be presented. The sample is a one-page summary of the key information required to be disclosed, with instructions as to where the responsible fiduciary can locate more detailed information. The DOL intends to ask for additional comments in the near future on the utility and design of a standardized form for providing the necessary disclosures.

What Other Requirements Must be Met for the Arrangement to be Considered “Reasonable”?

As 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 rules did not make any changes to this requirement.

How do the Rules Impact a Plan’s Reporting Obligations?

Responsible plan fiduciaries and plan administrators may 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 participant disclosure requirements under ERISA. The covered service provider must generally respond to these requests “reasonably in advance” of the date upon which the fiduciary or plan administrator states that it must comply with any applicable reporting or disclosure requirement.

Is There Any Relief Available for Errors Made in the Disclosure?

An error or omission in required disclosures will not result in a violation of the rules, provided: (1) good faith effort and reasonable diligence were used by the covered service provider in making the disclosures, and (2) 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.

How can Responsible Fiduciaries Avoid Penalties in the Event of Service Provider Non-compliance with the Disclosure Requirements?

The rules include a limited exemption from ERISA’s prohibited transaction rules where the requirements of the rule are not met due to a covered service provider’s failure to make the proper disclosures. The exemption protects a responsible plan fiduciary if it did not know of the disclosure failure, provided that it takes certain actions. When the fiduciary discovers the failure, it must make a written 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 fiduciary must notify the DOL of the failure (in a specific format specified in the rules) and must evaluate whether to terminate or continue the contract with the delinquent provider in a manner consistent with its ERISA fiduciary responsibilities. If the requested information relates to future services and is not disclosed promptly after the end of the 90-day period, the rules require that the fiduciary act expeditiously to terminate the contract or arrangement.

How do the Disclosure Rules Impact a Responsible Fiduciary’s Obligation to Prudently Select and Monitor Plan Service Providers?

A fiduciary’s decision to retain a plan service provider is subject to the general standards of fiduciary responsibility imposed under Section 404(a) of ERISA. The DOL interprets Section 404(a) as requiring that a responsible fiduciary must, before entering into a service provider arrangement, “obtain and carefully consider” information necessary to assess the services to be provided, the reasonableness of the fees for those services and any potential conflicts of interest that could affect the quality of the services.

This general fiduciary obligation is independent of the obligation to avoid having a plan engage in transactions that are prohibited under ERISA. Thus, responsible fiduciaries need to be aware that the information disclosed by a covered service provider in compliance with the new disclosure rules may not, in and of itself, be sufficient for a responsible fiduciary to make a fully informed decision as to whether to engage or continue to retain the service provider. Responsible fiduciaries should consider what additional information beyond the required disclosures may be necessary for them to adequately assess and monitor service providers, in accordance with their fiduciary responsibilities under ERISA. Such information would help them assess the quality of the provider’s services. In fact, the disclosure requirements regarding indirect compensation were designed by the DOL to help highlight for responsible plan fiduciaries potential conflicts of interest that could compromise the provider’s services or impact the overall reasonableness of the fees paid for those services.

Which Service Provider Arrangements are not Subject to the Disclosure Rules?

As noted above, only contracts or arrangements with covered service providers are subject to the new disclosure rules. Thus, for example, a provider of custodial services to a defined contribution plan or an actuary for a defined benefit plan, neither of whom receive any indirect compensation in connection with the services they provide, would not be covered service providers and thus would not be subject to the disclosure requirements.

In addition, some service provider arrangements may qualify for another exemption from ERISA’s prohibited transaction restriction, in which case the disclosure rules described above would not apply (although separate disclosure conditions may apply under those other exemptions). Examples of alternative exemptions are the exemptions for bank collective trusts and certain insurance company accounts; the qualified professional asset manager (QPAM) and in-house asset manager (INHAM) exemptions; and the exemption for “ancillary services” provided by a bank. However, the DOL may in the future extend the same or similar disclosure rules to some or all of these alternative exemptions.

How Should Responsible Fiduciaries Prepare for the New Rules?

For the reasons discussed above, responsible fiduciaries should not view the new disclosure rules as a compliance issue solely for covered service providers. Responsible fiduciaries need to take steps to confirm that their covered service providers furnish disclosures according to the new rules (thereby insuring that the prohibited transaction exemption for reasonable administrative services will apply). In addition, responsible fiduciaries need to evaluate the content and sufficiency of those disclosures in order to fulfill their general fiduciary duty to prudently select and monitor plan service providers. Finally, responsible fiduciaries should be mindful that the new disclosures are likely to generate greater scrutiny of the actions taken by responsible fiduciaries in selecting and continuing to retain plan service providers, particularly in light of recent litigation challenging the reasonableness of plan service provider compensation.

The following are some steps that responsible fiduciaries should consider incorporating into their existing processes for selecting and monitoring plan service providers:

  • Update/create an inventory of all service providers and determine which are subject the new rule. Proper identification of covered service providers will be essential for responsible fiduciaries to ensure compliance with the new rules.
  • Confirm that covered service providers are aware of and planning to timely provide the required disclosures. Confirm in advance with each of the plan’s existing covered service providers that they are aware of the rule and will provide the plan with the required disclosures by the July 1 effective date.
  • Obtain and review disclosures. Evaluate whether the disclosures meet the technical requirements of the rules and whether the disclosures are consistent with responsible fiduciaries’ expectations and understanding of the service arrangement (i.e., direct compensation, indirect compensation, use of affiliated service providers, etc.). The DOL has indicated that, as part of the “duty to carefully review the information they receive when entering into a contract or arrangement for plan services,” responsible fiduciaries must consider whether disclosures regarding the receipt of indirect compensation indicate potential conflicts of interest that could compromise a service provider’s ability to provide services effectively at a reasonable cost to the plan.
  • Document the review of disclosures and actions taken as a result. This can be done in meeting minutes or in a report provided to the plan fiduciaries by plan administrative personnel or other agents of the fiduciaries. Actions taken as a result of such a review, such as requests for supplementary disclosures, and the reasons for such actions should similarly be documented.
  • Incorporate the disclosures into the process of monitoring covered service providers. Consideration should be given to how disclosures will be used on an ongoing basis to evaluate service providers. For example, if a Section 401(k) plan recordkeeper discloses that it receives indirect compensation from various affiliated or unaffiliated investment options offered under its recordkeeping platform, the plan’s fiduciaries may need to consider whether they should negotiate for a rebate of some of that revenue or an offset against other expenses charged to the plan.
  • Have ongoing compliance processes in place for new and renewed service provider arrangements. As noted above, disclosures must be made “reasonably in advance” of the date on which a service provider contract or arrangement is first entered into. Disclosure must again be provided when the contract or arrangement is extended or renewed. Plan fiduciaries should have controls in place to ensure that these requirements will be met each time there is a new engagement of a covered service provider or renewal of an existing service provider’s contract.

What Relationship do These Rules Have to the New Participant-Level Disclosure Rules?

Beginning this year, administrators of retirement plans that allow for participant investment direction (excluding simplified employee pension (SEP) plans and simple retirement accounts (SIMPLE plans)) will need to begin providing participants a detailed array of information regarding the plan’s available investment options (referred to as the participant-level disclosure rules). For details, see our previous alert. Recordkeepers and brokers for plans that permit participant investment direction must include in their disclosures to the plan specific items of information about the investment options they provide as part of their services so that plan administrators will have information necessary to provide to plan participants. This includes basic descriptive information for the investment option (such as its name and investment category), performance data, benchmarks, and fee and expense information. In addition, covered service providers may also have to provide to the plan other information required under the participant-level disclosure rules, to the extent that information is within their control or reasonably available to them, such an investment option’s investment objective, principal strategies and risks, and portfolio turnover rates. In light of the delay in the effective date for the service provider disclosure requirements, the DOL has announced a delay in the effective date for the participant-level disclosure rules. Plan administrators for calendar year plans now must make the initial annual disclosure to participants under those rules by no later than Aug. 30, 2012, and the first quarterly statement (for fees incurred July through September) must be furnished no later than Nov. 14, 2012.