The Employee Retirement Income Security Act (ERISA) is one of the main
federal laws that govern the operation of employer-sponsored retirement
plans. Among the many topics it covers, ERISA sets forth the rules that
apply to plan fiduciaries. Generally speaking, plan fiduciaries include
those who have discretion over the administration or assets of a plan as
well as those who provide investment advice to a plan for a fee. Since its
passage in 1974, ERISA has included a requirement that a plan can only pay
reasonable fees for required services such as recordkeeping, compliance or
government reporting. If a plan pays fees that are not reasonable, such
payments are prohibited transactions subject to penalties by the DOL and
While this requirement may seem, well… reasonable, service providers have
not been legally obligated to disclose their compensation. That was not as
much of a challenge in 1974 when the predominant type of retirement plan was
the defined benefit plan. However, as the retirement plan world shifted from
defined benefit to defined contribution daily-valued, participant-directed
401(k), the platforms and financial products became more sophisticated and
complex. Service providers began receiving compensation via expenses built
into plan investments rather than by directly billing plan sponsors. Some
providers began marketing their services as no- or low-cost since their fees
were being subsidized by the investments rather than being billed to the
plan or the plan sponsor.
Having a plan automatically pay to operate itself might be convenient,
but it may result in plan fiduciaries who are unable to dissect complex fee
structures to determine how much each service provider is being paid. If
fiduciaries do not know the amount of the fees, there is no way they can
determine whether those fees are reasonable. With fee structures differing
from provider to provider, it has also become difficult for fiduciaries to
compare the fees and services of multiple vendors to determine which offers
the best value.
Recognizing this growing disconnect, the DOL embarked on a three-pronged
initiative to help ensure that fiduciaries have access to information they
need to fulfill the reasonableness requirement. First is the expanded fee
reporting on Form 5500, Schedule C, which was effective for plan years
beginning in 2009 and is generally required for plans with more than 100
participants. The second prong is the required disclosure to plan
participants at various times throughout the year.
Third is the requirement for service providers to disclose fee and
service information to plan sponsors. Regulations implementing this
requirement were first proposed in December 2007. After being revoked,
re-proposed and semi-finalized, the sponsor-level fee disclosure regulations
were finalized in February of this year.
The short answer is "No." The regulations coin a new term "Covered
Service Provider" (CSP) to describe those subject to the rules. CSPs fall
into three general categories:
These might seem straightforward, but the devil is in the details. Let's
consider several examples to help clarify.
The first category clearly indicates that Registered Investment Advisors
and other fiduciary advisors are CSPs. But, what about those who are
non-fiduciary brokers? Such individuals do not fit into the first category;
however, since they typically receive commissions, they are CSPs under the
This group seems relatively clear-cut. Any vendor, regardless of how it
is compensated, that provides the investment platform to a
participant-directed, defined contribution plan is a CSP. However, there are
some nuances. Assume an investment professional provides the investment
platform and partners with a separate firm who provides recordkeeping. In
this case, the investment professional, not the recordkeeper, is likely the
platform provider; therefore, the recordkeeper would probably not be a
category 2 CSP. However, since most recordkeepers receive revenue sharing
payments, they will typically be category 3 CSPs.
TPAs cannot be classified as a group because their services and
compensation arrangements can vary widely. Consider a TPA that provides
annual compliance testing and government reporting services but does not
provide recordkeeping. If all fees are paid by the plan sponsor or directly
from the plan, that TPA is not a CSP and is not subject to the new fee
disclosure requirements. This is due to the fact that all fees are being
paid directly and are, presumably, readily identifiable.
However, assume that the same firm regularly partners with an insurance
company for recordkeeping services. The insurance company pays the TPA a
marketing allowance based on the combined assets of all mutual clients. That
marketing allowance is indirect compensation, making the TPA a category 3
Whether other providers are CSPs depends largely on how they are
compensated. Attorneys and accountants generally will not be CSPs since
their typical compensation structures do not include indirect compensation.
The regulations require that the fees paid to affiliates or subcontractors
of a CSP must also be disclosed, so it is important to consider the
relationships service providers may have with other companies. Since those
affiliates often have no direct relationship with the plan, the CSP must
include their compensation with its disclosure.
Regardless of the category, a service provider must have a reasonable
expectation that its fees will be $1,000 or more under the life of its
contract with the plan in order for it to be a CSP.
There is quite a list of information a CSP must provide to a covered
plan. It is all designed to help plan fiduciaries understand the fees being
paid and the services to which they relate. In addition, full disclosure of
all compensation will help highlight any potential conflicts of interest in
the recommendations that service providers make to their clients.
Who: The CSP must identify itself and,
if applicable, provide a written statement that it will provide services as
a fiduciary or a Registered Investment Advisor.
What: The CSP must identify the services
it provides to a plan under the contract or arrangement.
How: The CSP must describe how it will
receive each category of compensation. For example, some fees may be
directly billed to the plan, while others may be deducted from investment
returns or paid via revenue sharing.
How Much: The CSP must report all direct
and indirect compensation paid to itself and/or any affiliates and should
include anything of monetary value, e.g. gifts, trips, etc. The fees should
be tied to the services to which they relate, and for indirect compensation,
the payer must also be identified. If recordkeeping is part of a bundle of
services and the CSP is unable to determine the portion of total
compensation related to that service, the CSP must provide a reasonable,
good-faith estimate or use the prevailing market rate for similar services.
If there are any fees related to the termination of the agreement, the CSP
must disclose those in addition to providing a description of how any
pre-paid amounts will be pro-rated and refunded.
In addition to the above, fiduciary CSPs are required to provide general
information about the investment options offered under the plan, including
expense ratios, wrap fees, historical rates of return, comparisons to
The goal of the regulations is to ensure plan fiduciaries have the
information to determine if a service provider's fees are reasonable in
advance of making the hiring decision. If a plan has already hired a service
provider that is a CSP, the CSP must provide the initial disclosures no
later than July 1, 2012. For all future arrangements, the CSP must disclose
"reasonably in advance of the date the contract is entered into, extended or
renewed." The inclusion of the words "extended or renewed" can present a
trap for the unwary. It is not uncommon for a contract to expire (after one
or two plan years) and automatically renew each year thereafter. In those
instances, the disclosures must be provided each year prior to the renewal
In many situations, the investment menu is not determined until after the
contract is signed. How can the CSP provide all the investment disclosures
in advance? If this circumstance occurs, the investment information must be
provided no later than 30 days after the CSP knows which platform, funds,
etc., will be used.
When any of the previously disclosed information changes, the CSP must
communicate those changes as soon as possible but no later than 60 days
after becoming aware of the change.
The DOL has made compliance an integral part of the reasonable fee
requirement; therefore, if there is no disclosure, the fees are
automatically deemed unreasonable. That means there is a prohibited
transaction. The non-disclosing CSP is subject to an excise tax equal to 15%
of the amount involved and may be required to unwind the arrangement by
returning the fees collected.
Prohibited transaction penalties usually apply to all parties involved,
which means the plan representative making the hiring decision (the
responsible plan fiduciary) may also be on the hook. However, the
regulations provide some relief if the responsible plan fiduciary did not
know the CSP was non-compliant and, immediately upon discovering the
failure, made a written request to the CSP for the required disclosures. If
the CSP does not respond to the request within 90 days, in order to avoid
liability for the prohibited transaction, the responsible plan fiduciary
must notify the DOL in writing of the CSP's failure and may be required to
fire the CSP.
The service provider fee disclosure rules are effective on July 1, 2012.
In addition, since the participant-level fee disclosure rules are so closely
linked, their effective date has also been pushed back to July 1st. For
existing service provider arrangements, plan sponsors should expect to
receive the required disclosure information no later than that date. The
initial annual participant disclosure is due August 30, 2012 (60 days after
the effective date) and the initial quarterly participant disclosure is due
November 14, 2012 (45 days after the close of the first quarter after the
It will be interesting to see how these new rules unfold. But one thing
is for sure… plan sponsors and participants will not have any shortage of
reading material by the end of this year.
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This newsletter is
intended to provide general information on matters of interest in the area
of qualified retirement plans and is distributed with the understanding that
the publisher and distributor are not rendering legal, tax or other
professional advice. Readers should not act or rely on any information in this
newsletter without first seeking the advice of an independent tax advisor such
attorney or CPA.
© 2012 Benefit Insights, Inc. All rights reserved.
The purpose of the new disclosure requirements is to ensure participants and beneficiaries have access to adequate information to enable them to comparison shop among investment options to make informed investment decisions.
Below is a general overview of the regulations' key disclosure requirements that become effective in 2012.