Reasonable Contract under ERISA 408(b)(2)
Disclosure Requirements
In 2008, we issued a series of ErisaALERTs discussing the proposed regulations regarding fee transparency (Plan participants, Reasonable Contract, 2009 Schedule C). The Obama administration delayed finalization of the regulations pending the new administration’s review. The wait is over; interim final regulations regarding the Reasonable Contract were issued on July 16, 2010. Interim final regulations mean you can rely on them as final but they are subject to change. Comments can be submitted to the DOL until August 30, 2010. In this ErisaALERT, we will cover the basics of the interim proposed regulations.
Bottom line:
- The interim final regulations are effective July 16, 2011. As noted above, comments can be submitted to the DOL until August 30, 2010.
- ERISA requires that only reasonable expenses be paid from plan assets.
- No contract or service agreement between a “covered service provider” and a “covered plan” will be reasonable unless the regulations are satisfied.
- If you meet the definition of “covered service provider” and “covered plan”, all contracts/agreements must be in compliance with the regulations on July 16, 2011 regardless of when the agreement/contract was established.
- The “covered service provider” who reasonably expects to receive more than $1,000 must provide certain disclosures.
- The responsible plan fiduciary must make sure they receive the required disclosures.
- If you are subject to the regulations and don’t follow them (this applies to both the plan sponsor of a covered plan and the covered service provider), you are facing a prohibited transaction because ERISA prohibits dealings between a plan and a party-in-interest. Any person providing services to a plan or its participants is considered a party in interest.
- A prohibited transaction can result in personal liability for the plan fiduciaries as well as an excise tax for the service provider.
- You are not off the hook if you are not specifically covered by the regulations; the preamble to the regulations provides that even if a contract/arrangement falls outside the scope of the regulations, ERISA 404(a) requires plan fiduciaries to obtain and carefully review the reasonableness of fees and expenses paid for services rendered to the plan.
- Welfare plans, your time may come! The regulations reserve a section for welfare plans.
Some key definitions
Covered plan – generally, all qualified retirement plans and 403(b) plans are covered; SEPs, IRAs, SIMPLE IRAs are excluded as are governmental plans and non-electing church plans. At the present time, health and welfare plans are not included but a section is reserved for health and welfare plans.
Covered service provider – a service provider that enters into a contract or arrangement with the covered plan and reasonably expects $1,000 or more in direct or indirect compensation for providing one or more services contained in the regulations. It doesn’t matter if the services will be performed or compensation received by the covered service provider, an affiliate or a subcontractor.
Services – services fall into three categories:
- Services as fiduciary or registered investment adviser
- Certain recordkeeping or brokerage services
- Other services for indirect compensation
Let’s look at services
Services as a fiduciary or registered investment adviser – include three categories:
- Services provided directly to the covered plan as a fiduciary,
- Services provide as a fiduciary to an investment contract, product, or entity that holds plan assets and in which the covered plan has a direct equity investment or
- Services provided directly to the covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any State law.
Certain recordkeeping or brokerage services – recordkeeping or brokerage services provided to a covered plan that is an individual account plan and that permits participants or beneficiaries to direct the investment of their accounts, if one or more designated investment alternatives will be made available.
Other services for indirect compensation – accounting, auditing, actuarial, appraisal, banking, consulting (i.e., consulting related to the development or implementation of investment policies or objectives or the selection or monitoring of service providers or plan investments), custodial, insurance, investment advisor (for plan participants), legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation services, for which the covered service, provider, an affiliate , or a subcontractor reasonably expects to receive indirect compensation or compensation among related parties.
Let’s look at the disclosures covered service providers must provide to the responsible plan fiduciary.
Compensation
- A description of all direct compensation i.e., compensation received directly from the plan
- A description of all indirect compensation i.e., compensation received from any source other than the covered plan, the covered service provider, an affiliate or a subcontractor including identification of the services for which the indirect compensation will be received and identification of the payer of the indirect compensation
- Compensation among related parties if it is set on a transaction basis (e.g., commissions, soft dollars, finder’s fees or other similar incentive compensation based on business placed or retained) or is charged against plan assets (e.g., 12b-1 fees).
- A description of any compensation that the covered service provider reasonably expects to receive in connection with termination of the contract/arrangement and how any prepaid amounts will be calculated and refunded upon termination
- A description of the manner in which compensation will be received, i.e., billed or deducted from the covered plan’s accounts(s) or investments.
Investment disclosure – fiduciary services
- A description of services to be provided
- If applicable, a statement that the covered service provider (affiliate or subcontractor)
- A description of annual operating expenses (e.g., expense ratio) if the return is not fixed; and
- A description of any ongoing expenses in addition to annual operating expenses (e.g., wrap fees, mortality and expense fees)
Investment disclosure – recordkeeping and brokerage services
- a description as noted above for each designated investment alternative for which recordkeeping and brokerage services are provided to a covered plan that is an individual account plan (most defined contribution plans)
- generally, a covered service provider may comply with this requirement by providing the disclosure material provided by the designated investment alternative
Recordkeeping services
Regardless of whether recordkeeping fees are included as part of a bundled service arrangement they must be reported separately.
- If recordkeeping services are provided to a covered plan, then a description of all direct and indirect compensation that the covered service provider expects to receive in connection with the recordkeeping services.
- If covered service provider reasonably expects recordkeeping services to be provided without explicit compensation or when offset or rebated based on other compensation received by the covered service provider, then a reasonable good faith estimate of the cost to the covered plan of the recordkeeping services including an explanation of the methodology and assumptions used to prepare the estimate and a detailed explanation of the recordkeeping services that will be provided to the plan.
Timing of disclosure requirements
- covered service provider must disclose information reasonably in advance of the date the contract is signed; if a designated investment alternative is not designated at the time of the contract (i.e., an investment choice is added later) generally as soon as practicable but not later than 60 days from the day the covered service provider is informed of the change unless that is not possible.
- Within 30 days of written request by the responsible plan fiduciary or covered plan administrator.
- If there are errors in the disclosure, the covered service provider must notify the responsible plan fiduciary as soon as practicable but not later than 30 days from the date the covered service provider knows of the error or omission.
What does it mean to the Plan Sponsor
- If the plan sponsor pays the service provider directly from general assets and there are no indirect compensation arrangements, then the regulations don’t apply.
- Identify the “responsible plan fiduciary” who has the authority to cause the plan to enter into, extend or renew a contract/arrangement with a covered service provider. This is the person who receives the disclosures.
- If you have a covered plan which receives covered services and you do not receive the appropriate disclosure, you don’t have a reasonable contract.
- If you don’t receive the appropriate fee disclosures, you must request it in writing from the service provider and if not received within 90 days, you must notify the DOL and decide whether or not you want to retain that particular service provider. The DOL has provided a sample notice which can be found on their website.
- Talk to your covered service providers and ask them how they think their current disclosures compare to what will be required and when will they comply with any missing or incomplete information.
- These rules should actually help you better understand the fees associated with the services you receive; just make sure you know what you are supposed to receive; something that could be clearer in the regulations
Disclaimer: This material is for the sole purpose of providing general information and does not under any circumstances constitute legal advice and should not be used as a substitute for legal advice. You should seek the advice of counsel when applying the requirements to your plan. For more information on this ErisaALERT contact us by phone at 610-524-5351 and ask for Mary Andersen or 973-994-7539 and ask for Theresa Borzelli.
