RULES RELATING TO 401(K) FEE DISCLOSURE OR INVESTMENT ADVICE GUIDANCE

December 19, 2010
(revised 6/25/12)

RULES RELATING TO 401(K) FEE DISCLOSURE OR INVESTMENT ADVICE GUIDANCE

            Recent guidance – some proposed some final, and some with effective dates that have been extended – relate to 401(k) plan fee disclosure and investment advice, as described further below:

• Fee disclosure by plan administrators to participants for participant-directed 401(k) plans regarding investment options with a comparative chart of investment options and with the administrative expenses of each option is required under DOL regulations proposed in July 2008 and finalized in Oct. 2010. The effective date was delayed to 60 days after the beginning of the plan year beginning on or after November 1, 2011, or 60 days after July 1, 2012 (i.e., August 30, 2012).
• Fee disclosure by service providers to responsible plan fiduciaries to show reasonableness of contract (required by service-provider exemption of ERISA § 408(b)(2)) as specified in final DOL regulations published February 3, 2012, with a delayed effective date of July 1, 2012.
• Regulations regarding investment advice arrangements that are permitted by the Pension Protection Act where there is level-fee or computer model arrangements were issued in January 2009 but were later withdrawn.  Revised regulations similar to the original regulations but with certain changes as described below, were issued in October 2011.
• Service provider disclosure on Form 5500 Schedule C is now required for both direct and indirect compensation.  This became effective with the 5500s for the 2009 plan years.

1.    Fee Disclosure to Participants (by Plan Administrators) Concerning Plan Investment Options – Final Regulations - Effective Date Extended

            Generally.  The Department of Labor has issued regulations, DOL Reg. §§ 2550.404a-5 and 2550.404c-1, proposed in 2008, 73 Fed. Reg. 43014 (July 23, 2008) and finalized in 2010, 75 Fed. Reg. 64910 (Oct. 20, 2010), requiring fiduciaries of individual account plans to provide specific disclosures to participants concerning plan investment options including fee and expense information.  The underlying concern is that participants in individual account plans be given sufficient information on investment choices including fees and expenses, as stated in the Preamble to the final regulations.

The regulations provide that when a plan allocates investment responsibilities to participants under a participant directed individual account plan, ERISA's duty of prudence requires the plan administrator to make sure that participants are made aware of their rights and responsibilities with respect to the investment of assets, and that sufficient information is provided regarding the plan and the plan's investment options including fee and expense information to make informed decisions how to invest their accounts.  DOL Reg. § 2550.404a-5(a).

This applies to "covered individual account plans," which are participant-directed individual account plans (regardless of whether or not such plans comply with ERISA § 404(c)), but excludes IRAs, SEPs, SIMPLE accounts and other plans exempt from ERISA.

The plan administrator must provide participants certain plan-related information and certain investment-related information, as described below.

Annual Plan-Related Information.   The plan-related information that must be disclosed includes:

·        general plan information about structure and mechanics of plan, such as how to give investment instructions, list of plan's current investment options, description of any "brokerage windows" or similar arrangement that enables the selection of investments beyond those designated by the plan, etc.;

·        administrative expenses information about fees and expenses for general plan administrative services that may be charged to individual accounts, such as fees and expenses for legal, accounting, and recordkeeping services; and

·        individual expense information including fees and expenses that may be charged to individual account of participant, such as fees for plan loans and for processing QDROs.   DOL Reg. § 2550.404a-5(c)(1)(i), (c)(2)(i)(A) and (c)(3)(i)(A).

This information must be given to participants on or before the date they can direct their investments, and then annually thereafter.  DOL Reg. § 2550.404a-5(c)(1)(i), (c)(2)(i)(A) and (c)(3)(i)(A).

Change in Plan Related Information.  If there is a change in any of the above plan-related information, the participant must be furnished with a description of the change within 30 to 90 days prior to the change, or in unforeseeable circumstances beyond the control of the plan administrator as soon as reasonably practicable.  DOL Reg. § 2550.404a-5(c)(1)(ii), (c)(2)(i)(B) and (c)(3)(i)(B).

Quarterly Plan Expense and Fee Information.  Statements must be furnished to participants at least quarterly showing the dollar amount of the plan-related administrative and individual fees and expenses actually charged to the individual accounts, as well as a description of the services.  These disclosures may be included in quarterly benefit statements required under ERISA § 105.  DOL Reg. § 2550.404a-5(c)(3)(ii).

Annual Investment-Related Information.  In addition to plan-related information, investment-related information must also be disclosed under the regulations on the date the participant can first direct the investment and annually thereafter.  This includes:

·        identifying information and investment category of each designated investment alternative;

·        performance data, with historical investment performance; one, five and ten-year returns must be provided for investment options that do not have fixed rates of return (such as mutual funds), and for investment options that have a fixed rate of return the annual rate of return must be provided;

·        benchmark information for investment options that do not have a fixed rate of return, with the returns of an appropriate broad-based securities market index over one-, five-, and ten-year periods (investment options with fixed rates of return are not subject to this requirement);

·        fee and expense information, which for investment options that do not a have a fixed rate of return requires total annual operating expenses expressed as both a percentage of assets and as a dollar amount and any shareholder-type fees or restrictions on the participant's ability to purchase or withdraw from the investment; for investment options that have a fixed rate of return, any shareholder-type fees or restrictions on the participant's ability to purchase or withdraw from the investment is required;

·        Internet website address must be included for investment-related information, which will provide participants access to specific additional information about the investment options if more current information is desired; and

·        a glossary of investment-related terms to understand the plan's investment options, or an Internet website address that provides access to such a glossary.  DOL Reg. § 2550.404a-5(d)(1)(i)-(vi).

Comparative Format Requirement.  The above investment-related information is to be furnished in a chart or similar format, so that a comparison of the available investment alternatives is easily observed, and the data should be prominently displayed.  DOL Reg. § 2550.404a-5(d)(2)(i).  The regulation includes an appendix with a model comparative chart.

Additional Information.  The investment related information must include the contact information for the plan administrator (or person designated on its behalf), where to obtain additional information, a reference to the web site with additional investment-related information and how to obtain a paper copy of certain information.  DOL Reg. § 2550.404a-5(d)(2).  Additional information must be made available on request, including copies of prospectuses of the funds, financial statements and shareholder reports, value of each share of designated investment alternatives and the assets comprising the portfolio of each fund.  DOL Reg. § 2550.404a-5(d)(3).

Original Effective Dates.  These final participant disclosure regulations were effective on December 20, 2010.  They become applicable to covered individual account plans for plan years beginning on or after November 1, 2011.  DOL Reg. § 2550.404a-5(j).  The initial disclosure was required by the date they can first direct investments, which is 60 days after the effective date of the service provider fee disclosure effective date.  (See also, 76 F.R. 31544 (June 1, 2011).)

Delayed Effective Date to August 30, 2012.  The final regulations have been amended in DOL Reg. § 2550.404a-5(j), in 76 Fed. Reg. 42539 (July 19, 2011) to provide that the initial disclosure to participants is required by the date the participant can first direct his or her investments (60 days after the beginning of the plan year beginning on or after November 1, 2011), or, if later, 60 days after the effective date of the 408b-2 regulations which is currently July 1, 2012, i.e., August 30, 2012.

Field Assistance Bulletin 2012-12.  DOL Field Assistance Bulletin 2012-12 (May 7, 2012), http://www.dol.gov/ebsa/regs/fab2012-2.html, contains 38 FAQs on fee disclosure to participants.  They provide: (i) designated investment managers that choose among investment alternatives (managed accounts) are not separate investment alternatives and do not require investment related disclosure but should be described under the plan related disclosure (Q&As 4 & 27); (ii) brokerage window fees and expenses must be disclosed to all participants with general information about the purchases and sales of securities and how to obtain more information (Q&As 13, 29 and 30); (iii) model portfolios of various investment alternatives offered among the plan need not contain extra disclosure unless the model portfolio provides a separate equity security or similar interest in the entity (Q&A 28); (iv) revenue sharing explanations must be provided quarterly but do not need to identify specific plan expenses or specific investments (Q&A 10); (v) multiple comparative charts can be used in a single mailing but may not be used if separately distributed (Q&A 21); (vi) a fund of funds would disclose the operating expenses of acquired funds in the annual operating expenses of the fund of funds (Q&A 31); (vii) stable value fund insurance contract fee to smooth the rate of return must be included in the total annual operating expenses of the stable value fund (Q&A 34); (viii) closed funds are still subject to fee disclosure because participant must still decide whether to transfer out of the fund (Q&A 15); and (ix) website information must be updated as soon as reasonably possible although the printed comparative chart only needs to be updated annually (Q&A 22).

2.    Interim Guidance on Electronic Delivery of Participant Fee Disclosure

DOL Tech Rel. 2011-03R (issued Sept. 13, 2011 and revised Dec. 8, 2011) provides interim guidance on fee disclosure by electronic delivery.  Where the disclosure is included as part of pension benefit statements or along with pension benefit statements, the guidance in FAB 2006-03 applicable to pension benefit statements can be used, which allows secure website access where certain notice requirements are met. 

Where the disclosure is not included as part of pension benefit statements, the safe harbor of DOL Reg. § 2520.104b-1(c) (from 2002) can be used, which allows  plan administrators to use electronic delivery of notices (i) for participants who can easily access electronic documents at their place of work and the computer is an integral part of his work, or (ii) where a participant does not have effective access at work but affirmatively consents to receive the document electronically.  Alternatively, DOL Tech. Rel. 2011-03R allows an email method where participants voluntarily furnish their email, an initial notice that satisfies  the specific notice is provided with the request for the email address, an annual notice containing similar information must be provided (which can be electronically if the participant has interacted with the electronic delivery system), the electronic delivery is reasonably calculated to ensure actual receipt (e.g. email return-receipt), confidentiality is maintained and the notice is calculated to be understood by the average plan participant.  Pursuant to DOL Tech. Rel. 2011-03R as revised, disclosure through electronic media may include a continuous access web site.

3.    Fee Disclosure by Service Providers (to Plan Fiduciaries) – Final Regulations – Effective Date Delayed to July 1, 2012

ERISA § 408(b)(2) Service Provider Exception.  ERISA § 406 generally prohibits transactions between an ERISA plan and a party in interest.  A service provider to a plan would be a party in interest, making the arrangement a prohibited transaction.  However, under the service-provider exception, ERISA § 408(b)(2) exempts service contracts or arrangements between a plan and a party in interest if (i) the contract or arrangement is reasonable, (ii) the services are necessary for the establishment or operation of the plan, and (iii) no more than reasonable compensation is paid for the services.

DOL Regulation § 2550.408b-2.  DOL Regulation § 2550.408b-2, proposed December 13, 2007, 72 Fed. Reg. 70988, revised as interim regulations, July 16, 2010, 75 Fed. Reg. 41600, and finalized Feb. 3, 2012, 77 Fed. Reg. 5632, clarify the meaning of a ''reasonable'' contract or arrangement.

Reasonable Contract.  Under the DOL regulations, to be a reasonable contract, a "covered service provider" (as defined below) must disclose certain information in writing to the "responsible plan fiduciary" (the fiduciary with authority to cause the plan to enter into or renew the contract).

·        This disclosure enables the fiduciary to determine whether the services are reasonable.

Covered Service Provider.  A "covered service provider" is a service provider that enters into a contract or arrangement with a "covered plan" (as defined below) and reasonably expects $1,000 or more in direct or indirect compensation to be received in connection with providing certain enumerated services.  This includes (i) services provided as a fiduciary to an investment vehicle holding plan assets and services provided as an investment advisor to a covered plan, (ii) certain recordkeeping and brokerage services to an individual account plan, or (iii) other services for which service provider, affiliate or subcontractor expect to receive indirect compensation (such as accounting, auditing, actuarial, appraisal, banking, consulting, attorney who is hired directly by the plan, and recordkeeper (but this category iii only applies for indirect compensation, e.g., consultant which also has investment fund)).  DOL Reg. § 2550.408b-2(c)(1)(iii).

Covered Plan.  "Covered Plan" is defined as an ERISA pension plan, but does not include a SEP, SIMPLE retirement plan, IRA or top-hat plan and also does not include a 403(b) plan that was frozen prior to January 1, 2009.  DOL Reg. § 2550.408b-2(c)(1)(ii).

Disclosure.  The disclosure must describe:

·        services to be provided (but not including non-fiduciary services to an investment contract or plan investment);

·        if applicable, status as a fiduciary or investment advisor;

·        any direct or indirect compensation the service provider, affiliate, or subcontractor expects to receive; and in the case of indirect compensation the services for which the indirect compensation will be received, the payer of the indirect compensation, and the arrangement pursuant to which the indirect compensation is paid; and where compensation is to be paid among related parties, i.e., between the service provider, affiliate and a subcontractor in connection with the services, the compensation to be paid if it is set on a transaction basis (e.g., commissions, soft dollars, finder fees, etc.), or if it is to be charged against the plan's investment (e.g., 12b-1 fees);

·        compensation expected in connection with termination of the contract;

·        with regard to recordkeeping services a description of direct and indirect compensation that is expected to be received;

·        whether the plan will be billed or the compensation will be deducted directly from the plan's individual accounts;

·        for fiduciary service providers with respect to plan assets, any compensation that will be charged directly against the amount invested (e.g., sales charges, loads, redemption fees, surrender charges, etc.) and operating expenses; and

·        for certain recordkeeping and brokerage services with respect to each designated investment alternative, current accurate disclosure materials of the issuer of the designated investment alternative that includes the information in the previous bullet.  DOL Reg. § 2550.408b-2(c)(1)(iv).

Timing of Service Provider Disclosure.  The service provider must disclose any additional information relating to compensation to the responsible plan fiduciary within the following time periods: (i) for initial disclosure reasonably in advance of the date the arrangement is executed, extended or renewed, (ii) when the investment entity does not initially hold plan assets, within 30 days of when the investment entity holds plan assets, and (iii) as soon as an investment alternative is designated.  Changes in the disclosed information must be communicated no later than 60 days from the date of change, and the covered service provider must disclose at least annually any changes to the investment and recordkeeping and brokerage services described in the last two bullets above.  DOL Reg. § 2550.408b-2(c)(1)(v).

Upon request, the service provider must furnish other information relating to the compensation received in connection with the contract.  DOL Reg. § 2550.408b-2(c)(1)(vi).  Good faith errors or omission in disclosing the information required will not cause there to be a failure, as long as the service provider discloses the correct information as soon as practicable and no later than 30 days after the service provider knows of such error or omission.  DOL Reg. § 2550.408b-2(c)(1)(vii).

Guide to Initial Disclosure.  The regulations strongly encourage service providers to offer fiduciaries a guide of the initial disclosures.  An appendix to the regulations provides a sample guide to initial disclosure in the form of a chart referencing the places in the service agreement or on a website where the required disclosures can be found.

Prohibited Transaction Class Exemption.  There is an exemption in the form of a prohibited transaction class exemption, and also incorporated into the regulations, for the responsible plan fiduciary from the prohibited transaction restrictions for a party in interest providing goods and services to or receiving assets from the plan, for any failure by a covered service provider to disclose the information required above, provided that the following conditions are met: (i) the plan fiduciary did not know that the service provider failed or would fail to make required disclosures and reasonably believed that the covered service provider disclosed the information required above, (ii) the plan fiduciary requests the additional information in writing and notifies  the DOL, and (iii) the service provider terminates the arrangement or complies with the request within 90 days.  DOL Reg. § 2550.408b-2(c)(1)(ix).

            Termination Without Penalty.  The regulations also require that for the contract to be reasonable, it must permit termination of the contract without penalty other than for reasonable start-up costs and expenses.  DOL Reg. § 2550.408b-2(c)(3).

            Effective Date.  The regulations were to be effective July 16, 2011.  DOL Reg. § 2550.408b-2(c)(1)(xii).   On June 1, 2011, 76 Fed. Reg. 31545, the DOL extended the effective date to January 1, 2012.  On July 19, 2011, 76 Fed. Reg. 42539,  the DOL extended the effective date to April 1, 2012.  On Feb. 3, 2012, 77 Fed. Reg. 5632, the DOL further extended the effective date of these service provider fee disclosure regulations to July 1, 2012 (amending DOL Reg. § 2550.408b-2(c)(1)(xii)).

The rules (under previous and current effective dates) apply to all contracts or arrangements, regardless of whether entered into before or after the effective date.

      4.  Eligible Investment Advice Arrangements by Fiduciary Advisors Under Pension Protection Act  –  Regulations Withdrawn and then Revised

Under ERISA § 408, as amended by the Pension Protection Act of 2006, a prohibited transaction statutory exemption is added for the provision of investment advice by a "fiduciary advisor" to participants of participant-directed plans through an "eligible investment advice arrangement."  ERISA §§ 408(b)(14) & 408(g). 

ERISA § 408(b)(14) & 408(g).  ERISA § 408(b)(14) and IRC § 4975(d)(17) state that the provision of investment advice regarding an investment or sale under the plan, or the receipt of fees by a fiduciary adviser or affiliate in connection with the investment advice, will be exempt from the prohibited transaction rules if the investment advice is provided under an "eligible investment advice arrangement" under ERISA § 408(g) and IRC § 4975(f)(8), which means that the arrangement must either (i) provide "level fee arrangements" that do not depend on investment, or (ii) uses a "computer model" that applies generally accepted investment theories, utilizes relevant information, utilizes objective criteria and does not favor investments offered by the fiduciary adviser.  ERISA § 408(g).

Regulations Issued, Withdrawn and Reissued.  In January 2009 the Department of Labor finalized regulations implementing the provisions of the statutory exemption for eligible investment advice arrangements for level-fee or computer model arrangements.  74 Fed. Reg. 3822 (Jan. 21, 2009), (originally proposed Aug. 22, 2008).  The DOL also provided an administrative class exemption pursuant to which the fee-leveling or computer model requirements would be liberalized.  The effective date was to have been March 23, 2009.   The effective date was delayed several times in 2009.  The DOL delayed and then withdrew these regulations and the class exemption in 2009.  74 Fed. Reg. 60156 (Nov. 20, 2009).  The DOL issued revised regulations, DOL Reg. § 2550.408g–1 and -2, reproposed March 2, 2010, 75 Fed. Reg. 9360 and finalized October 25, 2011, 76 Fed. Reg. 66136.

Arrangements Using Fee Leveling.  Fee level arrangements must be based on generally accepted investment theories, taking into account fees and expenses and the participants' age, other assets, risk tolerance and preferences, and provide that fees received by fiduciary advisers providing investment advice do not vary on the basis of the investments chosen (level fee arrangements).  DOL Reg. § 2550.408g-1(b)(3).

Arrangements Using Computer Models.  Computer model arrangements must (i) provide generally accepted investment theories taking into account historic risks and returns, (ii) take into account investment management and other fees and expenses, (iii) weigh factors used to estimate future returns, (iv) request information about age, life expectancy, risk tolerance, other assets and investment preferences, (v) use appropriate objective criteria, (vi) not favor investment options of the advisor and (vii) take into account all of the investment options of the plan.  DOL Reg. § 2550.408g-1(b)(4)(i).  In addition, the computer model must be certified in writing in advance by an eligible investment expert that the computer model meets the above requirements.  An eligible investment expert must have appropriate technical training or experience and proficiency to analyze and certify the computer model (and cannot have a material relationship with the fiduciary adviser).  The written certification must (i) contain the methodology in making the determination, (ii) state how the methodology shows that the computer model meets DOL Reg. § 2550.408g-1(b)(4)(i), (iii) describe the limitations imposed on the selection of appropriate methodology, and (iv) contain a representation that the methodology was applied by an expert.  DOL Reg. § 2550.408g-1(b)(4)(ii).

A plan fiduciary (or plan sponsor) must expressly authorize the investment advice arrangement, and an annual written audit by an independent auditor with appropriate expertise of the arrangement must be made.  DOL Reg. § 2550.408g-1(b)(5) & (6).

The fiduciary adviser must disclose to participants prior to the initial investment advice the following: (i) the role of any party that has a material affiliation, (ii) past performance of the investment options, (iii) all fees or compensation that the adviser or affiliate receives for the advice, sale, purchase or rollover, (iv) any material affiliation the fiduciary or affiliate has in the fund, (v) the manner in which participant information will be used, and (vi) the types of services provided by the fiduciary adviser in connection with the investment advice, (vii) that the adviser is a fiduciary and (viii) that the participants may arrange for advice by another adviser.  DOL Reg. § 2550.408g-1(b)(7).  The Appendix to DOL Reg. § 2550.408g-1 contains a model disclosure form that may be used to satisfy this disclosure requirement.

The fiduciary advisor must provide the authorizing fiduciary a written notice that it intends to comply with ERISA §§ 408(b)(14) and 408(g) that the adviser's arrangement will be audited annually, and that the auditor will furnish the authorizing fiduciary a copy of the auditor's findings within 60 days of completion of the audit.  DOL Reg. § 2550.408g-1(b)(8).

A "fiduciary adviser" is a fiduciary to the plan who is also a registered investment advisor, bank, insurance company, registered broker dealer or an affiliate or employee of any of the above.  DOL Reg. § 2550.408g-1(c)(2).

A prohibited transaction class exemption in the original 2009 regulations would have permitted follow-up individual advice subsequent to the computer model, and would have also permitted varying fees, as long as the individual employee providing the advice met the level fee requirements.  However, in response to comments questioning the potential for self-dealing, the class exemption has been eliminated in the revised 2011 regulations.

The regulations are effective 60 days after publication in the Federal Register, i.e. December 24, 2011, but go into effect on the first business day thereafter, i.e., Tuesday, December 27, 2011.  See DOL Reg. § 2550.408g–2(f).

      5.  Schedule C Service Provider Reporting – Effective for 2009 Plan Years; Good Faith Transition Rule  

            Final guidance for revised Form 5500 Schedule C disclosure provides for expanded requirements for service providers reporting of direct and indirect compensation, and requires fiduciaries to review and approve expenses, effective for 5500s relating to plan years beginning in 2009. 

• For Schedule C purposes, reportable compensation includes cash and any other items of value (e.g., gifts or awards) received from the plan (including fees charged as a percentage of assets and deducted from investment returns) in connection with services rendered to the plan. 
• Indirect compensation is compensation received from sources other than the plan or plan sponsor, in connection with services rendered to the plan, and would include, for example, fees and expense reimbursement payments received from a mutual fund, account maintenance fees, 12b–1 distribution fees, etc.  72 Fed. Reg. 64710 (Nov.16, 2007), amending DOL Reg. §§ 2520.103-1 & 2520.104-46.

            The DOL issued FAQs regarding the Schedule C requirements in July 2008 (www.dol.gov/ebsa/faqs/faq_scheduleC.html) and in October 2009 (www.dol.gov/ebsa/faqs/faq-sch-C-supplement.html).  FAQ 40 and Supplemental FAQ 10 provides transition relief where a service provider makes reasonable, good faith efforts to develop systems to provide information as required under Schedule C, but is not able to update the recordkeeping and information management systems in time for the 2009 filing.  There have been requests to extend the transition relief further.  For example, the American Society of Pension Professionals & Actuaries in a July 5, 2011 letter to the DOL (at www.asppa.org/Document-Vault/pdfs/GAC/2011/752011schc-comment.aspx) requests an extension of the transition relief for any plan year filing that may include periods during the plan year that preceded the effective date of the final fee disclosure for service providers regulations under ERISA § 408(b)(2).