ERISA 408(b)(2) Fee Disclosure Rules
Rev. 07/23/10; E-mail Alert 2010-11

On July 15, 2010, the DOL issued interim final regulations under ERISA 408(b)(2) (published in the July 16 Federal Register). This is generally a fee disclosure regulation which enables the fiduciary to fulfill his or her duty to make informed decisions about the reasonableness of fees as required under ERISA 404(a)(1). As the interim final regulations are an extensive revision of the prior administration’s proposed 408(b)(2) regulations, there is a 45-day comment period (discussed below).

Background
Section 401(a) of ERISA requires plan fiduciaries to act prudently and solely in the interest of the plan's participants and beneficiaries when selecting and monitoring service providers and plan investments. Fiduciaries must act with the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Thus, plan fiduciaries must ensure that arrangements with their service providers are "reasonable" and that only "reasonable" compensation is paid for services. Fundamental to a plan fiduciary’s ability to make these decisions is the availability of information sufficient to enable the plan fiduciary to make informed decisions about the services, the costs, and the service provider.

In recent years, changes in the way employee plan services are provided have improved efficiency and reduced the costs of administrative services and benefits for plans and their participants. Yet these same changes commonly blur how, and at what cost, service providers are compensated for the specific services being rendered (e.g. through revenue sharing and other arrangements). The purpose of this regulation is to have the service provider give disclosure to the plan sponsor and fiduciary in order for them to fulfill their obligations to determine both the reasonableness of what is being paid and the potential conflicts of interest that may affect the performance of those services.

Effective Date
The effective date of these regulations is July 16, 2011. Service providers not in compliance as of July 16, 2011 will be subject to the prohibited transaction rules of ERISA 406 and the IRC section 4975 penalties. Note that as the effective date approaches, the required disclosures should be provided with enough lead time in advance of July 16, 2011 to be in compliance as of the effective date.

We will be covering the 408(b)(2) interim final regulation in our regional Insights and Practitioner classes and
in our Fiduciary Update 2010 eSeminar.

BASIC RULES FROM THE REGULATION IN Q & A FORMAT

ii. What plans are covered by this regulation?
A “covered plan” is an “employee pension benefit plan” or a “pension plan” under ERISA 3(2)(A).

Specifically, plans covered by this regulation include:

• Defined contribution
• Defined benefit plans
• ERISA 403(b) arrangements

Plans not covered by this regulation are plans under ERISA 4(b):

• Governmental plan
• Non-electing church plan
• Plans maintained outside the United States primarily for nonresident aliens
• An unfunded excess benefit plan
• SEP (Simplified Employee Plans)
• SIMPLE IRA
• IRAs
• Non-ERISA 403(b)

Note that there is a reserved section of the regulation for welfare plans but the ruling does not currently cover welfare plans.

iii. Who are "covered service providers" under this regulation?

A “covered service provider” is a service provider that enters into a contract or arrangement with the covered plan and reasonably expects $1,000 or more in compensation, direct or indirect, to be received in connection with providing one or more of the services (described below in A, B and C) pursuant to the contract or arrangement, regardless of whether such services will be performed, or such compensation received, by the covered service provider, an affiliate, or a subcontractor.

(A) Services as a fiduciary or registered investment Adviser.

1. Services provided directly to the covered plan as a fiduciary as defined in ERISA 3(21).
2. Services provided as a fiduciary to an investment contract, product, or entity that holds plan assets (under ERISA 3(42) and 401 and 29 CFR 2510.3-101) and in which the covered plan has a direct equity investment (a direct equity investment does not include investments made by the investment contract, product, or entity in which the covered plan invests); or
3. Services provided directly to the covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any State law.

(B) Certain recordkeeping or brokerage services.
Recordkeeping services 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 (e.g., through a platform or similar mechanism) in connection with such recordkeeping services or brokerage services.

(C) 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 advisory (for plan or participants), legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation services provided to the covered plan, for which the covered service provider, an affiliate, or a subcontractor reasonably expects to receive indirect compensation (as defined below) or compensation (as defined below).

(D)  Limitations.
Notwithstanding the paragraphs (A), (B), or (C) above, no person or entity is a “covered service provider” solely by providing services –

1. As an affiliate or a subcontractor that is performing one or more of the services in paragraphs  (A), (B), or (C) above under the contract or arrangement with the covered plan; or
2. To an investment contract, product, or entity in which the covered plan invests, regardless of whether or not the investment contract, product, or entity holds assets of the covered plan, other than services as a fiduciary described in paragraph (A)(2) above.

iv. What must a covered service provider initially disclose to a responsible plan fiduciary?

The covered service provider must disclose the following information to a responsible plan fiduciary, in writing –

(A) Services.
A description of the services to be provided to the covered plan pursuant to the contract or arrangement (but not including non-fiduciary services as described in paragraph (c)(1)(iii)(D)(2) above).

(B) Status.
If applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan (or to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment) as a fiduciary; and, if applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any State law.

(C) Compensation.

1. Direct compensation.
   A description of all direct compensation (as defined in paragraph (c)(1)(viii)(B)(1) of this section), either in the aggregate or by service, that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with the services described pursuant to paragraph (c)(1)(iv)(A) of this section.

2. Indirect compensation.  
A description of all indirect compensation (as defined in paragraph (c)(1)(viii)(B)(2) of this section) that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with the services described pursuant to paragraph (c)(1)(iv)(A) of this section; including identification of the services for which the indirect compensation will be received and identification of the payer of the indirect compensation.

3. Compensation paid among related parties.  
A description of any compensation that will be paid among the covered service provider, an affiliate, or a subcontractor, in connection with the services described pursuant to paragraph (c)(1)(iv)(A) of this section 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 directly against the covered plan’s investment and reflected in the net value of the investment (e.g., Rule 12b-1 fees); including identification of the services for which such compensation will be paid and identification of the payers and recipients of such compensation (including the status of a payer or recipient as an affiliate or a subcontractor). Compensation must be disclosed pursuant to this paragraph (c)(1)(iv)(C)(3) regardless of whether such compensation also is disclosed pursuant to paragraph (c)(1)(iv)(C)(1) or (2), (F) or (G) of this section. This paragraph (c)(1)(iv)(C)(3) shall not apply to compensation received by an employee from his or her employer on account of work performed by the employee.

4. Compensation for termination of contract or arrangement.
A description of any compensation that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with termination of the contract or arrangement, and how any prepaid amounts will be calculated and refunded upon such termination.

(D) Recordkeeping services.
Without regard to the disclosure of compensation pursuant to paragraph (c)(1)(iv)(C), (F), or (G) of this section, if recordkeeping services will be provided to the covered plan –

1. A description of all direct and indirect compensation that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with such recordkeeping services; and
2. If the covered service provider reasonably expects recordkeeping services to be provided, in whole or in part, without explicit compensation for such recordkeeping services, or when compensation for recordkeeping services is offset or rebated based on other compensation received by the covered service provider, an affiliate, or a subcontractor, a reasonable and good faith estimate of the cost to the covered plan of such 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 covered plan. The estimate shall take into account, as applicable, the rates that the covered service provider, an affiliate, or a subcontractor would charge to, or be paid by, third parties, or the prevailing market rates charged, for similar recordkeeping services for a similar plan with a similar number of covered participants and beneficiaries.

(E) Manner of receipt.
A description of the manner in which the compensation described in paragraph (c)(1)(iv)(C) and (D) of this section will be received, such as whether the covered plan will be billed or the compensation will be deducted directly from the covered plan’s account(s) or investments.

(F) Investment disclosure – fiduciary services.
In the case of a covered service provider described in paragraph (c)(1)(iii)(A)(2) of this section, the following additional information with respect to each investment contract, product, or entity that holds plan assets and in which the covered plan has a direct equity investment, and for which fiduciary services will be provided pursuant to the contract or arrangement with the covered plan, unless such information is disclosed to the responsible plan fiduciary by a covered service provider providing recordkeeping services or brokerage services as described in paragraph (c)(1)(iii)(B) of this section –

1. A description of any compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer of, or withdrawal from the investment contract, product, or entity (e.g., sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees);
2. A description of the annual operating expenses (e.g., expense ratio) if the return is not fixed; and 
3. A description of any ongoing expenses in addition to annual operating expenses (e.g., wrap fees, mortality and expense fees.

(G) Investment disclosure – recordkeeping and brokerage services.

1. In the case of a covered service provider described in paragraph (c)(1)(iii)(B) of this section, the additional information described in paragraph (c)(1)(iv)(F)(1) through (3) of this section with respect to each designated investment alternative for which recordkeeping services or brokerage services as described in paragraph (c)(1)(iii)(B) of this section will be provided pursuant to the contract or arrangement with the covered plan.
2. A covered service provider may comply with this paragraph (c)(1)(iv)(G) by providing current disclosure materials of the issuer of the designated investment alternative that include the information described in such paragraph, provided that such issuer is not an affiliate, the disclosure materials are regulated by a State or federal agency, and the covered service provider does not know that the materials are incomplete or inaccurate.

v What are the timing requirements of the initial disclosure?

(A) A covered service provider must disclose the information required by paragraph (c)(1)(iv) of this section to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into, and extended or renewed, except that –

1. When an investment contract, product, or entity is determined not to hold plan assets upon the covered plan’s direct equity investment, but subsequently is determined to hold plan assets while the covered plan’s investment continues, the information required by paragraph (c)(1)(iv) of this section must be disclosed as soon as practicable, but not later than 30 days from the date on which the covered service provider knows that such investment contract, product, or entity holds plan assets; and
2. The information described in paragraph (c)(1)(iv)(G) of this section relating to any investment alternative that is not designated at the time the contract or arrangement is entered into must be disclosed as soon as practicable, but not later than the date the investment alternative is designated by the responsible plan fiduciary.

What about the timing requirements for changes to the initial disclosure?

(B) A covered service provider must disclose a change to the information required by paragraph (c)(1)(iv) of this section as soon as practicable, but not later than 60 days from the date on which the covered service provider is informed of such change, unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider’s control, in which case the information must be disclosed as soon as practicable.

vi May the responsible plan fiduciary or covered plan administrator ask for additional information relating to compensation received in connection to the contract or arrangement?

(A) Upon request of the responsible plan fiduciary or covered plan administrator, the covered service provider must furnish any other information relating to the compensation received in connection with the contract or arrangement that is required for the covered plan to comply with the reporting and disclosure requirements of Title I of the Act and the regulations, forms and schedules issued thereunder.

(B) The covered service provider must disclose the information required by paragraph (c)(1)(vi)(A) of this section not later than 30 days following receipt of a written request from the responsible plan fiduciary or covered plan administrator, unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider’s control, in which case the information must be disclosed as soon as practicable.

vii What if there is an error in the disclosure?

No contract or arrangement will fail to be reasonable under this regulation solely because the covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the information required pursuant to paragraph iv or vi above, provided that the covered service provider discloses the correct information to the responsible plan fiduciary as soon as practicable, but not later than 30 days from the date on which the covered service provider knows of such error or omission.

viii What are the Definitions used in this regulation?
For purposes of paragraph (c)(1) of this section:

(A) Affiliate. A person’s or entity’s “affiliate” directly or indirectly (through one or more intermediaries) controls, is controlled by, or is under common control with such person or entity; or is an officer, director, or employee of, or partner in, such person or entity. Unless otherwise specified, an “affiliate” in this paragraph (c)(1) refers to an affiliate of the covered service provider.

(B) Compensation. Compensation is anything of monetary value (for example, money, gifts, awards, and trips), but does not include non-monetary compensation valued at $250 or less, in the aggregate, during the term of the contract or arrangement.

(1) “Direct” compensation is compensation received directly from the covered plan.

(2) “Indirect” compensation is compensation received from any source other than the covered plan, the plan sponsor, the covered service provider, an affiliate, or a subcontractor (if the subcontractor receives such compensation in connection with services performed under the subcontractor’s contract or arrangement described in paragraph viii (F) below.

(3) A description or an estimate of compensation may be expressed as a monetary amount, formula, percentage of the covered plan's assets, or a per capita charge for each participant or beneficiary or, if the compensation cannot reasonably be expressed in such terms, by any other reasonable method. Any description or estimate must contain sufficient information to permit evaluation of the reasonableness of the compensation.

(C) Designated investment alternative. A “designated investment alternative” is any investment alternative designated by a fiduciary into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts. The term “designated investment alternative” shall not include brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants and beneficiaries to select investments beyond those specifically designated.

(D) Recordkeeping services. “Recordkeeping services” include services related to plan administration and monitoring of plan and participant and beneficiary transactions (e.g., enrollment, payroll deductions and contributions, offering designated investment alternatives and other covered plan investments, loans, withdrawals and distributions); and the maintenance of covered plan and participant and beneficiary accounts, records, and statements.

(E) Responsible plan fiduciary. A “responsible plan fiduciary” is a fiduciary with authority to cause the covered plan to enter into, or extend or renew, the contract or arrangement.

(F) Subcontractor. A “subcontractor” is any person or entity (or an affiliate of such person or entity) that is not an affiliate of the covered service provider and that, pursuant to a contract or arrangement with the covered service provider or an affiliate, reasonably expects to receive $1,000 or more in compensation for performing one or more services [described pursuant to paragraph iii(A) through (C) above] provided for by the contract or arrangement with the covered plan.

(ix) Is there a prohibited transaction class exemption for the responsible plan fiduciary who enters into a contract with a service provider without knowing that the service provider failed or would fail to comply with its disclosure obligation?

Yes. Pursuant to the exemptions from prohibited transactions [under ERISA section 408(a)], the prohibited transaction restrictions [in ERISA 406(a)(1)(C) and (D)] of furnishing of goods, services or facilities between the plan and a party-in-interest; or of transfer to or use by or for the benefit of party in interest, of any assets of the plan; shall not apply to a responsible plan fiduciary, notwithstanding any failure by a covered service provider to disclose information required by iv or vi above, if the following conditions are met:

(A) The responsible plan fiduciary did not know that the covered service provider failed or would fail to make required disclosures and reasonably believed that the covered service provider disclosed the information required by paragraph iv or vi above;

(B) The responsible plan fiduciary, upon discovering that the covered service provider failed to disclose the required information, requests in writing that the covered service provider furnish such information;

(C) If the covered service provider fails to comply with such written request within 90 days of the request, then the responsible plan fiduciary notifies the Department of Labor of the covered service provider’s failure, in accordance with paragraph (c)(1)(ix)(E) of this section;

(D) The notice shall contain the following information –

(1) The name of the covered plan;
(2) The plan number used for the covered plan’s Annual Report;
(3) The plan sponsor’s name, address, and EIN;
(4) The name, address, and telephone number of the responsible plan fiduciary;
(5) The name, address, phone number, and, if known, EIN of the covered service provider;
(6) A description of the services provided to the covered plan;
(7) A description of the information that the covered service provider failed to disclose;
(8) The date on which such information was requested in writing from the covered service provider; and
(9) A statement as to whether the covered service provider continues to provide services to the plan;

(E) The notice shall be filed with the Department not later than 30 days following the earlier of –

(1) The covered service provider’s refusal to furnish the information requested by the written request described in paragraph (c)(1)(ix)(B) of this section; or
(2) 90 days after the written request referred to in paragraph (c)(1)(ix)(B) of this section is made;

(F) The notice required by paragraph (c)(1)(ix)(C) of this section shall be sent to the following address: U.S. Department of Labor, Employee Benefits Security Administration, Office of Enforcement, 200 Constitution Ave., N.W., Suite 600, Washington, DC 20210; or may be sent electronically to OEDelinquentSPnotice@dol.gov; and

(G) The responsible plan fiduciary, following discovery of a failure to disclose required information, shall determine whether to terminate or continue the contract or arrangement. In making such a determination, the responsible plan fiduciary shall evaluate the nature of the failure, the availability, qualifications, and cost of replacement service providers, and the covered service provider’s response to notification of the failure.

x. Is there a preemption of State law?

Nothing in this section shall be construed to supersede any provision of State law that governs disclosures by parties that provide the services described in this section, except to the extent that such law prevents the application of a requirement of this section.

xi Coordination with the Internal Revenue Code.
Section 4975(d)(2) of the Code contains provisions parallel to section 408(b)(2) of the Act. Effective December 31, 1978, section 102 of the Reorganization Plan No. 4 of 1978, 5 U.S.C. App. 214 (2000 ed.), transferred the authority of the Secretary of the Treasury to promulgate regulations of the type published herein to the Secretary of Labor. All references herein to section 408(b)(2) of the Act and the regulations thereunder should be read to include reference to the parallel provisions of section 4975(d)(2) of the Code and regulations thereunder at 26 CFR 54.4975-6.

xii What Is the Effective Date?
Paragraph (c) of this section shall be effective on July 16, 2011. Paragraph (c)(1) of this section shall apply to contracts or arrangements between covered plans and covered service providers as of the effective date, without regard to whether the contract or arrangement was entered into prior to such date; for contracts or arrangement entered into prior to the effective date, the information required to be disclosed pursuant to paragraph (c)(1)(iv) of this section must be furnished no later than the effective date.

What Is the EBSA Contact Information?
For questions about the regulation, contact EBSA's Office of Regulations and Interpretations at 202.693.8500.

(2) WELFARE PLAN DISCLOSURE. [RESERVED]

(3) TERMINATION OF CONTRACT OR ARRANGEMENT. No contract or arrangement is reasonable within the meaning of section 408(b)(2) of the Act and paragraph (a)(2) of this section if it does not permit termination by the plan without penalty to the plan on reasonably short notice under the circumstances to prevent the plan from becoming locked into an arrangement that has become disadvantageous. A long-term lease which may be  terminated prior to its expiration (without penalty to the plan) on reasonably short notice under the circumstances is not generally an unreasonable arrangement merely because of its long term. A provision in a contract or other arrangement which reasonably compensates the service provider or lessor for loss upon early termination of the contract, arrangement, or lease is not a penalty. For example, a minimal fee in a service contract which is charged to allow recoupment of reasonable start-up costs is not a penalty. Similarly, a provision in a lease for a termination fee that covers reasonably foreseeable expenses related to the vacancy and reletting of the office space upon early termination of the lease is not a penalty. Such a provision does not reasonably compensate for loss if it provides for payment in excess of actual loss or if it fails to require mitigation of damages.

Other Points

Disclosure of Services and Compensation
Information required to be disclosed by plan service providers must be furnished in writing to the plan fiduciary.

The rule does not require a formal written contract delineating the disclosure obligations.

Disclosure whether services are bundled or not
Because certain services and costs are so significant or present the potential for conflicts of interest, information concerning those services and costs must be disclosed without regard to whether services are furnished as part of a bundle or package. For example, service providers must disclose whether they are providing recordkeeping services and the compensation attributable to such services, even when no explicit charge for recordkeeping is identified as part of the service contract.

Service providers must disclose whether they are providing any services as a fiduciary to the plan.

Ongoing Disclosure Obligations
Changes: A service provider generally must disclose a change to the initial information is required to be disclosed as soon as practicable, but no later than 60 days from the date on which the covered service provider is informed of such change.

Reporting and Disclosure Requirements
Service providers also must, upon request, disclose compensation or other information related to their service arrangements that is requested by the responsible plan fiduciary or plan administrator in order to comply with ERISA's reporting and disclosure requirements.

DOL Cited Benefits of Interim Final Regulation
DOL estimates that the rule will be economically significant. The non-discounted costs for the first year are estimated to be approximately $153 million.

The first year costs are attributable to reviewing and analyzing the regulation, conducting a compliance review to ensure that service providers comply with the regulation, and preparing any new disclosures required by the regulation. Costs in the second and subsequent years are expected to fall to an estimated $37 million.

The DOL estimates that benefits would result from reduced time and cost for fiduciaries to obtain compensation information needed to fulfill their fiduciary duties, the discouragement of harmful conflicts of interest, reduced information gaps, improved decision-making by fiduciaries about plan services, enhanced value for plan participants, and increased ability to redress abuses committed by service providers.

Public Notice and Comment on the Interim Final Regulation
The interim final regulation was published in the Federal Register on July 16, 2010.
Public comments from interested persons on the regulation may be made by August 30, 2010.
DOL requests input on the feasibility and cost effectiveness of requiring plan service providers to furnish plan fiduciaries a summary disclosure statement as part of the regulation.

Public comments can be submitted electronically by email to e-ORI@dol.gov or by using the Federal eRulemaking portal at www.regulations.gov. Persons interested in submitting comments on paper should send or deliver their comments to: Office of Regulations and Interpretations, Employee Benefits Security Administration, Room N-5655, U.S. Department of Labor, 200 Constitution Ave., N.W., Washington, DC 20210, Attention: 408(b)(2) Interim Final Rule. All comments will be available to the public, without charge, online at www.regulations.gov and www.dol.gov/ebsa, and at the EBSA Public Disclosure Room.

RESOURCES

July 16, 2010 Federal Register Version of the Interim Final Regulation

July 15, 2010 Version of Interim Final Regulation (Double Spaced)

Regulation section only

DOL Fact Sheet

DOL Class Exemption Sample Notice - Delinquent Service Provider Disclosure