Retirement Benefits Planning UpdateRetirement Benefits Planning Update Editor: Harvey B. Wallace II, Berry Moorman PC, The Buhl Building, 535 Griswold, Suite 1900, Detroit, MI 48226-3679, hwallace@ berrymoorman.com.

Probate & Property Magazine, January/February 2009, Volume 23, Number 1

RETIREMENT BENEFITS PLANNING UPDATE

 

Disclosure, Disclosure, Disclosure

During the past two years, the U.S. Department of Labor, Employee Benefits Security Administration (DOL) has exercised its interpretive authority over ERISA by issuing three types of guidance on plan fee and expense disclosure for employee benefit plans subject to ERISA, as follows:

  1. Disclosure by plan fiduciaries to the DOL under ERISA § 103 by revising the Form 5500 annual report for large ERISA plans by proposed amendments to ERISA Reg. § 2520.103-1 (29 C.F.R. Part 2520) on November 16, 2007, 72 Fed. Reg. 64,710–64,730, and by a notice of adoption of revisions to annual return/report forms. 72 Fed. Reg. 64,731–64,850.
  2. Disclosure by service providers to plan fiduciaries under ERISA §§ 404(a) and 408(b)(2) by proposed amendments on December 13, 2007, to ERISA Reg. § 2550.408b-2(c), 72 Fed. Reg. 70,988–71,005, and by issuing Proposed Class Exemption for Plan Fiduciaries When Plan Service Arrangements Fail to Comply with ERISA § 408(b)(2). 72 Fed. Reg. 70,893–70,896.
  3. Disclosure by plan fiduciaries to plan participants and beneficiaries in participant directed plans under ERISA §§ 404(a) and 404(c) by proposed amendments on July 23, 2008, to ERISA Reg. §§ 2550.404a-5 and 2550.404c-1. 73 Fed. Reg. 43,014–43,044.

The goals of the proposed changes to Form 5500 Schedule C are to increase transparency regarding fees and expenses paid by employee benefit plans and to ensure that plan officials obtain the information they need to assess the compensation paid for services rendered to the plan, taking into account revenue sharing arrangements among plan service providers and potential conflicts of interest. 72 Fed. Reg. 64,738. The goals of the proposed changes to the rules governing the relationship between plan service providers and plan fiduciaries is to provide sufficient information to enable plan fiduciaries to make informed decisions about the services, the costs, and the service provider. 72 Fed. Reg. 70,988. Finally, the goal of the new rules for disclosure by plan fiduciaries to plan participants and beneficiaries is to ensure that participants and beneficiaries are made aware of their rights and responsibilities for managing their individual accounts and are provided sufficient information regarding the plan, including its fees and expenses, and designated investment alternatives, including fees and expenses attendant thereto, to make informed decisions about the management of their individual accounts. 73 Fed. Reg. 43,014.

Expanded Form 5500 Reporting

Beginning with the 2009 plan year, the Form 5500 for ERISA plans with over 100 participants must generally identify and report specific information on a revised Schedule C for each person (any individual or trade or business, whether incorporated or not) who receives, directly or indirectly, $5,000 or more in reportable compensation in connection with services rendered to the plan or their position with the plan. In the case of certain key service providers (including each person who is a fiduciary to the plan or who provides services to the plan as contract administrator, consultant, investment advisor (to the plan or its participants), investment manager, securities broker, or record keeper), indirect compensation of $1,000 or more must be reported even if total reportable compensation is less than $5,000. The type of services provided and the types of fees received by each reported person are to be identified by codes set forth in the instructions (32 codes for services and 26 codes for payment methods). Although the filing date for a calendar year plan is not until July 31, 2010, the initiation of systems for gathering the detailed information regarding the service provider compensation to be reported must occur immediately unless the effective date is pushed back. Certain service providers are excluded at the outset by the instructions to the revised Form 5500 (found at 72 Fed. Reg. 64,731). These include

  • an employee of the plan whose compensation is less than $25,000 for the plan year,
  • an employee of the plan sponsor or other business that is reported on Schedule C as a service provider if the employee did not separately receive reportable compensation from the plan,
  • persons whose compensation consists of insurance fees and commissions listed on Schedule A of Form 5500, and
  • persons who received payments directly from the plan’s sponsor that are not reimbursed by the plan.

Reportable compensation includes money, any other thing of value (gifts, awards, trips, for example), and fees charged as a percentage of assets and deducted from investment returns.

The Form 5500 instructions define “direct compensation” as payments made directly from a plan account, charges to the plan’s forfeiture account, charges to the plan’s trust account before allocations are made to individual participant accounts, or direct charges to participant accounts. “Indirect compensation” consists of fees and expense reimbursement payments received from sources other than directly from the plan or plan sponsor such as fees charged against separately managed accounts and pooled investment funds and reflected in the value of the plan’s investment. For example, indirect compensation can include

  • investment advisor investment management fees,
  • fees related to purchases and sales of interests in the fund (including 12b-1 fees),
  • brokerage commissions and fees relating to purchases and sales of interests in the fund (regardless of whether the broker is granted discretion),
  • sub-transfer agency fees,
  • float revenue (earnings on funds placed in a holding account pending instructions for investment or distribution from the plan),
  • finder’s fees,
  • research or other products or services received from broker-dealers or other third parties in connection with securities transactions other than execution (“soft dollars”),
  • fees for providing services to plan investors or plan participants such as communication and other shareholder services,
  • account maintenance fees, and
  • plan administration fees such as record keeping, preparation of Form 5500, discrimination testing, QDRO and loan administration, and other compliance services.

Compensation is considered to have been received in connection with a person’s position with the plan or for services rendered to the plan if the person’s eligibility for payment or the amount of the payment is based, in whole or in part, on services that were rendered to the plan or on a transaction or series of transactions with the plan. Certain fees and expenses charged against an investment fund (and affecting its value) are thus not considered compensation (for example, payments for legal or accounting services rendered to an investment fund or fees associated with SEC filing requirements or printer’s fees). Brokerage costs associated with a broker-dealer affecting securities transactions within the portfolio of a mutual fund (or the portfolio of an investment fund that holds “plan assets” for ERISA purposes) are treated as an expense of the operating fund not reportable as indirect compensation. Department of Labor, FAQs About the 2009 Form 5500 Schedule C, FAQ 4, www.dol.gov/ebsa/faqs/faq_scheduleC.html.

Bundled Services and Alternative Reporting

The Form 5500 instructions (supplemented by FAQs About the 2009 Form 5500 Schedule C published on the Department of Labor’s web site cited above on July 14, 2008) provide for limited exceptions to the general requirement that all service providers receiving compensation of $5,000 or more be separately reported. First, in the case of a “bundled service arrangement”—any service arrangement in which the plan hires one company to provide a range of services either directly from the company, through affiliates or subcontractors, or through a combination, which are priced to the plan as a single package rather than on a service-by-service basis—direct payments to the bundled service provider are to be reported as direct compensation to the bundled service provider. An “affiliate” of a person includes any person, directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the person, applying principles consistent with the Treasury Regulations under Code § 414(e). Such direct payments need not be allocated among affiliates or subcontractors and reported as indirect compensation except in three cases. First, any amount paid by the bundled service provider that is determined on a per transaction (or service-by-service) basis must be separately reported. Second, fees charged to a plan investment fund and reflected in the fund’s net value (such as management fees paid to the fund’s investment advisors, float revenue, commissions (including “soft dollars”), finder’s fees, 12b-1 distribution fees, account maintenance fees, and shareholder servicing fees) must be treated as separate compensation by the person receiving the fee. Third, in the case of key service providers as defined above, fees paid (from a fund or otherwise) as commissions and other transaction-based fees, finder’s fees, float revenue, soft dollars, and other monetary compensations must be separately stated.

The second exception to separate reporting of each service provider’s compensation is the alternative reporting allowed for persons who receive only “eligible indirect compensation”—fees or expense reimbursement payments charged to investment funds and reflected in the value of the investment or return on investment of the participating plan or its participants, finder’s fees, “soft dollar” revenue, float revenue, and/or brokerage commissions or other transaction fees for transactions or services involving the plan that were not paid directly by the plan or the plan sponsor for which the plan has received certain written disclosures. If the appropriate disclosure is received, only the person furnishing the disclosure needs to be identified on the Form 5500 Schedule C and neither the service provider nor the amount of indirect compensation needs to be disclosed. The written disclosure must consist of written materials that disclose and describe (1) the existence of the indirect compensation, (2) the services provided or purpose of payment, (3) the amount (or estimate) of the compensation or a description of the formula used to calculate or determine the compensation, and (4) the identity of the party or parties paying and receiving the compensation. In the case of a bundled arrangement, the written disclosure must separately disclose and describe each element of indirect compensation that would be required to be separately reported if the alternative reporting for eligible indirect compensation were not being relied on.

Part II of the 2009 Schedule C requires the plan fiduciary to list each plan service provider who failed or refused to provide the information needed to complete Schedule C for the plan, the nature of the services provided, and a description of the information that the service provider failed or refused to provide. Clearly, the burden of gathering the fee and expense information and properly categorizing that information for the purposes of revised Schedule C falls principally on the plan service providers. Although plans must complete the form, plan administrators and their financial advisors will have to turn to the financial firms involved to disclose information relating to their compensation. In recognition of the magnitude of the task, the DOL will excuse plan administrators who fail to provide fee and compensation information from reporting service providers in Part II for the 2009 plan year if the service provider furnishes the plan administrator with a written statement that the service provider has made a good faith effort to make necessary record-keeping and information management system changes in a timely fashion and, despite such efforts, the service provider was unable to complete the changes for the 2009 plan year. FAQs About the 2009 Form 5500 Schedule C, FAQ 40, supra.

New Service Provider Contractual Requirements

ERISA § 406(a) prohibits a plan fiduciary from causing plan assets to be transferred to a “party in interest,” which includes a service provider to the plan. ERISA § 408(b)(2) provides an exemption from the broad proscription of ERISA § 406(a) for transfers to service providers as long as the terms of the service provider arrangement and the compensation received by the service provider are reasonable, necessary, and appropriate for the services provided and the arrangement is approved by an independent party on behalf of the plan. The DOL takes the position that a fiduciary cannot enter into a reasonable contract with a service provider unless the fiduciary has been provided sufficient information about the total compensation the service provider will receive and any actual or potential conflicts of interest under which the provider might be operating. 72 Fed. Reg. 70,989. The Proposed Regulations, which are to be effective 90 days after Final Regulations are published, significantly expand the contractual requirements and fees and conflict of interest disclosures required of service providers and require service providers to actually comply with the disclosure undertakings in the contractual agreement. The new specific disclosure requirements apply to any service provider who

  • provides (or may provide) services as a fiduciary under ERISA or under the Investment Advisers Act of 1940,
  • provides (or may provide) securities or other brokerage, consulting, investment, advisory, investment management, custodial, record keeping, banking, insurance, or third-party administrative services, or
  • receives (or may receive) indirect compensation or fees for accounting, actuarial, appraisal, auditing, legal, or valuation services.

For this purpose, compensation or fees include money or any other thing of monetary value (for example, gifts, rewards, and tips) received, or to be received, directly from the plan or plan sponsor or indirectly (that is, from any source other than the plan, the plan sponsor, or the service provider) by the service provider or its affiliate in connection with the services to be provided under the contract or arrangement or because of the service provider’s or affiliate’s position with the plan. An “affiliate” of a service provider is any person directly or indirectly (through one or more intermediaries) controlling, controlled by, or under common control with the service provider, or any officer, director, agent, or employee of, or partner with, the service provider.

Service Provider Contract Terms

The contract or arrangement with any of the above service providers must be in writing. The contract terms must require the service provider to disclose

  • all services it provides to the plan;
  • all compensation or fees it or its affiliates will receive, directly or indirectly, in connection with such services (in the case of bundled services, only the service provider offering the bundled services must provide the disclosures);
  • the manner of the receipt of such compensation (for example, deducted from plan accounts, charged against the plan investment fund);
  • whether the service provider will provide any services as a fiduciary either under ERISA or the Investment Advisers Act of 1940;
  • any financial or other interest the service provider may have in any transaction with the plan;
  • whether the service provider has any material financial, referral, or other arrangement with money managers, brokers, or other service providers that creates or may create a conflict of interest in rendering services;
  • whether the service provider can affect its own compensation or fees (for example, as a result of incentive, performance-based, float, or other contingent compensation) and, if so, a description of such compensation; and
  • whether the service provider has any policies or procedures to address actual or potential conflicts of interest (and, if so, an explanation of such policies).

The contract must also require the service provider to disclose to the plan fiduciary any material change to the information required to be disclosed not later than 30 days from the date on which the service provider acquires knowledge of the material change. Finally, the service provider must agree to furnish all information requested by the plan to allow the plan to comply with its reporting and disclosure requirements (Form 5500, for example). The provisions of the existing regulation requiring that any provider contract be terminable without penalty by the plan on reasonably short notice continues to apply and has been renumbered as ERISA Reg. § 2550.408b-2(c)(2).

Should the contract entered between a plan and a service provider fail to conform to the foregoing requirements (or fail to be administered in accordance with the proper contract terms), a violation of the prohibited transaction rules of ERISA § 406(a)(1)(C) occurs. In the case of a service provider, the activity must cease, the transaction must be rescinded, and the service provider would be subject to the confiscatory excise taxes of Code § 4975(a) and (b) of 15% of the amount involved per year and up to 100% of the amount involved if no correction occurs after a DOL notice is given. Under ERISA § 502(l), the DOL may impose a penalty on a fiduciary who knowingly participates in a prohibited transaction equal to 20% of the amount involved. The proposed class exemption for plan fiduciaries when plan service agreements fail to comply with ERISA § 408(b)(2) provides relief for a fiduciary who enters into a contract satisfying the regulatory requirements with a service provider that fails to make the disclosures required by the regulations.

Disclosure to Participants in Participant Directed Account Plans

The Proposed Regulations requiring disclosure to participants in participant directed account plans apply to plans with directed individual accounts, regardless whether or not the plan is designed to comply with ERISA § 404(c), that provides certain protections to plan fiduciaries for participant investment choices. The Proposed Regulations are issued under ERISA § 404(a) with conforming amendments to the regulations under ERISA § 404(c). When finalized, the regulations are proposed to be effective for plan years beginning on or after January 1, 2009. The regulations require annual and yearly disclosures of “plan-related” information and “investment-related” information.

Plan-related Information

On or before an individual becomes eligible to be a participant or beneficiary under the plan and annually thereafter, plan fiduciaries must furnish each participant and beneficiary the following “plan-related” information:

  1. General information about the plan operation, including
    • an explanation of the circumstances under which participants and beneficiaries may give investment instructions;
    • an explanation of any specified limitations on such instructions such as restrictions on transfers to or from a designated investment alternative;
    • a description of or references to plan provisions relating to the exercise of voting, tender, and similar rights as well as any restrictions on such rights;
    • an identification of any designated investment alternatives offered under the plan (meaning only the “core” investment options, specifically excluding self-directed brokerage windows); and
    • an identification of any designated investment managers.
  2. Administrative expense information, including an explanation of any fees and expenses related to plan administrative services (for example, legal, accounting, record keeping) that may be charged to the plan and the basis on which such charges will be allocated (whether pro rata or per capita) to each individual account.
  3. Individual expenses, providing an explanation of any fees and expenses that may be charged against a participant’s individual account for services provided on an individual (rather than plan) basis such as fees to process loans or QDROs or fees for investment advice.

If distributed with sufficient frequency, the foregoing information may be provided as a part of the plan’s Summary Plan Description under ERISA § 105(a)(1)(A)(i) or pension benefit statement under ERISA § 105(a)(1)(A)(i). Participants and beneficiaries must be notified within 30 days of the adoption of any material change to any of the foregoing information. In addition, on a quarterly basis, the plan fiduciaries must provide a statement to each participant and beneficiary that shows the amounts actually charged during the preceding quarter to the individual’s account for administrative services (for example, record keeping) and for individual services (for example, fees for loan processing) with a description of the services provided in each case. The quarterly information may be included as part of a pension benefit statement.

Investment-related Information

On or before an individual becomes eligible to be a participant or beneficiary under the plan and annually thereafter, the fiduciary must provide each individual the following information for each designated investment alternative under the plan (exclusive of “brokerage windows” or “self-directed” brokerage accounts):

  1. Identifying information, including
    • the name of the investment alternative;
    • an Internet web site address sufficiently specific to lead individuals to supplemental information regarding the investment alternative (including the name of the issuer/provider, principal strategies and risks, assets comprising the portfolio, portfolio turnover, investment’s performance, and related fees and expenses);
    • the type of investment (for example, money market fund, balanced fund, large cap fund);
    • the type of management (for example, actively or passively managed);
    • a statement of the name, address, and phone number of the fiduciary to contact for information available on request; and
    • a statement that more current investment-related information may be available at the listed web site address.
  2. Performance data and benchmark information, including
    • in the case of investment alternatives without a fixed return, the average annual total return (percentage) for one-year, five-year, and ten-year periods (measured as of the end of the applicable calendar year), a statement that an investment’s past performance is not necessarily an indication of how the investment will perform in the future, and the name and returns of an appropriate broad-based securities market index over comparable one-year, five-year, and ten-year periods; and
    • in the case of investment alternatives with fixed returns, the fixed rate of return and the term of the investment.
  3. Fee and expense information, including
    • for investment alternatives without a fixed return, the amount and description of each shareholder-type fee (that is, fees charged directly against a participant’s investment) such as sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, purchase fees, mortality and expense fees, the total operating expenses of the investment expressed as a percentage (for example, expense ratio), and a statement indicating that fees and expenses are only one of several factors that participants should consider when making investment decisions; and
    • for investment alternatives with a fixed return, the amount and a description of any shareholder-type fees that may be applicable to a purchase, transfer, or withdrawal of the investment, in whole or in part.

The information described above is required to be furnished in a chart or similar format that is designed to facilitate comparison of such information for each designated investment alternative available under the plan. An appendix to the Proposed Regulations includes two model charts, one for performance information and one for fees and expense information. Although this format is not required to be used, the Proposed Regulations provide that the accurate completion of the model chart for each of the plan’s designated investment alternatives is deemed to satisfy the investment-related disclosure requirements. According to footnote 7 in the preamble to the Proposed Regulations, however, fiduciaries shall not be liable for their reasonable and good faith reliance on information furnished by their service providers about the disclosures required to be made in the comparative format.

In addition to the above periodic disclosures of information, plan fiduciaries are required to provide each participant or beneficiary who has invested in a designated investment alternative any materials provided to the plan relating to the exercise of voting, tender, and similar rights appurtenant to the investment to the extent that such rights are passed through to the participant under the terms of the plan. Finally, the fiduciaries, at the request of any participant or beneficiary who has invested in a designated investment alternative, must provide (1) copies of prospectuses (or any short-form summary prospectus approved by the SEC), (2) copies of any financial statements or reports (such as statements of additional information and shareholder reports) provided to the plan, (3) a statement of the value of a share or unit of each investment alternative and the date of valuation, and (4) a list of the assets comprising the portfolio of each investment alternative that constitutes plan assets and the value of each asset (or the proportion of the investment that it comprises).

Numerous questions have been raised in the comments to the Proposed Regulations regarding the practical difficulties of providing information immediately on the eligibility date, determining benchmarks, applying the one-year, five-year, and ten-year performance data to target-date or life cycle funds, and what charges are material for purposes of the 30-day update, among others. It may be expected that the Final Regulations will include significant changes. Although the use of charts in the Proposed Regulation’s appendix provides a kind of disclosure safe harbor for plan fiduciaries, the Proposed Regulations state that nothing in the regulations is intended to relieve a fiduciary of its duty to prudently select and monitor providers of services to the plan or designated investment alternatives.

Join a Group or Committee Today!

RPTE members can join a group or committee (or several) online at www.abanet.org/rpte/join. For questions regarding membership, contact the Section at (312) 988-5651 or e-mail rpte@staff.abanet.org.

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