DOL-Proposed Rules Require Providers to Disclose Fees

Plan fiduciaries/service providers have guidance on level of fee disclosure required by ERISA

On December 13, 2007, the Department of Labor (DOL) issued proposed rules governing fee disclosures by plan service providers and a proposed prohibited transaction class exemption for plan fiduciaries. The rules provide welcome guidance regarding the nature and extent of required fee disclosures under ERISA and relief for plan fiduciaries who select service providers on behalf of the plan. 

Background
Because a plan’s service provider is a party in interest with respect to the plan, ERISA prohibits any transactions between the service provider and the plan unless a prohibited transaction exemption applies. Section 408(b)(2) of ERISA provides such an exemption if (1) the service contract or arrangement is reasonable, (2) the services are necessary for the establishment and operation of the plan, and (3) no more than reasonable compensation is paid for the services. 

With the recent increased focus on plan fees resulting from governmental investigations and participant lawsuits, the proposed rules provide both plan sponsors and service providers with much needed clarity on the disclosures required for a service provider contract or arrangement to qualify as “reasonable” under the Section 408(b)(2) exemption. 

Proposed Rules
The rules apply to contracts or arrangements (including extensions or renewals) between a plan and a service provider who:

a.  serves as a fiduciary to the plan;
b.  provides banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping, brokerage, or third party administration services to the plan; 

or 

c.  receives indirect compensation or fees in connection with accounting, actuarial, appraisal, auditing, legal, or valuation services pursuant to the contract. 

If a contract contains specific terms and the service provider discloses the information identified in the proposed regulations, the contract will be considered to be reasonable and covered by the prohibited transaction exemption under Section 408(b)(2) of ERISA.

Required Terms
The contract must be in writing, require the disclosure of the information described below, and include a representation by the service provider that disclosure was made before the plan entered into the contract. In addition, the contract must require the service provider to disclose any material change to the information required to be disclosed within 30 days of the date the service provider becomes aware of the change. As with prior DOL rules, the proposed rules require that the terms of the contract permit the plan to terminate it on “reasonably short notice under the circumstances” without penalty. Reasonable compensation for a service provider’s losses upon termination of the contract does not qualify as a penalty for the purposes of this rule. 

Required Disclosures
The contract must require the disclosure of the following information:

1. All services to be provided under the contract and the compensation for each service with a description of how the compensation is paid. Compensation includes money or any other thing of monetary value received in connection with the services or because of the service provider’s position with the plan. Compensation may be expressed as a monetary value, formula, percentage of plan assets, or per capita charge as long as there is sufficient information to enable the plan fiduciary to evaluate its reasonableness. In disclosing how compensation is paid, the service provider must indicate whether the compensation or fees are billed to the plan, deducted directly from plan accounts, or charged against plan investments and describe how any prepaid fees will be calculated and refunded when the contract terminates.
2. All services and the aggregate compensation received directly or indirectly (including compensation received by any other party) in connection with bundled services. The bundled services provider would not have to disclose the allocation of revenue sharing or similar payments among the parties, except in the case of (A) separate asset-based fees, for example mutual investment management fees or float revenue, which are charged directly against the plan investment and reflected in the investment’s net value and (B) fees charged per transaction, such as brokerage commissions or soft dollars, regardless of whether the fees are paid from mutual fund management or similar fees.
3. If the service provider will act as a plan fiduciary with respect to any services under the contract. The preamble to the regulations states that this requirement is intended to ensure that each party understands at the outset of the relationship whether or not the service provider considers itself to be a fiduciary and how this status affects the nature of its services.
4. Any relationships or interests potentially leading to a conflict of interest between the service provider and the plan. This disclosure must include a statement of whether or not the service provider will be able to affect its own compensation or fees under the contract without the prior approval of an independent plan fiduciary and a description of any policies or procedures that address actual or potential conflicts of interest.
5. All information requested by the plan fiduciary in order to comply with ERISA’s reporting and disclosure requirements.

Compliance Requirement
Including the above requirements in the contract is not alone sufficient to meet the standard for reasonableness. In order for the contract to be reasonable, the service provider must actually provide all required disclosures. Written disclosures may consist of separate documents from separate sources and may be delivered electronically as long as the documents collectively provide all the required information before the plan enters into the contract. In addition, under some circumstances the parties to the contract may choose to incorporate materials containing the information by reference. 

Proposed Class Exemption for Plan Fiduciaries
Because a failure by the service provider to make the disclosures required by the rules and the contract will result in a prohibited transaction affecting both the service provider and the fiduciary who entered into the contract, the DOL has also proposed a prohibited transaction class exemption for plan fiduciaries who meet certain conditions. 

Under the proposed exemption, a plan fiduciary will not be considered to have entered into a prohibited transaction if:

• Based on the information available at the time, the plan fiduciary reasonably believed that the contract was compliant and did not know or have reason to know of the service provider’s failure.
• Upon discovering the failure, the plan fiduciary in writing requests the required disclosure from the service provider and notifies the DOL if the service provider does not comply within 90 days.
• After discovering the failure, the plan fiduciary determines whether to terminate or continue the contract by evaluating the nature of the failure and determining the actions necessary under the facts and circumstances.

The proposed regulations and prohibited transaction exemption will both become effective 90 days after final versions are published. In the meantime, however, plan fiduciaries and service providers finally have clear and specific guidance on the level of fee disclosure required to satisfy the obligation to ensure that a contract with a plan service provider is “reasonable” for purposes of the prohibited transaction exemption under Section 408(b)(2) of ERISA.