3 Service Provider Disclosure - Background Retirement system shift to participant-directed defined contribution plans Development of fee structures relying on indirect and hidden direct compensation (retirement and welfare plans) New class action litigation against plan sponsors and plan service providers Media attention and legislative pressure to improve disclosure
4 Service Provider Disclosure Two DOL regulatory projects address disclosure of fees and service provider conflicts. Disclosure of Fees Paid in a Plan Year - Amendment of Form 5500 Schedule C requires more disclosure of compensation paid directly and indirectly for plan services. Point of Sale Disclosure - Proposed amendment of ERISA section 408(b)(2) regulation (services exemption) will require disclosure by covered service providers.
5 Service Provider Disclosure Amendments to the Form 5500 are final and effective for 2009 plan years. Proposed Amendments to ERISA section 408(b)(2) regulations were not finalized before January 20, 2009. Obama Administration may propose or issue similar rules. Congress may act.
6 Service Provider Disclosure Some Themes Disclosure burden shifts to non-fiduciary service providers, with enforcement mechanisms For service providers – complex new requirements to interpret and implement disclosure of indirect compensation reporting relief for bundled arrangements coordination with other service providers For plan sponsors – more information
7 Service Provider Disclosure Form 5500 Form 5500 is an annual report filed with the DOL for ERISA-covered plans. Significant new Form 5500 package published November 16, 2007 Generally effective for 2009 plan year filing. Significant changes to Schedule C. Affects both pension and welfare plans. 72 Fed. Reg. 64710 and 64731. DOL FAQs issued July 14, 2008.
8 Service Provider Disclosure Form 5500 - Schedule C Report service providers receiving $5000 or more direct or indirect compensation paid by the plan Applies if plan has more than 100 participants. DOLs goal in revamping Schedule C was to expand reporting of indirect compensation. Key changes - New definitions - indirect compensation, bundle, investment fund Report source of indirect compensation Reporting relief for eligible indirect compensation and bundled arrangements
9 Service Provider Disclosure Schedule C – Indirect Compensation Indirect compensation means payments from sources other than the plan or plan sponsor that are in connection with services to the plan or the persons position with the plan. Include compensation received if the persons eligibility for the payment or the amount of the payment is based, in whole or in part, on services rendered to the plan or transactions with the plan. Dont include compensation that would have been received had the service not been provided or the transaction had not taken place and that cannot be allocated to services.
10 Service Provider Disclosure Schedule C – Indirect Compensation Examples provided by Schedule C: Finders fees, float, brokerage commissions, soft dollars and other transaction-based fees received in connection with transactions or services involving the plan. Amounts charged to the plans investments and reflected in unit value, e.g., investment management fees, 12b-1 fees. Not included – investment fund operating expenses, e.g., portfolio brokerage expenses.
11 Service Provider Disclosure Schedule C – Mechanics Line 2 (Part I) of Schedule C requires for each service provider (receiving > $5,000): Service Provider Name, EIN Amount of direct compensation Report of indirect compensation FAQs clarify that indirect compensation may be reported as a formula rather than an amount or estimate. Line 3 (Part I) requires identification of source of indirect compensation, if (a) over $1,000, or (b) reported as a formula.
12 Service Provider Disclosure Schedule C – Alternative Reporting If a Service Provider receives Eligible Indirect Compensation (EIC) and no other compensation in connection with the plan, plan reporting is limited. Plan administrator still receives detailed information. Schedule C identifies person who provided information. Even if other compensation received by a Service Provider (direct or ineligible direct) is reported, amount of EIC need not be reported. Line 3 source reporting not required for EIC.
13 Service Provider Disclosure Schedule C – Alternative Reporting Eligible Indirect Compensation includes: Fees charged against investment funds, e.g., investment management fees Finders fees, float, brokerage commissions, soft dollars Other transaction-based fees paid for transactions or services involving the plan, if charged against the plans investment. Disclosure required for EIC: The existence of indirect compensation, and service provided or other purposes of payment The amount or an estimate of, or the formula to calculate, the fee The identity of the parties paying and receiving the fee.
14 Service Provider Disclosure Schedule C – Bundled Arrangements A bundled arrangement A service arrangement where the plan hires one company to provide a range or services either directly or indirectly 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. An investment transaction in which the plan receives a range of services either directly from the investment provider, through affiliates or subcontractors, or through a combination.
15 Service Provider Disclosure Schedule C – Bundled Arrangements Payments received by the bundled providers affiliates or subcontractors are not reported unless these amounts are – Set on a per transaction basis (e.g., brokerage); Fees charged against the value of the plans investments (e.g., management fees); or Finders fees, float, soft dollars, and non-monetary compensation earned by certain providers (fiduciary, investment manager or adviser, consultant, recordkeeper, broker).
16 Service Provider Disclosure Form 5500 – Schedule C Schedule C Implementation Issues Scope of covered indirect compensation EIC definition; disclosure formats Defining a bundle Service provider disclosure obligations Disclosing fees received Disclosing fees paid to other persons in connection with plan services Duties of service providers responsible for Form 5500 preparation
17 Service Provider Disclosure Schedule C - Responsibilities Plan administrators, not service providers, are obligated to complete Form 5500. Schedule C requires the plan administrator to report service providers who refuse to provide necessary information following a request. Illustrates DOLs intention to use the Form 5500 as an enforcement tool. FAQs provide relief to service providers that notify plans trial they have made a good faith effort to collect information, but could not complete recordkeeping changes for 2009 plan year.
18 Meals, Gifts and Entertainment Form 5500 – Schedule C Direct and indirect compensation may include some compensation received by employees of plan sponsors and service providers. Not reported – compensation, e.g., salary, received by a plan sponsor or service provider employee, from his or her employer. Reportable – other compensation, including non- monetary compensation, received by a plan sponsor or service provider employee from a third party.
19 Meals, Gifts and Entertainment Form 5500 – Schedule C Indirect compensation may include meals and entertainment received by employees of sponsors and service providers. But, insubstantial non-monetary compensation (e.g., gifts and meals of insubstantial value) need not be reported if: 1. the compensation is tax deductible to the payor and excluded from taxable income for the recipient, and 2. the gift is valued at under $50 and total gifts to the recipient from the same source during the year do not exceed $100.
20 Service Provider Disclosure 408(b)(2) Amendment Proposed amendment to ERISAs services exemption regulation would: require written service agreements. require detailed disclosure by service providers, before or at the time the plan enters a service arrangement and upon material changes in fees. apply to non-fiduciary service providers. 72 Fed. Reg. 70988 (Dec. 13, 2007 ). Final Rule was withdrawn from OMB on Jan 26, 2009
21 Service Provider Disclosure 408(b)(2) Amendment Proposed amendment only applies to covered service providers, including: any provider of banking, consulting, insurance, investment advisory (plan or participants), investment management, recordkeeping, securities or other investment brokerage, or third party administration, and any provider that receives or may receive indirect compensation that provides one or more of the following services – accounting, actuarial, appraisal, auditing, legal or valuation.
22 Service Provider Disclosure 408(b)(2) Amendment Proposed regulations would require covered providers to disclose (before parties enter a service agreement): All services to be provided under the arrangement. The compensation or fees to be received by the service provider with respect to each service. Includes all indirect compensation and the manner of receipt of compensation. Primary provider under a bundle of services reports amounts received by affiliates, subcontractors and other parties in connection with bundle of services (but generally does not report the allocation of compensation among these parties).
23 Service Provider Disclosure 408(b)(2) Amendment Proposed regulations also would require providers to disclose (before the parties enter into a service agreement): Whether provider will provide services as a fiduciary. Any participation or interest the provider may have in plan transactions. Any material financial, referral or other relationship that creates or may create a provider conflict of interest. Whether the provider will be able to affect its own compensation without prior approval of the plan fiduciary. The providers policies or procedures to address potential conflicts of interest.
24 Service Provider Disclosure 408(b)(2) Amendment Indirect Compensation – compensation received from any source (other than plan/plan sponsor) by service provider or its affiliate in connection with services provided or because of service providers or affiliate's position with the plan.
25 Service Provider Disclosure 408(b)(2) Amendment If a provider offers a bundle of services priced as a package, rather than on a service by service basis, bundle provider must provide disclosures - aggregate of compensation received by subcontractors, affiliates or any other party need not disclose allocation among affiliates, subcontractors, other parties (subject to exceptions)
26 Service Provider Regulation 408(b)(2) Amendment Covered service providers who do not comply with proposed regulation could violate ERISAs prohibited transaction rules. Potential liability for excise taxes under Code section 4975 (for pension plans) Potential section 502(i) penalty (for welfare plans)
27 Meals, Gifts and Entertainment 408(b)(2) Regulations Key providers must provide advance disclosure of compensation (amount, estimate) sufficient info for fiduciary to evaluate reasonableness Compensation – includes "gifts, awards and trips for employees" received directly or indirectly either (1) in connection with services to be provided to the plan or (2) because of the provider's "position with the plan." Issues/Challenges Meals trigger heightened disclosure for a non-key provider? How to disclose in advance?
28 Service Provider Regulation 408(b)(2) Amendment Next Steps? Could be re-proposed with new notice and comment period (similar to Investment Advice Rule and Exemption) Could be supplanted by legislation
29 Participant Disclosure Proposed Regulations Proposed rules would enhance disclosures provided to participants in participant-directed individual account plans. 73 Fed. Reg. 43014 (July 23, 2008). Only would apply to individual account pension plans; would not apply to welfare plans or DB plans. Unlike existing 404(c) regulations, proposed rules would be mandatory. Proposed effective date of Jan. 1, 2009; but the rules must be finalized in order to be effective.
30 Participant Disclosure Proposed Regulations Proposed regulations issued under ERISA section 404(a); with conforming changes to 404(c) regulations. Incorporates DOL view that plan fiduciaries are responsible to prudently select and monitor service providers and investment options. Would identify a fiduciary duty under section 404(a) to provide sufficient information regarding the plan, its expenses, and investment options to allow participants to make informed investment decisions. Proposed regulations describe four categories of information, to be provided on a regular and periodic basis.
31 Participant Disclosure Proposed Regulations 1.Plan Information: At eligibility and annually thereafter: Circumstances where participants may give investment instructions and limitations or restrictions on these rights Plan rules regarding proxy voting rights Identification of designated investment options and investment manager. Can provide via SPD.
32 Participant Disclosure Proposed Regulations 2.Plan Administrative Expenses: At eligibility and annually thereafter: Explanation of administrative fees that will be charged to the plan and the basis on which the fees will be allocated to or affect participant account balances (pro rata or per capita). Note: Excludes expenses that are paid through expense ratio of investment options. Can provide via SPD.
33 Participant Disclosure Proposed Regulations 3.Individual Participant Expenses At eligibility and annually thereafter: Explanation of any fees that will be charged against the individual account of a participant (i.e, loan processing, QDRO expenses, investment advice fees). Can provide via SPD.
34 Participant Disclosure Proposed Regulations Quarterly disclosure of: The actual dollar amount of administrative expenses and individual service charges assessed against the participants account during the preceding quarter A description of the services provided for such fees. Can provide in quarterly benefits statement.
35 Participant Disclosure Proposed Regulations 4.Investment Information A. Automatic Disclosures (provide in comparative form): Name of designated investment option Internet web address for further information Type of investment (e.g. money market fund) Type of management 1, 5, & 10-year performance data for option and for an appropriate market index Any shareholder fees (sales loads, redemption fees, etc.) Annual Operating expenses expressed as %
36 Participant Disclosure Proposed Regulations 4.Investment Information (continued) B. Upon Request Disclosures Prospectuses Financial or shareholder reports, to the extent provided to the plan Value of a share or unit & valuation date List of portfolio assets for plan asset vehicles
37 Participant Disclosure Proposed Regulations A plan fiduciary must provide specific investment information in a chart or similar format that is designed to facilitate comparison of investment options. Use of model disclosure form provided by DOL will be deemed to satisfy the requirement to provide information in a comparative format. A plan fiduciary is not required to use the model disclosure form. Must also provide a statement that more current information may be available at listed Web site addresses, and a statement indicating who to contact for certain information made available upon request.
38 Participant Disclosure Proposed Regulations Below is the Performance Information table from DOLs sample disclosure form at www.dol.gov/ebsa.
39 Participant Disclosure Proposed Regulations Below is the Fees and Expense Information table from DOL sample disclosure form.
40 Participant Disclosure Proposed Regulations Participant Disclosure Regulations have not been finalized, and will likely not be finalized as proposed. Could be re-proposed with new notice and comment period. Could be supplanted by Legislation.
41 The 401(k) Fair Disclosure For Retirement Security Act of 2007, H.R. 3185 (The Miller Bill) The Miller Bill would amend ERISA to impose three new requirements with respect to the fees that 401(k) and similar plans pay for services. Service Provider Disclosure: Prior to entering into any contract for services for $1,000 or more plan administrator receive a service provider disclosure. Identification of all parties that would be performing services under the contract; Description of services and total cost; Itemized list of services and expenses (i.e. sales commissions, expenses for investment advice); Disclosure of any conflicts of interest; If applicable, disclosure of impact of share classes and certain free, discounted or rebated services.
42 Miller Bill Provisions Would require Plan Administrators of participant-directed plans to provide participants or beneficiaries with notice of investment options. Detailed information about each investment option (i.e. investment objectives, level of risk, historical returns); A Fee Menu relating to all options under the plan, disclosing potential service fees that could be assessed against participant accounts; Disclosure of potential conflicts of interest.
43 Miller Bill Provisions Would require Plan Administrators to provide participant- specific benefit statements within 90 days of the close of the plan year. Require statement to disclose several subcategories of fees assessed from each participants account for each investment option selected.
44 Miller Bill Provisions Participant-directed account investment menu must include at least one nationally- recognized index fund likely to meet retirement income needs at adequate levels of contribution.
45 Miller Bill Provisions Would direct the DOL to enforce new requirements and create statutory penalties for failure to comply. Establishment of an Advisory Committee Creation of a penalty structure authorizing the DOL to assess a penalty against Plan Administrators of up to $100 per day for a failure. Authorize DOL to publicly disclose identity of noncompliant service providers.
46 401k Plan Litigation Class Actions against Plan Sponsors (by participants) Class Actions against Recordkeepers (by participants and sponsors)
47 Participants vs. Plan Sponsors: The Players What: Class actions challenging 401k recordkeeping and investments Who: Participants: (by class action lawyers Schlicter Bogard) Plan sponsors: Boeing; Lockheed Martin; Exelon; Caterpillar; General Dynamics; United Technologies; Bechtel; International Paper; Kraft; Northrop Grumman; Deere & Co.; and ABB
48 Participants vs. Plan Sponsors: The Claims Procedural Prudence - Did the plan fiduciaries exercise due diligence in their consideration of the plans compensation arrangement with service providers, including any revenue sharing component? Reasonableness of Fees – Did the plan fiduciaries cause the plan to pay excessive compensation to service providers because of revenue sharing or other circumstances? Disclosure – Did the plan fiduciaries violate ERISA in how and what they disclosed to plan participants about revenue sharing and other fees charged to the plan?
49 Participants vs. Plan Sponsors: The Claims Claims also include – Failure to capture float and other revenue streams Participants investing in mutual funds pay more than their share of administrative fees Fiduciary favored its DB plan run by same manager Use of master trust results in fee layers Mutual funds vs. separate accounts, and retail mutual funds Actively managed funds functions as passive funds, so their higher fees not justified
50 Participants vs. Plan Sponsors: The Claims Allegations regarding the plans company stock fund Cash component increases tracking error versus stock Investment management and other fees not justified Forcing participants to own company stock in order to participate in the 401k plan
51 Participants vs. Plan Sponsors: Disclosure of Rev. Sharing to Participants Disclosure not required Hecker v. Deere (CA 7 2009) – nothing in ERISA specifically requires disclosure of revenue sharing to participants. Taylor v. United Technologies (MSJ 2009) – rev sharing info is not material to reasonable investor
52 Participants vs. Plan Sponsors: Disclosure of Rev. Sharing to Participants Disclosure may be required (or advisable) Tussey v. ABB – disclosure not required, but could affect participants control under 404(c). Kanawi v. Bechtel – failure to disclose could potentially support a fiduciary breach claim and affect 404(c) relief
53 Participants vs. Plan Sponsors: The Section 404(c) Defense Some courts have held that 404(c) is a defense to claims that selection of plan investment options was imprudent. Langbecker v. Elec. Data Sys. Corp (CA 5 2007) Hecker v. Deere & Co. (CA 7 2009)
54 Participants vs. Plan Sponsors: The Section 404(c) Defense Other courts disagree Tussey v. ABB, Inc. (2008) Tittle v. Enron Corp. (S.D. Texas 2003) (whether 404(c) shields fiduciaries is a question of fact).
55 Participants vs. Plan Sponsors: The Section 404(c) Defense Hecker v. Deere & Co (CA 7 affirms motion to dismiss 2/09) Plan offered a sufficient mix of investments so that inclusion of expensive funds did not constitute a breach (plan had brokerage window) even if there was a breach as to fund selection, section 404c precluded liability Rehearing sought Suggests that sponsors have no duty to review fees so long as participants have thousands of choices (brokerage window) DOL disagrees
56 Participants vs. Plan Sponsors: Revenue Sharing Taylor v. United Technologies (MSJ for UT granted 3/3/09) Properly selected mutual funds Recordkeeping fees were reasonable when compared to market Not required to disclose to participants that revenue sharing was used to reduce amount UT paid to recordkeeper in fees UT properly monitored cash in stock fund
57 Suits vs. Recordkeepers Participants vs. Recordkeepers – Included as defendants in participant suits vs sponsors See ABB, Deere complaints Adds - an opportunity to allege self-dealing based on recordkeepers receipt of revenue sharing Plan Sponsors vs. Recordkeepers Defendants: Nationwide, Principal, Hancock, ING, American Skandia, Paychex, Fidelity Sponsors allege that recordkeeper was a fiduciary and that receipt of revenue sharing involved a conflict of interest
58 Suits vs. Recordkeepers Recordkeepers Fiduciary Status Is recordkeeper a fiduciary in plans selection of investment funds? Hecker v. Deere & Co. (2007)- Fidelity not a fiduciary Columbia Air Services v. Fidelity (2008) - Fidelity dismissed Tussey v. ABB (2008) - Fidelity could be a fiduciary
59 Suits vs. Recordkeepers Recordkeepers Fiduciary Status Does recordkeeper have fiduciary discretion to add/delete investment funds? Charters v. John Hancock (2008, plaintiffs MSJ partially granted) - Hancock could be a fiduciary Phones Plus v. Hartford (2007, MTD denied): Hartford could be a fiduciary based on ability to change funds available under annuity contract. Haddock v. Nationwide (2006): Nationwide may be a fiduciary
60 Questions? Jennifer E. Eller, Esq. - (202) 861-6604 Groom Law Group, Chartered 1701 Pennsylvania Avenue, NW Suite 1200 Washington, DC 20006 firstname.lastname@example.org