July 9, 2013
ERISA Section 408(b)(2) (Fee Disclosure Regulation)
What is Section 408(b)(2)?
In July of 2012, the final service provider disclosure regulation became effective, and was issued under ERISA Section 408(b)(2). This regulation requires covered service providers (CSPs) to provide plan fiduciaries with the appropriate disclosures in regards to the services that are being performed for the Plan as well as all the costs, both direct and indirect, that will be charged for those services. The regulation applies to CSPs who expect to receive at least $1,000 in compensation for services rendered to a covered plan and applies to the following service providers:
- ERISA fiduciary service providers to a covered plan or to a plan asset vehicle in which such plan invests
- Investment advisers registered under Federal or State law
- Record-keepers or brokers who make designated investment alternatives available to the covered plan
- Providers of one or more of the following services to the covered plan who receive or expect to receive indirect compensation (that is compensation received from any source other than the plan sponsor, the plan service provider, an affiliate or a subcontractor) in connection with their services such as:
- Accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, third party administration or valuation services.
Once CSPs provide the necessary disclosures to plan fiduciaries, it is incumbent upon the Plan Sponsor to assess that the fees being charged for the services being rendered are reasonable. This regulation provides an exemption for reasonable contracts and arrangements for plan services that would have been considered prohibited transactions. The fee disclosures must be made by CSPs in order for the fees and services to be considered reasonable. In any circumstance where a CSP has not made the required disclosures, a possible prohibited transaction may have occurred.
Now What Do I Do?
Plan sponsors and the plan's fiduciaries should identify all CSPs and determine whether the appropriate disclosures were made for all covered plans and that the disclosures are complete and understandable. While this sounds simple, there can be complications to identifying these providers, assuring the disclosures are complete and understandable. As a general rule of thumb, if you cannot do the math to recalculate the fees being charged or the disclosure is unclear and confusing, go back to the CSP and ask questions. It is important to understand that this regulation puts the satisfaction of the completed disclosures on the shoulders of the plan sponsor and its fiduciaries. If the disclosures are incomplete this could lead to a fiduciary breach and potentially a prohibited transaction.
Once this is done, the plan sponsor and its fiduciaries must now assess that the fees are reasonable. While the fee reasonableness evaluation process may be undertaken without assistance, a best practice of working with a knowledgeable and independent adviser to assist in this process would offer the best evaluation. Many sponsors use independent benchmarking services to aid in the assessment of fee reasonableness, while others use an RFP process for all service providers performing services to the plan and still others use a combination of the two. Either way documenting the process and its results is the best way to assist you with assessing fee reasonableness. The evaluation process should answer the following, but not limited to:
- Are all sources of compensation, not just the fees paid directly by the plan or the sponsor being assessed? Revenue sharing from mutual funds and other forms of compensation eventually come from the plan and are tied into the participants' investment returns.
- Are the services appropriate for the plan?
- Do the services meet the needs of the participants?
- Are there any conflicts of interest that could affect the participant's best interest? If so can they be managed appropriately?
- Does the arrangement provide for termination on reasonably short notice and without great penalty to the plan?
What's on the horizon?
Section 408(b)(2) creates a two-way street for the advisor and sponsor. Information must be properly given to the sponsor and that information must be assessed by the sponsor for reasonableness. While testing for reasonableness can be a subjective exercise, someone will be keeping an eye out to make sure excessive fees are being curtailed. On May 17, 2013, the Director of the Philadelphia Region of the Employee Benefits Security Administration noted that one ERISA violation that the EBSA plans to focus on in the coming months is cases where retirement plan participants appear to be paying higher aggregate fees than other plans. The focus will be on what the disclosures look like, what did the fiduciaries look at to assess reasonableness, were the fees being charged documented for reasonableness.
Plan sponsors should prepare for the difficulties that Section 408(b)(2) presents. The duty of the plan sponsor and its fiduciaries is to exercise prudence when it comes to these new fee disclosure regulations.