Hidden in Plain Sight?

The Department of Labor (DoL) believes that the increased complexity in the way services are provided to employee benefit plans has created conceptual difficulties for plan fiduciaries and, as a result, plan fiduciaries now find it harder than ever to understand precisely how service providers (including advisers) are compensated for such services. The DoL also has concluded that it is more difficult for plan fiduciaries to determine whether potential conflicts of interest have had an impact on the services provided to their plans. The DoL has been working on a three-pronged approach to fee disclosure, which includes: (i) fee disclosure to the government; (ii) fee disclosure to plan fiduciaries; and (iii) fee disclosure to plan participants.

The first prong of the approach was completed in November 2007 when the DoL issued its final rule requiring that, beginning with the 2009 plan year, direct and indirect compensation paid to plan service providers be reported on Schedule C of the Form 5500. The second prong was begun in December 2007 when the DoL issued a proposed rule that would require service providers to disclose to plan fiduciaries of retirement, health, and welfare plans detailed information regarding fees and conflicts of interest (see “Second Cite,” page 54). The DoL intends that the final rule will assist plan fiduciaries in determining whether the fees paid by plan assets are reasonable.

Under the recently issued DoL proposal, a plan service provider (such as an adviser) will be required to disclose, in writing to a plan fiduciary, all direct and/or indirect compensation it receives and any potential conflicts of interest that may arise as a result of providing services to a plan. The disclosure will include money and any other items of monetary value received by the service provider or its affiliate in connection with the services provided to the plan or the financial products in which plan assets are invested. However, if a service provider is unable to disclose its compensation in terms of a specific dollar amount, then the service provider is permitted to disclose its compensation in the form of a formula or percentage of plan assets or a per-capita charge for each plan participant/beneficiary.

The proposed rule will be imposed on the following types of service providers and their services:

1. a service provider that provides services to employee benefits plans as a fiduciary under ERISA or the Investment Advisers Act of 1940;
2. a service provider that supplies any of the following types of services—banking, consulting, custodial, insurance, investment advisory or investment management, recordkeeping, securities or other investment brokerage, or third-party administration services;
3. a service provider receiving indirect compensation in connection with accounting, actuarial, appraisal, auditing, legal or valuation services—a provider whose only compensation involves a fixed fee or a fee based upon a disclosed hourly rate will not be included in this category.

The terms of the written contract between the fiduciary and the plan service provider must identify, among other things, how the service provider will receive its fees from the plan, the services that will be provided to the plan, how prepaid fees will be calculated and refunded upon the contract’s termination, and must contain a statement as to whether the service provider is a fiduciary. In addition, the service provider must agree and actually disclose any material changes regarding its previously disclosed information to the plan’s fiduciaries within 30 days of acquiring knowledge of the material change.

The proposed rule also requires the service provider to disclose: (i) any material relationships (e.g., financial or referral) with other parties that may result in a conflict of interest; (ii) whether the service provider may receive compensation without prior approval by an independent fiduciary with respect to the performance of services; and (iii) any policies and procedures designed to prevent the disclosed compensation, relationships, or conflicts from adversely affecting its services to the plan. The proposed rule will be effective 90 days after publication of the final rule.

As for the last of the three prongs, in 2008, we expect the DoL to issue rules that will be imposed on employee benefit plans to disclose fee information to participants.

Quana C. Jew is a partner at the law firm of Arent Fox, focusing on ERISA, employee benefits, and executive compensation. Quana has served as a guest lecturer in the employee benefits area for various law school, bar seminar, and employee benefits-related organizations. She also serves on the Advisory Board of the Women’s Pension Exchange. Most recently, Washingtonian magazine named Quana as one of Washington’s best tax lawyers.