Hidden in Plain Sight?
New fee disclosure proposals from the Department of Labor’s Employee Benefits Security Administration (EBSA) not only will require more compensation reporting from retirement plan advisers, but also could position them between other plan providers that must disclose fees and plan sponsors who must report that information to participants.
This year, EBSA has put forth no fewer than three fee disclosure-related initiatives, although they all had been on the agenda for years, explained panelist Roberta Ufford, Principal, Groom Law Group. The first two deal with how service providers disclose fees to sponsors; the third deals with disclosure to plan participants.
The 5500
Although two parts of the disclosure package are still in proposed form, the changes to the annual Form 5500 (see “Coming Soon,” PLANADVISER, January-February 2008) that must be completed by plan administrators are official, Ufford noted. The changes require disclosure of indirect compensation—compensation received by any person in connection with services administered to the plan or position with the plan.
Compensation reported on the 5500 is divided into direct compensation, eligible indirect compensation, and ineligible direct compensation. Of these three, only the direct compensation must be disclosed in a hard-dollar amount. Because of that, the new 5500 does not change much for registered investment advisers (RIAs) or advisers who receive compensation in a direct check from the plan, said Fred Reish, Managing Director, Reish Luftman Reicher & Cohen.
Reish added that administrators will have to check a box on the Form 5500 saying they have received the necessary information on eligible indirect compensation, and will have to report whether the compensation is paid as a percentage or flat fee, how it is paid, by whom, and who receives the indirect compensation.
“Even if you’re not involved [in preparing the 5500], I’d guess that plan sponsors will ask you to help them understand the information,” Ufford said. She said that, while plan administrators complete the Form 5500, the DoL requires them to report providers who refuse to give the information necessary for filing the report—indicating the DoL’s intent to use the Form 5500 as an enforcement tool.
What the Proposals Say
Additionally, a proposed amendment to the Employee Retirement Income Security Act (ERISA) 408(b)(2) service exemption will require written service agreements (see “Second Cite,” PLANADVISER, January-February 2008) as well as detailed fee disclosure before the agreement is signed and upon any material change in fees. Ufford pointed out that this requirement applies to both fiduciary and nonfiduciary providers, and noncompliance could trigger ERISA prohibited transaction rules, since compliance will be required to qualify for the exemption going forward.
“Everybody in this room is likely covered by these new rules,’ said Reish. Ufford acknowledged that the Form 5500 is only required for plans with more than 100 participants, but pointed out that the 408(b)(2) changes apply to all ERISA plans, regardless of size. Reish said this will bring advisers closer to broker/dealers because of the required service agreements. He adds that the agreements must describe service fees and certain specified potential conflicts of interest. For 12b-1 fees, Ufford said that how they are reported depends on how they are treated. If they are held in a separate account from the plan trust, and the adviser’s fee is paid from that separate account, it is reported as indirect compensation.
Advisers should assume these rules will be effective January 1, Reish suggested, and begin getting their written contracts in order. The contracts will have to be with the broker/dealer or the RIA, not the individual adviser representative or the financial adviser, he explained.
“[This is] not about costs; this is about compensation,’ Reish noted. Some of the difficulties he expects advisers to have with the new rules are how to form the contracts for those advisers being paid by 12b-1 fees. For example, how will those advisers be able to detail their compensation at the time of a proposal, before the specific funds are selected for the plan, if they are paid by 12b-1s and, therefore, will not know their compensation until the funds are selected?
The time frame for implementing the third EBSA proposal, designed to make sure participants in participant-directed plans have information to make informed investment decisions (see “Writing a Tell-All,” PLANADVISER, September-October), is still uncertain Ufford noted. There is a “laundry list” of rules, she said, that will require disclosure of administrative costs to the plan and total compensation for each investment option in the plan. However, the proposal does not require that participants see the details of the revenue-sharing arrangements because the DoL “does not think it is important for participants to understand how revenues are shared between service providers,” she explained. She warned that the DoL put out a model format for disclosure and expects a comparative format.
The most interesting thing about this proposal, according to Reish, is the difference between how administrative fees are handled: If the recordkeeper and adviser are paid through the investments, the participants will not see that, whereas, if the fees are paid directly by the plan, the participants would see those payments on the new disclosures.
Impact of Fee Disclosure Rules
People providing investment services to plans are “struggling mightily with this,” Ufford acknowledged. Beyond the recordkeeping and investment community, the new fee disclosure rules will affect not only how advisers report compensation but also likely their business operations.
For broker/dealers, Reish said, if administrative expenses are paid out of management fees, then no additional reporting will be required, other than each fund’s expense ratio. However, if the expenses are paid out of the plan, broker/dealers must report the dollar cost to the account. Similarly, if broker/dealer compensation is paid from plan investments, then no participant reporting is required. However, if it is paid out of the plan, a fee allocation must be disclosed to all participants.
For financial advisers and RIAs, other than affecting the way they report compensation, Reish said the new rules could affect their business models. He predicted a market split as advisers adjust their business models to fit their specific client market. As an example, he said some advisers may move from being clients’ primary investment guru to their primary consultant on the success of the plan. Some advisers may get out of the industry and some may decide to offer greater specialization in one product or market.
Tommy Thomasson, President and CEO of DailyAccess Corporation, suggested the new disclosure rules do not have to discourage advisers’ current business models. “It all comes down to the value propositions advisers and providers can offer sponsors,” he said. Advisers now will have to make sure sponsors understand the value of their services and that the sponsors are getting what they are paying for.
Thomasson reminded advisers that the fee disclosure rules are not just about lowering costs, but that ERISA requires that fees are “reasonable.’ He added that advisers will need help from providers on how to comply with new disclosure rules, and providers are prepared to give help.
Participant disclosure rules will have an additional impact on advisers’ businesses, Thomasson contended, as more education will need to be provided to participants explaining the charges they see on their statements, and more education will need to be provided to sponsors on communicating with participants and Form 5500 changes. This will increase an adviser’s costs to do business. “Fee disclosure isn’t free,” Thomasson said.
If people get upset when they see a $2 ATM fee on their bank statement, what are they going to do with a $5, $10, or even $1,200 fee, when considering investment expenses, on their 401(k) statements, Thomasson asked. Predicting that participants “will freak out” when they see the charges they did not see before, Thomasson said “advisers and brokers will have a whole new world to deal with.”
However, Reish said he thinks people do not give participants credit for their ability to evolve. He said participants will improve as investors as more information is provided to them, and “we’ll come out on the other side with better participant investors and better prepared participants.”
According to Reish, “There may be three or four difficult years, but it will be worth the cost.”
Illustration by Ronald Kurniawan