Investment Management/
ERISA Fiduciary Alert
July 2010
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
New Disclosure Requirements for Plan
Service Providers
The U.S. Department of Labor (“DOL”) has issued its long-awaited regulation
imposing new disclosure requirements on service providers to ERISA plans
(“Amended Rule”).1 The Amended Rule – designated as an “interim” final rule –
will greatly expand the types of information that service providers to ERISA-covered
employee benefit plans (and to investment vehicles deemed to hold “plan assets”)
will be required to disclose to such plans. Perhaps more significant is the practical
consequence of non-compliance with the Amended Rule – for most service
providers, the new disclosures will be necessary in order to avoid violating ERISA’s
prohibited transaction provisions and the parallel provisions of the Internal Revenue
Code (“Code”).
The DOL has thus far declined to clarify the impact the Amended Rule may have
where service providers are relying on another prohibited transaction exemption,
such as the commonly relied upon “QPAM Exemption.”2 Because the consequences
of non-compliance with the Amended Rule could be severe, service providers may
wish to comply with the Amended Rule even if they rely on another exemption for
particular services or transactions.
As discussed below, the Amended Rule will apply only to certain ERISA-covered
plans and investment vehicles deemed to hold “plan assets.” It will not apply to
service arrangements with individual tax-favored retirement savings arrangements,
such as individual retirement accounts (“IRAs”). In addition, the Amended Rule
only applies to certain “covered service providers” as described in greater detail
below. The breakdown between service providers who are – and who are not –
covered by the Amended Rule is illustrated in the following table:
“Covered Service Providers”
ERISA fiduciaries and registered
investment advisers providing services
directly to “covered plans”
Fiduciaries – e.g., advisers and
managers – of “plan-assets”
investment vehicles in which “covered
plans” hold direct equity interests,
such as
private investment funds (hedge funds)
bank collective funds
insurance company separate accounts
1
Service Providers Not Covered
Providers of services to “covered plans”
solely in their capacity as affiliates of or
subcontractors to covered service
providers
Service providers to “non plan-assets”
investment vehicles, such as mutual
funds, non plan-assets private
investment/hedge funds, “venture capital
operating companies,” and “real estate
operating companies”
75 Fed. Reg. 41599 (July 16, 2010). The DOL has requested further comments on various aspects
of the Amended Rule. The deadline for comments is August 30, 2010.
Prohibited Transaction Exemption 84-14, which provides an exemption for certain transactions by
“qualified professional asset managers.”
2
Investment Management/
ERISA Fiduciary Alert
July 2010
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
Recordkeepers and broker-dealers for
participant-directed individual account
plans, if they provide or make available
“designated investment alternatives” in
connection with the services
Providers of non-fiduciary services to
“plan-assets” investment vehicles (as
well as to non plan-assets investment
vehicles)
Providers of certain types of services
that receive or may receive “indirect
compensation or fees” in connection
with services provided to a “covered
plan”
Service providers to plan-assets
investment vehicles in which “covered
plans” hold only indirect equity
interests, such as an underlying fund of
a plan-assets fund-of-funds
The Amended Rule goes into effect on July 16, 2011, and reflects a number of
changes from the proposed rule, as noted below.
Overview and Background
Seeking to address the perceived lack of clarity in retirement plan compensation
arrangements, the DOL has amended the current regulations implementing certain
statutory exemptions found in ERISA and the Code. Those exemptions, in
substance, permit persons who are third-party service providers to provide services to
plans without engaging in prohibited transactions.3 ERISA section 408(b)(2) and
Code section 4975(d)(2) each provide an exemption for services rendered to plans
pursuant to “reasonable arrangements.” The existing regulations for these statutory
exemptions are straightforward in their current requirements: (1) the services must be
appropriate and helpful to the plan, (2) the arrangement must be reasonable—
specifically, it must be terminable by the plan without penalty on reasonably short
notice, and (3) the compensation received by the service provider must be
reasonable. These requirements are largely transparent and self-implementing and,
in most cases, readily satisfied by the basic terms of service providers’ ordinary
arrangements, with little additional compliance effort.
The Amended Rule changes things dramatically. Under the Amended Rule, an
arrangement is not reasonable—and the exemption is not available—unless the
service provider makes certain detailed disclosures regarding its direct and indirect
compensation.4
3
29 C.F.R. § 2550.408b-2, which implements section 408(b)(2) of ERISA, and 26 C.F.R. § 54.49756, which implements section 4975(d)(2) of the Code, the parallel provisions to section 408(b)(2) of
ERISA. With limited exceptions, plans that are subject to the prohibited transaction provisions of
ERISA are also subject to the prohibited transaction excise tax provisions of section 4975 of the
Code. Except where noted otherwise, references to section 408(b)(2) of ERISA and the impact of
the Amended Rule on the regulations thereunder are intended to include the parallel exemption and
regulations under section 4975(d)(2) of the Code.
4
The DOL views these changes as complementing the previous changes it implemented to Schedule
C of the Form 5500 Annual Report. 72 Fed. Reg. 64731 (Nov. 16, 2007).
Investment Management/
ERISA Fiduciary Alert
The Amended Rule also requires disclosure of a
service provider’s status as an ERISA fiduciary or
registered investment adviser, as applicable, which
in some cases as to ERISA fiduciary status may not
be as clear as the DOL appears to assume. If the
service provider fails to provide the required
disclosures to an ERISA plan, its arrangement with
the plan will not be considered “reasonable” and the
statutory exemption will not apply. As a result, the
service provider could be deemed to have engaged
in a prohibited transaction and, thus, become
exposed to liability for losses suffered by the plan
and the excise taxes imposed by section 4975 of the
Code.
Service Providers Covered under the
Amended Rule
The new requirements of the Amended Rule cover
any service provider seeking to rely on the section
408(b)(2) exemption that enters into a contract or
arrangement with an ERISA plan, reasonably
expects to receive $1,000 or more in compensation
(direct or indirect), and falls within one or more of
the following three categories:
1. ERISA fiduciaries or investment advisers
registered under the Investment Advisers
Act of 1940 (“Advisers Act”) or state law.
This category includes: (a) an ERISA
fiduciary providing services directly to a
plan; (b) an ERISA fiduciary providing
services to a plan-assets vehicle in which
the plan has a direct equity investment (but
not a fiduciary to a second-tier vehicle in
which the top-tier vehicle invests); and (c) a
registered investment adviser providing
services directly to a plan.
2. Providers of recordkeeping or brokerage
services to a participant-directed individual
account plan (such as a 401(k) plan), if one
or more designated investment alternatives
will be made available (such as through a
platform of investments) in connection with
such services.
3. Providers of accounting, auditing,
actuarial, appraisal, banking, consulting
(related to the development or
implementation of investment policies or
objectives, or the selection or monitoring of
service providers or plan investments),
custodial, insurance, investment advisory
(whether or not registered), legal,
recordkeeping, securities or other
investment brokerage, third party
administration, or valuation services to a
plan, for which the service provider (or its
affiliate or subcontractor) reasonably
expects to receive “indirect” compensation
or certain payments from related parties
(any such service provider that reasonably
expects to receive only direct
compensation, and is not otherwise covered
by another category, thus would not be
covered under the Amended Rule).
A service provider may be covered even if some or
all of the services provided are performed by
affiliates or subcontractors. Additionally, even if an
arrangement falls outside the scope of the Amended
Rule (i.e., the service provider does not receive
compensation meeting the dollar threshold or fall
within one of these categories) the DOL notes that
the more general “reasonable” arrangement
requirement must be satisfied for ERISA section
408(b)(2) to apply.
Service providers to investment vehicles that are not
plan assets, such as mutual funds, are not covered
by the Amended Rule.
Disclosure Required under the
Amended Rule
Disclosures
Under the Amended Rule, a covered service
provider must disclose the following, in writing, to
a responsible plan fiduciary:5
•
A description of the services to be provided.
•
The service provider’s status. If the service
provider (or its affiliate or subcontractor, as
applicable) will act as either an ERISA
fiduciary or a registered investment adviser to
the plan (or a plan-assets investment vehicle in
which the plan has a direct equity investment),
or both, the service provider must so state.
5
A “responsible plan fiduciary” is a fiduciary with authority to
cause the plan to enter into, or extend or renew, the
arrangement.
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Investment Management/
ERISA Fiduciary Alert
•
4. Compensation for termination of
arrangement. The service provider must
disclose the compensation that it, its
affiliates, or its subcontractors reasonably
expect to receive in connection with
termination of the arrangement and how
any prepaid amounts will be calculated and
refunded upon such termination.
The compensation the service provider (or its
affiliate or subcontractor, as applicable)
reasonably expects to receive in connection with
its services to the plan. The service provider
must describe:
1. Direct compensation – i.e., compensation
received directly from the plan. Direct
compensation may be disclosed either in the
aggregate or on an itemized, service-byservice basis (except that certain
recordkeeping compensation must be
disclosed separately, as described below).
•
2. Indirect compensation – i.e., compensation
received from any source other than the
plan, the plan sponsor, the covered service
provider, an affiliate, or a subcontractor (if
the subcontractor receives such
compensation in connection with services
performed under the subcontractor’s
contract or arrangement with the covered
service provider). The service provider
must identify the services for which the
indirect compensation will be received and
the payer of the indirect compensation.
3. Compensation paid among related parties –
i.e., compensation paid among the service
provider, its affiliates, and subcontractors.
Compensation among related parties must
be separately disclosed if, and only if, it is
set on a transaction basis (such as
commissions, soft dollars, finder’s fees or
other similar incentive compensation based
on business placed or retained) or is charged
directly against the covered plan’s
investment and reflected in the net value of
the investment (such as Rule 12b-1 fees).
The service provider must identify the
services for which such compensation will
be paid, the payers and recipients of such
compensation, and the status of each payer
or recipient as an affiliate or subcontractor.
Such compensation must be disclosed
regardless of whether it is already disclosed
under another requirement of the Amended
Rule. However, compensation received by
an employee from his or her employer on
account of work performed by the employee
does not need to be disclosed under this
provision.
Separate disclosure regarding recordkeeping
compensation. Notwithstanding other
disclosure requirements, a provider of
recordkeeping services must separately disclose
compensation received by it, its affiliates or its
subcontractors in connection with
recordkeeping services provided to the plan.
Recordkeeping services include services
relating to plan administration and monitoring
of plan, participant, and beneficiary
transactions, as well as maintenance of plan,
participant, and beneficiary accounts, records
and statements.
If the service provider reasonably expects to
provide recordkeeping services without explicit
compensation, or if the compensation for
recordkeeping will be offset or rebated based on
other compensation received by the service
provider, its affiliate, or its subcontractor, the
service provider must: (a) furnish an estimate of
the cost to the plan of such recordkeeping
services, (b) explain the methodology and
assumptions used to prepare the estimate, and
(c) describe in detail the recordkeeping services
that will be provided to the plan.
•
Manner of Receipt. The service provider must
describe how the compensation described above
will be received (e.g., whether the plan will be
billed or whether the compensation will be
deducted directly from the plan’s account).
•
Investment-Related Disclosure. If the service
provider is an ERISA fiduciary to a plan-assets
investment vehicle in which the plan has a
direct equity investment, the service provider
must supply the following additional
disclosures with respect to each such
investment vehicle, unless this disclosure is
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Investment Management/
ERISA Fiduciary Alert
provided by a recordkeeper or broker, as
described below:
If the service provider becomes covered under
the Amended Rule subsequent to a plan’s
investment in an investment vehicle – which
may occur if an investment vehicle becomes a
plan-assets vehicle when it previously was not –
the service provider must disclose the required
information as soon as practicable, but not later
than 30 days from the date on which the service
provider knows that such entity holds plan
assets.
1. A description of any compensation that will
be charged directly against the amount
invested in connection with the acquisition,
sale, transfer of, or withdrawal from the
investment vehicle (e.g., sales loads, sales
charges, deferred sales charges, redemption
fees, surrender charges, exchange fees,
account fees, and purchase fees);
2. A description of the annual operating
expenses (e.g., expense ratio) if the return is
not fixed; and
•
Change in Information. The service provider
must disclose a change to the required
information as soon as practicable, but not later
than 60 days from the date on which the service
provider is informed of such change, unless
precluded due to extraordinary circumstances
beyond the service provider’s control, in which
case the information must be disclosed as soon
as practicable. It is important to note that
disclosure is required for any change, not just
“material” changes.
•
Additional Information Requested by Plan. The
service provider must provide, upon the request
of a responsible plan fiduciary or plan
administrator, any other information related to
compensation required for the plan to comply
with the reporting and disclosure requirements
of ERISA and regulations thereunder,
including, for example, Schedule C of the Form
5500. This information must be disclosed not
later than 30 days following receipt of a written
request from the responsible plan fiduciary or
plan administrator, unless such disclosure is
precluded by extraordinary circumstances
beyond the service provider’s control, in which
case such disclosure must be made as soon as
practicable.
3. A description of any ongoing expenses in
addition to annual operating expenses (e.g.,
wrap fees, mortality charges, and expense
fees).
Recordkeepers and brokers that make investment
alternatives available for participant-directed
individual account plans must also make these
additional investment-related compensation
disclosures. To meet these obligations,
recordkeepers and brokers may pass-through the
current disclosure materials of the investment
vehicle’s issuer that include the required information
if: (a) the issuer is not an affiliate of the
recordkeeper or broker, (b) the disclosure materials
are regulated by a state or federal agency, and (c) the
recordkeeper or broker does not know the materials
are incomplete or inaccurate.
Timing and Obligation to Disclose
Changes and Provide Requested
Information
•
Initial Disclosures. The disclosures required by
the Amended Rule must initially be provided to
the responsible plan fiduciary reasonably in
advance of the date the arrangement is entered
into, extended, or renewed. The DOL did not
provide any further information about what
“reasonably in advance” means, other than to
note that it is “best left to the responsible plan
fiduciary and its potential service providers to
work out the amount of time, prior to entering
into the contract or arrangement, that the
responsible plan fiduciary would need to review
the disclosures.”
Cure Period
No arrangement will fail to be reasonable under the
Amended Rule solely because the service provider,
acting in good faith and with reasonable diligence,
makes an error or omission in disclosing the
information required by the Amended Rule.
However, the service provider must disclose the
correct information as soon as practicable, but not
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Investment Management/
ERISA Fiduciary Alert
later than 30 days from the date on which the service
provider knows of such error or omission.
Compensation
The Amended Rule broadly defines “compensation”
as anything of monetary value (for example, money,
gifts, awards, and trips), but excludes non-monetary
compensation valued at $250 or less, in the
aggregate, during the term of the arrangement.
Other common items of value mentioned in the
Amended Rule which would also presumably be
considered “compensation” are 12b-1 fees,
commissions, soft dollars, finder’s fees or other
similar incentive compensation.
Class Exemption
The Amended Rule provides an exemption that
relieves a responsible plan fiduciary from liability
for engaging in a prohibited transaction in cases
where a service provider fails to disclose
information required under the Amended Rule.6
This relief is available if the plan fiduciary:
•
Did not know that the service provider failed or
would fail to make required disclosures and
reasonably believed that the service provider
had such disclosures;
•
The description or an estimate of compensation may
be expressed as a monetary amount, formula,
percentage of the covered plan’s assets, or a per
capita charge for each participant or beneficiary or,
if the compensation cannot reasonably be expressed
in such terms, by any other reasonable method.
Upon discovery of the service provider’s failure
to disclose the required information, requests, in
writing, that the service provider furnish the
required information;
•
If the service provider does not comply with the
request within 90 days, notifies the DOL of
such failure as prescribed in the Amended Rule;
and
Presentation of Disclosures
•
After discovery of the service provider’s failure
to disclose required information, takes such
failure into account in determining whether to
terminate or continue the service arrangement.
The Amended Rule does not prescribe any particular
method or format for making the required
disclosures, and the disclosures need not be
contained in a single document. The DOL has
requested comment on whether it should require a
standardized, summary disclosure statement that
would include key information and point to where
plan fiduciaries could find the other required
information. This is a major change from the
original proposal, which had mandated that the
required disclosures be set forth directly in a service
contract or agreement.
Covered Plans
The plans covered by the Amended Rule are
employee pension benefit plans or pension plans
within the meaning of ERISA section 3(2)(A)(but
not governmental plans, church plans, or other such
plans described in ERISA section 4(b)). However,
the Amended Rule does not apply to IRAs, including
SEP and SIMPLE IRAs, or individual retirement
annuities. This exclusion reflects the DOL’s view
that an IRA owner should not be held to the same
fiduciary duties to scrutinize and monitor plan
service providers and their total compensation as
plan sponsors and other fiduciaries of pension plans
under Title I of ERISA.
Differences from the Proposed Rule
The Amended Rule reflects several important
changes from the DOL’s original proposal.7
Specifically, the Amended Rule:
•
Does not require a formal written contract or
arrangement delineating the service provider’s
disclosure obligations.
•
Does not apply to welfare benefit plans, which
the DOL plans to address separately.
•
Excludes IRAs.
•
Excludes from the categories of covered
persons those who are service providers to non
plan-assets investment vehicles (such as mutual
funds) and service providers furnishing non-
6
Although commenters requested similar relief for service
providers, the DOL declined to extend the exemption.
7
72 Fed. Reg. 70893 (Dec. 13, 2007). The DOL received
over 100 written comments on the proposal and additional
testimony from its public hearings.
July 2010
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Investment Management/
ERISA Fiduciary Alert
fiduciary services to plan-assets investment
vehicles.
•
Adds de minimis provisions to the definition of
compensation and covered service provider.
•
Does not require specific narrative conflict of
interest disclosure.
•
Specifies that service providers must separately
disclose the cost to the plan of recordkeeping
services.
•
Includes a cure period for inadvertent errors and
omissions.
Impact on Other Exemptions
A service provider may not need to rely on the
Amended Rule with respect to certain of its services
to a plan or certain transactions involving the plan, if
such services or transactions are exempt from the
prohibited transaction provisions on a basis other
than ERISA section 408(b)(2) and its Code
counterpart. Several commenters to the original
proposal sought clarification on how the Amended
Rule would affect existing statutory and
administrative exemptions, such as the QPAM
Exemption. The DOL expressed “no view at this
time” on how the Amended Rule would impact
existing exemptions and stated that it will be
reviewing these issues in the future on a case-bycase and exemption-by-exemption basis.
Even where there are other exemptions on which a
service provider could rely to avoid having to
comply with the requirements of the Amended Rule,
it is important to note that (i) the service provider
would still need to provide plans with disclosures
required by Schedule C of the Form 5500 and (ii) as
a business matter, plans may begin to require that
service providers comply with the Amended Rule as
a prerequisite to entering into any service contract.
The Amended Rule is a sea change for service
providers and their plan clients. Current disclosure
documents and other materials used by service
providers are unlikely to satisfy the provisions of
the Amended Rule and likely will need review and
revision. Additionally, because the Amended Rule
creates a strong incentive for plans to report to the
DOL service providers that are delinquent in
making disclosures specified by the Amended Rule
or otherwise requested by plans, service providers
should be prepared to provide such required
disclosures in a timely and complete manner.
Please contact any member of the ERISA Fiduciary
Group listed below if you want to discuss any of
these or other issues raised by this Client Alert, or if
you have further questions.
Catherine S. Bardsley
catherine.bardsley@klgates.com
202-778-9289
Mark J. Duggan
mark.duggan@klgates.com
617-261-3156
John J. Nestico
john.nestico@klgates.com
704-331-7529
David E. Pickle
david.pickle@klgates.com
202-778-9887
William A. Schmidt
william.schmidt@klgates.com
202-778-9373
Charles R. Smith
charles.smith@klgates.com
412-355-6536
Mary Turk-Meena
mary.turk-meena@klgates.com
704-331-7590
William P. Wade
william.wade@klgates.com
310-552-5071
Kristina M. Zanotti
kristina.zanotti@klgates.com
202-778-9171
July 2010
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Investment Management/
ERISA Fiduciary Alert
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July 2010
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