Investment Management/
ERISA Fiduciary Alert
January 2008
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DOL Takes Action on Disclosure of
Compensation
The U.S. Department of Labor (“DOL”) recently took two actions that will significantly
expand the types of information that must be disclosed by persons who provide services to
ERISA-covered employee benefit plans. This Alert describes the DOL actions and offers
some preliminary thoughts on the practical implications.
Overview
The two DOL actions on fee disclosures are:
• A final revision to the schedule plan sponsors must use to disclose fees paid by
plans for services. This schedule is part of the Form 5500 Annual Return/Report
filed annually by plans and, as revised, will require plan sponsors to disclose both
direct and indirect compensation received by plan service providers. These new
requirements are applicable for plan years beginning after December 31, 2008.1
• A proposed amendment to DOL’s existing regulation implementing the statutory
exemption from the ERISA prohibited transaction restrictions permitting “parties
in interest” to provide services to plans. The proposed amendment would require
detailed disclosure of direct and indirect compensation received by service providers.
These new requirements would be effective 90 days after issuance of the final
amendment to the regulation. Comments on the proposed amendment must be
submitted by February 11, 2008.2
For the reasons discussed below, the new requirements will affect virtually all plan service
providers and will significantly complicate doing business with ERISA plans.
Reporting of Direct and Indirect Compensation to Service Providers
(“Schedule C”)
Plan sponsors of ERISA-covered employee benefit plans generally must file an annual
report for the plan on Form 5500.3 For plans covering more than 100 employees, the Form
5500 must include a completed Schedule C, setting forth information about fees of $5,000
or more paid by the plan for the provision of services. Completed Form 5500s, including
Schedule Cs, are public documents and are widely available.
The revised Schedule C:
• B roadens the definition of “service provider” whose compensation must be
reported,
• Provides for reporting of “direct compensation” paid to service providers, and
• For the first time, requires reporting on indirect compensation received by service
providers.
1 7 2 Fed. Reg. 64731 (Nov. 16, 2007). See also 72 Fed. Reg. 64710 (Nov. 16, 2007) (adoption of final reporting and disclosure regulations conforming
with changes to the reporting forms).
2 72 Fed. Reg. 70988 (Dec. 13, 2007).
3 The reporting requirements generally are applicable both to plans with 100 or more participants and to certain pooled investment vehicles that file
reports directly with DOL (i.e., “direct filing entities” or “DFEs”). The analysis of the new reporting requirements that follows relates also to filing
requirements applicable to the sponsors/managers of DFEs.
Investment Management/ERISA Fiduciary Alert
These revisions reflect DOL’s concern that plan
fiduciaries may not have adequate information about the
total compensation, especially indirect compensation,
received by service providers to plans. Although ERISA
requires banks and insurance companies to provide
plan sponsors with information needed to complete the
Form 5500, there currently is no such requirement for
service providers generally. Plan sponsors are keenly
aware of their reporting responsibilities, however,
and will almost invariably require service providers
to provide the needed Schedule C information as a
condition to doing business with plans.
Service Provider Redefined
Under revised Schedule C, the term “service provider”
is defined to include any person who provides services
directly to a plan or to another service provider to a
plan, as well as any person who provides services in
connection with a transaction involving a plan. Thus,
persons who have no direct relationship with ERISAcovered plans—such as service providers to mutual
funds in which plans invest—may be considered
service providers for purposes of revised Schedule
C and, therefore, may be expected to assemble and
provide the required information.
Direct Compensation
Revised Schedule C distinguishes between “direct”
and “indirect” compensation paid to service providers.
The instructions define “direct compensation”
as compensation paid directly by a plan or a plan
sponsor to a service provider, as well as compensation
paid or debited directly from a plan account. Direct
compensation does not, however, include payments
made by the plan sponsor that are not reimbursed by the
plan. The revised Schedule C requires the plan sponsor
to: (1) identify each service provider (subject to the
$5,000 threshold discussed above), (2) describe the
relationship of the service provider to the plan sponsor
(or to any person known to be a party in interest to the
plan), (3) provide the total direct compensation paid
to the service provider, and (4) provide a statement of
whether the service provider received any “indirect
compensation” (discussed below). If a service provider
received direct compensation from several plans, the
service provider may use any reasonable method of
allocating the compensation among the plans.
Reporting Indirect Compensation—General
Rule
“Indirect compensation” is defined in the instructions
as all compensation, other than direct compensation,
received by a service provider in connection with
services provided to the plan or in connection with a
person’s position with a plan. The instructions indicate
that compensation is received “in connection with”
services provided to the plan or a person’s position
with a plan if the payment is based, in whole or in
part, on services provided to the plan or on one or
more transactions involving the plan. Thus, for
example, indirect compensation received by a provider
of brokerage services to the plan, in general, would
include payments received by the broker-dealer for
order flow in connection with the plan’s brokerage
transactions as well as sales charge reallowances or
revenue sharing received in connection with the plan’s
mutual fund investments. Indirect compensation does
not include compensation that a person would have
received if the service for, or transaction involving, a
plan had not occurred.
Indirect compensation, for Schedule C reporting
purposes, includes fees and expense reimbursement
payments received from mutual funds, bank
commingled trusts, insurance company pooled separate
accounts, separately managed accounts, or other
pooled investment funds in which a plan invests, if
the payments are charged against the fund or account
and are reflected in the value of the plan’s investment.
The material accompanying revised Schedule C
indicates that these fees include “management fees
paid by a mutual fund to its investment adviser, subtransfer agency fees, shareholder servicing fees,
account maintenance fees, and 12b‑1 distribution fees
. . .” (even if the recipients of these fees provide their
services only to the fund). The material also indicates
that other examples of indirect compensation are
finder’s fees, float revenue, brokerage commissions,
research, other products or services received from a
broker-dealer or other third party in connection with
securities transactions, and other transaction-based fees
received in connection with transactions or services
involving a plan. Thus, for example, persons who
provide services to an investment fund in which a plan
invests and receive asset-based or transaction-based
fees from the investment fund would be viewed as
service providers for purposes of revised Schedule C,
and plan sponsors would be required to report on these
fees (subject to the special rule and general reporting
threshold discussed below).
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Investment Management/ERISA Fiduciary Alert
If a service provider receives total compensation of
$5,000 or more that includes any indirect compensation,
the revised Schedule C must (unless the special rule for
“eligible indirection compensation,” described below,
is applicable) include: (1) the service provider’s name
and tax identification number, (2) a statement that
the service provider received indirect compensation,
and (3) the total amount of the indirect compensation
received by the service provider (actual or estimated).
If a service provider receives indirect compensation
but is unable to determine the specific amount of the
compensation, the revised Schedule C must include
a description of the method or formula used by the
service provider to determine the amount of indirect
compensation.
If, however, a service provider is a plan fiduciary or
provides contract administration, consulting, investment
advisory, investment management, brokerage or
recordkeeping services and receives $1,000 or more
in indirect compensation from any source, then the
revised Schedule C must include, for each person
paying such indirect compensation: (1) the payor’s
name and tax identification number, (2) a statement
of the total indirect compensation received by the
service provider from the payor, and (3) a description
of the indirect compensation and any formula used to
determine the amount of the indirect compensation.
Special Rule for “Eligible Indirect
Compensation”
Under revised Schedule C, a plan sponsor is not
required to separately report “eligible indirect
compensation” received by a plan service provider.4
Moreover, if a service provider receives only eligible
indirect compensation and certain disclosures are made
to the plan, the plan sponsor is only required to report
the name and tax identification number of the service
provider (or the name and taxpayer identification
number of any other person who provided the plan
sponsor with the required information about eligible
indirect compensation received by the service
provider).
“Eligible indirect compensation” is defined as
indirect compensation that is received by a service
provider as fees charged to investment funds in which
a plan invests that are reflected in the value of the
investment or in the return on investment and that
constitute compensation for distribution, investment
management, recordkeeping or shareholder services
4 See revised Schedule C, Part I, line 2, column (g), 72 Fed. Reg. at 64790.
or that constitute commissions, finder’s fees, float
revenue, other transaction-based fees (whether or
not they are capitalized as investment costs) or “soft
dollar” revenue.5
To take advantage of the alternative reporting method
for eligible indirect compensation, a plan sponsor must
certify on revised Schedule C that it has been provided
with written or electronic materials that disclose the
following:
• T h e e x i s t e n c e o f e l i g i b l e i n d i r e c t
compensation;
• T he services provided for the indirect
compensation or the purpose for the payment
of the indirect compensation;
• The amount, or an estimate, of the compensation
“or a description of the formula used to calculate
or determine the compensation”; and
• The identity of the party or parties paying and
receiving the compensation.
In this connection, the material accompanying
the issuance of revised Schedule C states that this
information could be provided to the plan in separate
disclosures from multiple parties.
Excludable Non-Monetary Compensation
Revised Schedule C provides that non-monetary
compensation, such as business meals, gifts,
promotional items and the like, need not be reported
if it is both insubstantial and tax deductible to the
person paying the compensation. The revised Schedule
C defines “insubstantial” as gifts or gratuities valued
at less than $50 that do not in the aggregate exceed
$100 annually from any single source. Gifts of
$10 or less need not be counted for purposes of the
$100 threshold, but all such compensation must be
reported if the $100 threshold is reached or exceeded.
Although the revised Schedule C is unclear on this
point, multiple employees of one service provider
entity should probably be treated as from a single
source for purposes of the $100 threshold. 6
5 7 2 Fed. Reg. at 64742 (preamble discussion). The instructions to revised Schedule C,
however, omit reference to fees for “investment management,” 72 Fed. Reg. at 64826,
suggesting an inadvertent omission in the instructions or a typographical error in the
Federal Register.
6 It is not clear why the “insubstantial” exceptions for Schedule C purposes are not at
the same levels as applicable for purposes of the reporting rules under Form LM-10 for
gratuities to union officials, as revised by DOL in 2006. See our November 2005 Client
Alert “DOL Issues New Guidance Requiring Investment Advisers, Broker-Dealers and
Other Financial Institutions to Report Certain Costs of Marketing to Taft-Hartley Plans
on Form LM-10.” http://www.klgates.com/files/Publication/1a85f326-ba8c-4065975f-f952f36028f8/Presentation/PublicationAttachment/65d08e3f-ab09-4301-b865e63cdf805853/IMA_1105.pdf
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Investment Management/ERISA Fiduciary Alert
Insurance Commissions
Service provider compensation that consists only of
insurance fees and commissions (which are reported
currently on Schedule A of Form 5500) need not be
reported on revised Schedule C.
Bundled Service Arrangements
Revised Schedule C provides that the “lead service
provider” in a bundled service arrangement generally
may report all direct compensation received in
connection with the arrangement. If, however, another
service provider in the bundled arrangement receives
compensation that is (i) a separate charge directly
against a plan’s investment reflected in the net value
of the investment or (ii) paid on a transactional basis,
that service provider’s direct compensation must be
reported separately.
For service providers in a bundled arrangement that
are fiduciaries or that provide contract administration,
consulting, investment advisory, investment
management, brokerage, or recordkeeping services,
the plan sponsor must report indirect compensation
separately (as discussed above) regardless of whether
direct compensation received by the service provider is
included in a report by a lead service provider.
Service Providers That Fail or Refuse to
Provide Information
If a service provider fails to provide a plan sponsor with
the information needed to complete revised Schedule
C, the plan sponsor must report the name and tax
identification number of the service provider and a
description of the information that was not provided.
Nevertheless, the instructions to revised Schedule C
make clear that it is the plan sponsor’s responsibility
to request the necessary information. The instructions
also remind plans to inform service providers that the
foregoing information will be provided for service
providers who do not supply the needed information;
however, plans are not required to do so.
Proposed Amendment to 408(b)(2)
Regulation Implementing Statutory
Exemption Permitting Parties in Interest
to Provide Services to Plans
Background
Persons providing services to an ERISA-covered
plan are “parties in interest” of the plan and are in a
seemingly impossible position—providing services
makes a person a party in interest, and ERISA section
406(a) prohibits parties in interest from providing
services to a plan. Fortunately, ERISA section 408(b)
(2) breaks this circularity by providing an exemption
for “reasonable arrangements” under which parties
in interest may provide services to a plan. The
current regulations under section 408(b)(2) were
issued by DOL shortly after ERISA was enacted,
and their requirements are straightforward: (1) the
services must be appropriate and helpful to the plan,
(2) the arrangement must be terminable by the plan
without penalty on reasonably short notice, and (3)
the compensation received by the service providers
must be reasonable. Indeed, the requirements of the
current regulations have been largely transparent
and self-implementing. In most instances, service
providers have been eligible for the section 408(b)(2)
exemption without the need to consider in any detail
how to comply.
The proposed amendments to the regulations under
section 408(b)(2) will change things dramatically. If
the proposed amendments are adopted, in order to rely
on the section 408(b)(2) exemption, service providers
will need to assemble and report information about
a host of matters relating to their direct and indirect
compensation. As discussed below, under the proposed
regulations, the exemption would be conditioned in
part on a requirement that the service provider disclose
compensation information to enable the plan to fulfill
Form 5500 reporting requirements. Thus, the potential
impact of the proposed section 408(b)(2) regulations
is that a service provider who fails to provide the
information requested by a plan for revised Schedule
C purposes (or to satisfy any other requirement of
the proposed regulations) could be deemed to have
engaged in a prohibited transaction and, thus, exposed
to liability unless another exemption is available to the
service provider.
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Investment Management/ERISA Fiduciary Alert
Requirements under the Proposed
Amendments
Under the proposed 408(b)(2) amendments, any
service arrangement with a plan must:
• Be in writing;
• Specifically require the service provider to
disclose, to the best of its knowledge: (1) all
services to be provided to the plan, (2) all of the
service provider’s “compensation or fees” for
the services, and (3) how the service provider
will receive such compensation or fees (the
expansive definition of “compensation or fees”
for these purpose is discussed below);
• Include a representation by the service provider
that, before the contract or arrangement was
entered into, all required information was
provided to a responsible plan fiduciary;
• R equire the service provider to disclose
information to help the plan fiduciary assess
conflicts of interest, including: (1) whether
the service provider will be a fiduciary to the
plan, either under ERISA or the Investment
Advisers Act of 1940, (2) any financial or
other interest in transactions to be entered
into by the plan in connection with the service
arrangement, (3) any material financial,
referral, or other relationship with various
parties, such as investment professionals,
other service providers, or clients, that may
give rise to conflicts of interest,7 (4) whether
the service provider can affect its own
compensation without the prior approval of an
independent plan fiduciary, and the nature of
this compensation, and (5) whether the service
provider has policies or procedures to manage
conflicts of interests and, if so, an explanation
of those policies or procedures;
of ERISA and the regulations, forms, and
schedules thereunder (including Form 5500);
and
• Permit termination of the arrangement by the
plan without penalty and on reasonably short
notice.8
Even if the service contract contains all the required
provisions, the service provider must actually make the
necessary disclosures for the contract or arrangement to
be considered “reasonable”—and thus exempt—under
the proposed amendments.
Compensation or Fees
The proposed amendments define “compensation or
fees” very broadly to include, in addition to money,
any other thing of monetary value received by the
service provider or its affiliates “in connection with”
the services provided to the plan. This definition
raises many questions on where to draw the line for
compensation to be considered “in connection with”
services to the plan. Examples DOL gives of covered
compensation include, among other things, gifts,
awards, trips, research, float, 12b-1 fees, commissions
and various other fees.9
DOL indicates in explaining the proposed regulations
that, if a service provider does not know the exact
amount of compensation when it signs a contract with
a plan, compensation may be disclosed and expressed
in terms of a formula, a percentage of the plan’s
assets, or a per capita charge for each participant or
beneficiary.10
Bundled Arrangements
• Require the service provider to comply with
requests for fee and compensation information
from a responsible plan fiduciary in order to
fulfill the reporting and disclosure requirements
The proposed regulations would require a provider of
“bundled” plan services priced as a package, rather
than on a service-by-service basis, to make all of the
required disclosures, even if another provider actually
performs one or more of the underlying services.
Generally, a bundled service provider would not be
required to break down how the compensation relates
to each component service within the arrangement,
or to disclose how revenue sharing or other indirect
payments are allocated among service provider
participants in the bundled arrangement. A bundled
service provider would, however, be required to
disclose any compensation separately paid to an
7 A
ccording to DOL, if the relationship between the service provider and one of the third
parties described above “is one that a reasonable plan fiduciary would consider to be
significant in its evaluation of whether an actual or potential conflict exists,” the service
provider must disclose the relationship. 72 Fed. Reg. at 70992.
8 T
his requirement would be unchanged from the current regulation. See 29 C.F.R. §
2550.408b-2(c).
9 72 Fed. Reg. at 70990.
10 Id.
• Require the service provider to disclose any
material change in the information required to
be disclosed within 30 days of its knowledge
of such change;
January 2008 | 5
Investment Management/ERISA Fiduciary Alert
underlying service provider that would be reflected
in the net value of the plan’s investment. Examples
of such compensation include management fees paid
by mutual funds to their investment advisers and
other asset-based fees charged to pooled investment
funds. In addition, a bundled service provider would
be required to separately disclose any compensation
paid on a transactional basis—such as finder’s fees,
brokerage commissions, or soft dollars.
Presentation of Disclosures
The proposed regulations do not establish a particular
method for making the required disclosures. In the
material accompanying the proposal, DOL states
that disclosures may be in separate documents, from
separate sources, and may be provided in electronic
form. DOL also notes that other documents, such as
a prospectus or a Form ADV, may contain some of
the required information and that contracting parties
would be free to incorporate those documents by
reference as long as the agreement clearly describes
those documents and explains the information they
contain.11
Scope of the Proposed Regulations
The new disclosure requirements in the proposed
regulations are limited to arrangements with service
providers that fall within three categories that DOL
believes have the most potential for conflicts of
interest: (i) service providers who are also fiduciaries
under ERISA or the Investment Advisers Act of 1940;
(ii) service providers who provide banking, consulting,
custodial, insurance, investment advisory, investment
management, recordkeeping, securities or other
investment brokerage, or third party administration
services; and (iii) service providers who receive indirect
compensation in connection with accounting, actuarial,
appraisal, auditing, legal, or valuation services. On the
general subject of conflicts of interest, DOL states in
the material accompanying the proposed regulations:
Plan fiduciaries must know of . . . [a service
provider’s business] relationships and indirect
sources of compensation because they may
impact the manner in which the provider
performs services for the plan. There may
be other, oftentimes subtle, influences on the
service provider or its affiliates that may be
relevant to a plan fiduciary’s assessment of the
objectivity of a service provider’s decisions or
recommendations.12
11 Id.
12 72 Fed. Reg. at 70991.
Proposed Class Exemption
DOL issued a proposed prohibited transaction class
exemption simultaneously with the issuance of
the proposed amendments to the section 408(b)(2)
regulations.13 The proposed class exemption would
relieve plan fiduciaries, other than in their capacity
as service providers, from liability for engaging in a
prohibited transaction in cases where an arrangement
with a service provider fails to be “reasonable” due
to the service provider’s failure to comply with its
contractual disclosure obligations.
In order for this relief to be available, a plan
fiduciary:
• M ust reasonably believe the contract or
arrangement is reasonable as defined in the
proposed section 408(b)(2) regulations
described above, and must not know, or have
any reason to know, that the service provider
would fail to meet its obligations.
•Upon discovery of the service provider’s failure
to comply with its contractual obligations,
must have requested in writing that the service
provider furnish the required information.
• If the service provider does not comply with
the request within 90 days after the written
request for the required information, must
notify DOL.
•After discovery of the service provider’s failure
to comply with its contractual obligations, must
take the service provider’s failure to provide
the required information into account in
determining whether to terminate or continue
the service arrangement.
The changes to Schedule C to Form 5500 and the
proposed regulations under ERISA section 408(b)
(2) are two of three regulatory initiatives undertaken
by DOL to revamp its approach to service provider
compensation issues. DOL also is expected to propose
amendments to the regulations under ERISA section
404(c) “to ensure that participants and beneficiaries in
individual account plans are provided the information
they need, including information about fees and
expenses, to make informed investment decisions.”14
13 72 Fed. Reg. 70893 (Dec. 13, 2007).
14 72 Fed. Reg. at 64738.
January 2008 | 6
Investment Management/ERISA Fiduciary Alert
Please contact any member of the K&L Gates ERISA Fiduciary Group if you have further questions on the
issues discussed in this Alert. Members of the ERISA Fiduciary Group and their telephone numbers and email
addresses are listed below.
Los Angeles
Alexandra C. Sparling alexandra.sparling@klgates.com 310.552.5563
William P. Wade william.wade@klgates.com 310.552.5071
Catherine S. Bardsley catherine.bardsley@klgates.com 202.778.9289
Susan I. Gault-Brown susan.gaultbrown@klgates.com 202.778.9083
David E. Pickle david.pickle@klgates.com 202.778.9887
William A. Schmidt william.schmidt@klgates.com 202.778.9373
Kristina M. Zanotti kristina.zanotti@klgates.com 202.778.9171
Washington, D.C.
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