DOL Proposes Regulation and Class Exemption for Fee Disclosure

The U.S. Department of Labor (DOL) has released proposed regulations that require certain service providers to disclose information about fees and compensation – both direct and indirect – to plan fiduciaries. The proposal applies to fiduciary service providers; providers of banking, consulting, custodial, insurance, investment advisory or management, record-keeping, securities brokerage or third-party administration services; and providers who receive indirect compensation for accounting, actuarial, appraisal, auditing, legal or valuation services.

The department is also proposing a related class exemption to provide relief to plan fiduciaries who unknowingly enter into contracts with noncompliant service providers.

The proposed regulation and proposed class exemption will take effect 90 days after they are finalized. The guidance applies to all ERISA-covered plans, including health and welfare, and retirement plans.

This is the second of three plan fee transparency initiatives. The first initiative focused on revisions to Form 5500, which include expanded reporting of investment fees and revenue-sharing arrangements that compensate brokers, pension consultants and other investment service providers. The third initiative, planned for early 2008, will address disclosures by plan sponsors to participants. The DOL hopes that the new disclosures will lower fees paid by plans to service providers. Although the proposed regulations stop short of requiring fiduciaries to compare fees among service providers, benchmarking studies can help plan fiduciaries ensure that their service providers’ fees are competitive.

Written comments on the proposed regulation and proposed class exemption are due by February 11, 2008.

Background
ERISA requires fiduciaries to exercise prudence in selecting service providers and to ensure that the compensation service providers receive is not excessive. According to the DOL, it has become increasingly difficult for plan fiduciaries to decipher compensation to service providers and spot possible conflicts of interest that could affect service providers’ performance. The proposed regulation would require more comprehensive fee and compensation disclosures from service providers to plan fiduciaries.

Proposed Disclosure of Services and Fees
Service contracts would have to require the service provider to disclose (in writing) all services it will perform and all associated fees and compensation, whether received directly from the plan or plan sponsor, or indirectly from another party.

For bundled services, in which a group of services is provided and priced as a package, only the provider of the bundle would have to make the disclosure. The bundled service provider would have to disclose all services and the aggregate compensation or fees to be received, directly or indirectly, by the service provider, any affiliate or subcontractor of such service provider, or any other party in connection with the bundled services. The bundled service provider would not be required to disclose the allocation of such compensation or fees among its affiliates, subcontractors or other parties, except to the extent such party received or could receive compensation or fees: (1) that are a separate charge directly against the plan’s investment reflected in the net value of the investment or (2) that are set on a transaction basis, such as finder’s fees, brokerage commissions and soft dollars.

Disclosures would not have to be contained in one document, and in certain circumstances, service providers could incorporate existing documents by reference. Fees could be disclosed in terms of a dollar value, formula, percentage of the plan’s assets or per capita charge for each participant.

The responsible plan fiduciary would have to receive the required information before the contract is entered into or extended or renewed.

Proposed Disclosure of Conflicts of Interest
An affected service provider also would have to disclose any potential conflicts of interest, including:

• Whether it will provide fiduciary services to the plan
• Any financial or other interest in plan transactions
• Any material relationships with other parties that could create conflicts of interest
• Whether it can affect its own compensation without the prior approval of an independent plan fiduciary
• Any policies or procedures in place to address potential conflicts of interest

Proposed Ongoing Disclosures
The proposal also requires ongoing disclosures in some circumstances:

• Service providers must disclose material changes to information provided earlier within 30 days of the changes.
• Service providers must disclose compensation or other information related to the contract or arrangement requested by the responsible plan fiduciary or plan administrator in order to comply with ERISA’s reporting and disclosure requirements.

Proposed Class Exemption
Failure to satisfy the conditions of the proposed regulation would result in the contract being a prohibited transaction under ERISA. The plan fiduciary, by participating in the prohibited transaction, would have violated ERISA’s prohibited transaction rules. The service provider would be subject to excise taxes.

The proposed class exemption would provide relief to a plan fiduciary where a service provider failed to disclose required information, but the plan fiduciary was not aware of it. If the fiduciary discovers the service provider’s failure to disclose, he or she must request in writing that the service provider furnish the information. If the service provider fails to provide the requested information within 90 days, the plan fiduciary has 30 days to notify the DOL.

In addition, the plan fiduciary must determine whether to terminate or continue the contract given the particular facts and circumstances. The fiduciary should consider, among other factors, the availability, qualifications and costs of potential replacement service providers, and the responsiveness of the service provider in furnishing the information that the service provider should have disclosed, but did not, under its disclosure obligations.