401(k) Fee Disclosure a Priority to Legislators and Regulators

Fee disclosure is receiving considerable attention from the media, lawmakers and regulators. Legislators have held hearings to consider the appropriate disclosures for plan sponsors and plan participants, and have introduced several bills. Although the legislative outcome is uncertain, the regulatory changes are moving along. In December 2007, the U.S. Department of Labor (DOL) released proposed regulations on sponsor-level disclosure, and the department intends to propose regulations on participant-level disclosure this year. And the U.S. Securities and Exchange Commission (SEC) has introduced a simplified prospectus that would apply to all investment vehicles.

Chairman Miller’s Bill
Chairman George Miller (D-California) of the House Education and Labor Committee has been actively pushing the 401(k) Fair Disclosure for Retirement Security Act since he introduced the bill in July 2007 (see Watson Wyatt Insider, September 2007). His committee recently passed a revised version of the bill — with lawmakers voting along party lines — which is cleared for action on the House floor.

The act would require service providers to provide plan administrators with a disclosure statement showing all annual fees, displayed as a total and as allocated among four categories: plan administration fees, investment management fees, transaction-based fees and other fees specified by the secretary of Labor.

If the service provider received a material benefit, the statement would also have to disclose any financial or personal relationship with the plan, plan sponsor or anyone else providing service to the plan. Plan administrators would have to receive the disclosure statement at least 10 days before entering into a contract with a service provider for more than $5,000. Service providers would have to update statements annually and within a reasonable period following a material change.

Plan sponsors would have to provide a notice to participants at least 10 days before investing any contributions and at least 10 days before a material change in investment options took effect. Plans with immediate eligibility or automatic enrollment would have to provide the notice within a reasonable period before the first investment of contributions. The notice could be part of participants’ annual benefit statement, but quarterly benefit statements would have to include the following key information for each investment option elected:

• The objective and principal investment strategy of the option
• The level of risk associated with the option
• Any fees assessed in connection with the option and the one-year, five-year and 10-year history of returns, net of fees and expenses
• A fee comparison chart disclosing four categories of service and investment fees that could be assessed against the participant’s account:
  • Fees that vary depending on the investment option chosen
  • Fees assessed as a percentage of assets
  • Administration and transaction-based fees
  • Other fees and expenses that could be deducted from the participant’s account, and the portion of each fee that applies to investment management, transactions, plan administration and recordkeeping or other services

The notice would also explain that investment options should not be selected solely on the basis of fees.

Chairman Miller’s original bill would have mandated that plans offer a market index fund as an investment option. After several committee members from both parties expressed concern about the implications of the requirement, the committee relaxed the mandate. The revised bill would require sponsors to provide an index fund to qualify for protection under ERISA section 404(c). Opponents of the index fund requirement argue that making liability protection contingent on offering an index fund acts as a de facto mandate.

Key Issues
There are two other bills in Congress on fee disclosure. Ways and Means Committee member Representative Richard Neal (D-Massachusetts) introduced the Defined Contribution Plan Fee Transparency Act, and Senators Tom Harkin (D-Iowa) and Herb Kohl (D-Wisconsin) introduced the Defined Contribution Fee Disclosure Act of 2007. Both bills would establish new requirements for disclosures to participants and plan sponsors, although a few key areas remain at issue:

• Scope of reform — will the new requirements apply only to 401(k) plans or to 403(b) plans and governmental 457 plans as well?
• The number of fee categories required for the unbundling of services
• Disclosure of dollar amounts versus basis points
• Electronic delivery — the ability to provide disclosures through an electronic medium would lower the administrative costs to employers.
• Coordination with the DOL regulatory process — it is unclear how legislative requirements, if enacted, would be coordinated with existing requirements or with the upcoming DOL regulations.
• Fiduciary protections — the fiduciary duty of plan sponsors regarding disclosures from service providers is unclear. For example, how should plan sponsors interpret the allocation of bundled services in determining whether fees are reasonable?
• Penalty structure — under the Miller bill, failing to provide a notice to participants carries a $100 per day per participant penalty, and the Neal bill includes a similar penalty tax. These penalties would impose significant costs on large employers who failed to provide the required notices on time.

Next Steps
Chairman Miller’s fee disclosure bill is technically cleared for action on the House floor, but there is no clear path for its progress through the House. The House Ways and Means Committee intends to act on fee disclosure this legislative session. The committee could work on the bill introduced by Representative Neal, mark up the revised Miller bill or draft new legislation. At this time, the Senate seems unlikely to act on the issue, so fee legislation is not expected to be enacted during 2008. And the elections this fall will affect its evolution and outcome.