Fee Disclosure Compliance Delayed

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By Fred Reish, Esq., and Bruce Ashton, Esq.  

Drinker Biddle & Reath LLP, Los Angeles, CA

In July 2011, the U.S. Department of Labor announced a three-month delay in the compliance date for the service provider fee disclosure regulation (the §408(b)(2) regulation). This means that service providers to §401(k) and other retirement plans will have until April 1, 2012, to make the required disclosures to their existing clients regarding their services, fees and fiduciary status. It also means that they can wait until then to implement the disclosure documents and procedures for new clients. (At the same time, DOL announced a five-month delay for calendar year plans to comply with the new participant disclosure requirements.)

Why the Delay?  

The fee disclosure requirements were originally released as an "interim final" regulation. In other words, DOL told us they might make changes. The regulation asked for comments on whether a "summary and roadmap" of the disclosures should be required. That is, should service providers be required to briefly summarize the disclosures and, to the extent they use multiple documents to provide the disclosures, should they say what information is provided by those documents and indicate where to look for that information in the documents? Beginning earlier this year, DOL said it was working on amendments to the regulation. In late July 2011, those changes were sent to the Office of Management and Budget (OMB) for the required review. The OMB takes roughly 90 days to perform its review before approving and releasing a regulation. At this point, it will likely be October, or possibly November, before we see the amendments to the regulation.

In its announcement of the compliance delay, the DOL said that it does not anticipate that any further delay will be needed because the changes in the amendment will not require significant additional effort. This suggests that the changes either may not be extensive or may simplify the disclosure requirements, or both.  That said, since the DOL has not given any indication regarding what the changes might cover — other than the possible requirement for a summary and roadmap — it is impossible for us to draw any conclusions about their impact.

What's the Impact of the Delay?  

Since the release of the interim final regulation in mid-2010, we have worked with a large number of service providers — registered investment advisors (RIAs), broker-dealers, bundled providers, independent recordkeepers and third party administrators — on their disclosure documents and procedures and on drafting compliant service agreements. Many have completed their documentation and updated their procedures and are prepared to make the required disclosures.  Even those that have not completed the process are generally well-situated to disclose their services and fiduciary status, but are still working on their compensation disclosures. Nevertheless, the delay will be welcome relief for a variety of service providers, because it will give them additional time to address some of the more complicated issues. Here are examples of what we mean:

  •  As we have worked with our clients, we have seen that full disclosure of all compensation, on a plan-by-plan basis, can be daunting for some service providers. This is true because of the requirement to disclose indirect compensation. Indirect compensation covers anything the service provider receives from a third party, including monetary and non-monetary amounts, in connection with providing its services.  Indirect compensation comes in many forms and is difficult for some service providers to identify for disclosure purposes on a plan-by-plan basis. For example, an investment manager may receive "soft dollar" compensation; how should that be allocated to "covered plan" clients?
  •  To provide another example, a broker-dealer may receive bonus compensation based on its level of business with a mutual fund family. This must be identified and disclosed to each plan client that holds those funds.
  •  Or consider the RIA that holds a seminar for its plan clients each year and receives payments from fund managers or others to help with the cost of putting on the seminar. How much, if any, of these payments constitute compensation that must be disclosed and how should it be allocated among the plans the RIA serves? In our experience, RIAs and third party administrators have less trouble with indirect compensation disclosure, though many TPAs receive payments from plan providers that are based on eligibility requirements (e.g., number of plans or amount of plan assets) and may vary in amount.  Thus, the TPA may not know from year to year whether it will receive the payments or, if it does, how much they will be. This makes upfront disclosure difficult. In working with our clients, however, we have found ways to address this.
  •  Recordkeepers frequently receive revenue sharing (e.g., sub-transfer agency fees) on the investments in the plans to which they provide services, but the amount they receive varies from investment to investment. For recordkeepers with a limited number of funds on their platforms — e.g., an insurance company that includes 100 or 200 mutual funds in its group annuity contract from which a plan sponsor chooses the investment line-up for its plan — the issue has been to develop systems and procedures to capture the information on a fund-by fund basis and disclose it to plan clients. For "open architecture" recordkeepers, where thousands of funds may be available for inclusion in an individual plan's investment line-up, the issue is the same; but the task of complying is more complex because the volume of data that must be collected and disclosed is much greater.
  •  Broker-dealers may be in the most difficult position.  In addition to identifying all of the clients to which the disclosure requirements apply — a time-consuming effort for some of our clients — they need to figure out what they are going to be paid as commissions or 12b-1 fees (which are usually indirect compensation), how to make the disclosures at the outset of the relationship and how they are going to be able to disclose changes to the information from time to time as required by the regulation. We have already noted the problem of disclosing "soft dollar" and bonus compensation on a plan-by-plan basis. In addition to identifying and quantifying these amounts, there is also the issue of whether the amount being received actually constitutes compensation for the services being provided to a given plan. If not, it does not have to be disclosed; but if so, the broker-dealer must describe how the amount is determined, the services for which they receive it and who is paying it. The delay in the compliance date will give broker-dealers time to work on their procedures for meeting this challenge.
  •  Some entities that provide services to "covered plans" still do not realize that they are subject to the regulation and, therefore, have not taken steps to comply. These include managers of investments that hold plan assets, such as collective trusts, separate accounts and hedge funds and partnerships in which benefit plans hold 25% or more of the interests. It also includes those who manage portions of the money in pooled retirement plans, such as large defined benefit pension plans. While these entities are conscious of their obligations under the securities laws, some have not paid attention to the disclosure requirements of ERISA.

What Do We Recommend?  

For service providers that have completed the steps necessary to comply or are well on their way to complying, we suggest that they "stay the course." By that, we mean continue the process of preparing for implementation of the disclosure process, but delay full implementation until the amendments to the regulation are published — with two exceptions:

  •  The first is those service providers that have already implemented their disclosure process — e.g., they are already using a §408(b)(2)-compliant service agreement. If they are required to add any additional disclosures, they can simply augment what they have already done. This assumes that the DOL is correct in saying that compliance with any new requirements created by the amendment to the regulation will not be difficult to do.
  •  The second exception is RIAs and compliance-only TPAs that will make all of the required disclosures in a single document, such as a service agreement. These entities may wish to proceed with implementing the disclosure process, because it would appear that the only additional requirement might be the summary and roadmap, which can be provided separately as a supplemental disclosure.

For those that are still working on their compliance documents and procedures, we recommend that they continue to work through the process at the pace they are currently on. We say this because even though the DOL has granted a compliance extension, we believe there is still time pressure to establish the procedures and develop the disclosures needed to comply. For some service providers, there is the practical issue of capturing all of the compensation information and figuring out how to disclose it to each plan client.  We have observed that this is more difficult than it may seem and generally takes longer than anticipated. The delay in the deadline gives these service providers time to get ready in an orderly way.

For those that have not examined this issue and begun compliance efforts, the delay may be what saves them from serious problems later on.

 For more information, in the Tax Management Portfolios, see Kushner, 361 T.M., Reporting and Disclosure Under ERISA, and Horahan and Hennessy, 365 T.M., ERISA—Fiduciary Responsibility and Prohibited Transactions, and in Tax Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions and ¶5570, Reporting and Disclosure Requirements for Benefit Plans.

© Drinker Biddle & Reath LLP 2011