Now the DOL is FAQuing It - Having Fun with ''Funds'' on the Form 5500
Issues relating to fees to service providers have become high-profile issues, with a proliferation of indirect-fee class actions and the inevitable follow-on press reports. These issues have generated activity in four theaters: (i) the regulations under ERISA Section 408(b)(2), (ii) the rules governing Form 5500, Schedule C, (iii) the "404(c)" rules for covered plans with participant-directed investments, and (iv) a number of legislative proposals in Congress. The DOL has moved forward in the first of these two arenas with proposed 408(b)(2) regulations and new rules for Form 5500, Schedule C, which have turned out to be flashpoints in the market for a firestorm of controversy affecting financial services organizations and plan sponsors alike. Much (but not all) of the controversy has centered around the DOL's attempt to expand certain rules to a variety of types of indirect compensation and, apparently, in some cases, compensation for supposed indirect services, particularly in the context of fees surrounding "investment funds."
On July 14, the DOL issued FAQs intended to help with the administration and implementation of the new 5500 rules. To its credit, using the efficient FAQ mechanic, the DOL is reacting quickly to a real need in the marketplace for guidance as to how these rules will work. Putting aside the question as to whether everyone will agree with everything the DOL has done in the FAQs, it was critical that the DOL start to get on the record as to a range of seminal interpretive questions. (And, thankfully, the FAQs were released almost a full week before the release of the The Dark Knight, so that I could read them without being distracted by what I'm anxiously hoping will be One of the Greatest Movies Ever Made.)
I'm writing here to take note of an arguably arcane but ultimately critical and interesting feature of the FAQs, relating to the nature of what is an "investment fund" for purposes of the new 5500 rules. It did not go unnoticed by some that the new rules seemed to latch onto the concept of "investment funds" as a major underpinning of when the new indirect-type rules apply; however, the concept appeared to spring suddenly from within the authority, and didn't have a firm express basis is that which had come before. (Yeah, it's a "lawyer point," I guess, in a group of FAQs with more direct practical implications, but, then again, I'm a lawyer.) The issue was made more vexing by the fact that the new rules did not tap into the existing regime for look-throughs to investing plans, the so-called "plan asset" regulations (as modified by ERISA as recently amended), but rather went down this new, undefined "investment fund" road.
Thus, the scope of the "investment fund" concept, and by extension the very scope of a substantial portion of the new rules, became subject to something of a cloud right from the get-go. For example, what is an "investment fund" anyway? How do hybrid entities, like REOCs (real estate operating companies) and VCOCs (venture capital operating companies) under the "plan asset" regulations fit in? How does the general "operating company" concept overlay on top of the fund analysis? These questions, and the lack of any answers (or even discussion) regarding them, resulted in a significant analytical detour right out of the interpretive gate.
Well, Q&A 7 of the new FAQs is packed with a lot of information and goes a long way towards shedding light on how the DOL views these matters. There is the description by example of what "investment fund" means, where the DOL says in a parenthetical: "e.g., mutual funds, collective investment funds." (It may not seem like much, but it was more than we had.) There is the posing of the basic question of whether compensation received in connection with the management of VCOCs, REOCs and other operating companies needs to be reported, and there is the DOL's pithy and straightforward (and, to me, clearly correct and appropriate) answer, "No." There is the clarification that, notwithstanding the foregoing, fees or commissions received by a manager or adviser in connection with an investment in an operating company could be reportable. And, underscoring the extent to which the DOL really seems to have created a whole new quasi-"plan asset" framework in the context of the reporting rules, the DOL states: "This answer would not be affected by whether the VCOC, REOC, or other operating company were wholly owned by a plan such that [under the "plan asset" regulations] the assets of the entity would be deemed to be plan assets."
This last nuance indicates that the formalistic approach under the bedrock "plan asset" rules falls, in the reporting context, to what may be a more intuitive analysis. As a result, essentially all that matters here is whether there is an operating company present effectively to block the look-through, not whether the entity's assets technically are "plan assets." (The need to apply the technical rules to determine whether an entity is a VCOC or REOC (or other operating company) is still present.) It remains to be seen whether this new conceptual approach will eventually be given application for other ERISA purposes.
The foregoing is just one small aspect of an important set of FAQs, and shows, even standing alone, how interesting the development of the reaction to the fees issue has been and probably will continue to be. In this regard, note also that, in Q&A 40, the DOL states: "In an effort to address the concerns of both service providers and plans, the Department has decided that, with respect to those employee benefit plans which are dependent on service providers for information necessary to complete the Schedule C, the plan administrator will not be required for 2009 plan year reports to list a service provider on line 4 of the Schedule C [which basically calls for the listing of uncooperative service providers] as failing to provide information necessary to complete the Schedule C if the plan administrator receives from the service provider a statement that (i) the service provider made a good faith effort to make any necessary recordkeeping and information system changes in a timely fashion, and (ii) despite such efforts, the service provider was unable to complete the changes for the 2009 plan year." Bravo - this relief (which presumably will spawn quite a lot of "statements") is extremely welcome in light of the fact that, as shown above, on even the most basic gateway issues there is a great deal of new concepts, analyses and information to digest.