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The following article was taken from the 2/6/12 issue of Pension & Benefits Week.

2/7/12 -- EBSA finalizes regs on fee disclosures

DOL's Employee Security Benefits Administration (EBSA) has issued a final rule concerning the fee disclosures that must be furnished to plan fiduciaries in order for a contract or arrangement to be "reasonable," as required by ERISA § 408(b)(2). The final regs are effective on July 1, 2012. (Labor Reg § 2550.408b-2(c))

Background. The furnishing of goods, services, or facilities between a plan and a party in interest to the plan generally is prohibited under ERISA § 406(a)(1)(C). As a result, a service relationship between a plan and a service provider would be a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a "party in interest" to the plan. However, ERISA § 408(b)(2) exempts arrangements between plans and service providers that otherwise would be prohibited transactions under ERISA § 406, if: (i) the contract or arrangement is reasonable, (ii) the services are necessary for the establishment or operation of the plan, and (iii) no more than reasonable compensation is paid for the services.

On July 16, 2010, EBSA published an interim final rule that required that reasonable contracts or arrangements between employee pension benefit plans and certain providers of services to the plans include specified information to assist plan fiduciaries in assessing the reasonableness of compensation paid for services, and the conflicts of interest that may affect a service provider's performance of services. EBSA had previously (on December 13, 2007) published a proposed reg and a proposed class exemption that would have imposed similar requirements.

Finalized rule. The final rule retains most of the disclosures required by the interim final rule, but makes several significant modifications. Highlights follow.

Covered plan. Under the final rule, a "covered plan" does not include all, or that part, of a 403(b) plan that consists exclusively of "frozen" contracts or custodial accounts--i.e., contracts for which the plan sponsor ceased to have any obligation to make contributions (including employee salary reduction contributions), and in fact did cease making contributions, for periods before January 1, 2009. Further, (i) the contract or account must have been issued to a current or former employee before January 1, 2009; (ii) all the rights and benefits under the contract or account must be legally enforceable against the insurer or custodian by the individual owner of the contract or account, without any involvement by the employer; and (iii) the individual owner must be fully vested in the contract or account. (Labor Reg § 2550.408b-2(c)(1)(ii))

Covered service provider. The final regs (like the interim final regs) provide several categories of covered service providers, including (a) ERISA fiduciary or registered investment adviser; (b) providers of recordkeeping services or brokerage services to a covered plan that permits participants and beneficiaries to direct the investment of their accounts; and (c) those providing specified services to the covered plan when the covered service provider reasonably expects to receive indirect compensation or certain payments from related parties.

The final rule clarifies that the party entering into the contract or arrangement with the covered plan is the covered service provider responsible for making the regs' required disclosures, even if other parties perform some of the services. Thus, no person or entity is a covered service provider solely by providing services as an affiliate or a subcontractor that is performing one or more of the services to be provided under the contract or arrangement with the covered plan, or to an investment contract, product, or entity in which the covered plan invests. (Labor Reg § 2550.408b-2(c)(1)(iii))

Initial disclosure of indirect compensation. Under a newly added rule, a covered service provider must identify not only the payer of indirect compensation, but also describe the arrangement between the payer and the covered service provider, affiliate, or subcontractor (as applicable), under which the indirect compensation is paid.

This new requirement is intended to illustrate for the responsible plan fiduciary, potential conflicts of interest on the part of the covered service provider (or affiliate or subcontractor) resulting from the receipt of indirect compensation, EBSA said. The covered service provider must describe its arrangement with the payer of the indirect compensation so that the responsible plan fiduciary can analyze why the payer, generally an unrelated third party, is compensating the covered service provider in connection with the contract or arrangement with the covered plan. To the extent that this information is unknown at the time the disclosures are made (for example, for broker-dealers who cannot properly identify the payer of indirect compensation in advance of service arrangements involving securities purchased through brokerage windows, self-directed brokerage accounts, or similar arrangements), the description need not identify the specific payer in advance of the service arrangement. Instead, the description may provide information that would allow the responsible plan fiduciary to compare the expected compensation with compensation that would be received by competing broker-dealers for similar investment services. (Labor Reg § 2550.408b-2(c)(1)(iv)(C)(2))

Conforming to participant-level disclosure regs. Additional investment disclosures must be made by covered providers of fiduciary services to an investment that holds plan assets and in which the covered plan has a direct equity investment. The interim final rule required (1) a description of any compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer of, or withdrawal from the investment; (2) a description of the annual operating expenses if the return is not fixed; and (3) a description of any ongoing expenses in addition to annual operating expenses. These categories of investment-related information have been modified to better conform to the investment-related information required under the participant-level disclosure reg, Labor Reg § 2550.404a-5, EBSA said. Specifically, for an investment that is a designated investment alternative (DIA), the covered service provider must disclose the total annual operating expenses for the DIA calculated according to Labor Reg § 2550.404a-5(h)(5), rather than rely on the interim final rule's more general standards. This rule is intended to ensure consistent disclosure, and prevent confusion to the extent a covered service provider otherwise may have had to disclose expense information for the same investment differently under the participant-level disclosure reg. (Labor Reg § 2550.408b-2(c)(1)(iv)(E))

Investment-related disclosures--recordkeeping and brokerage services. The final rule (like the interim final rule) requires the same investment disclosure from covered providers of recordkeeping or brokerage services to an individual account plan that permits participants and beneficiaries to direct the investment of their accounts, if one or more DIAs will be made available in connection with those services.

Under the final rule, covered service providers may comply with these disclosure requirements for DIAs by providing current disclosure materials of the DIA issuer, or information replicated from these materials, that include the required information, provided that: (1) the issuer cannot be an affiliate of the covered service provider; (2) the issuer is (i) a registered investment company, (ii) an insurance company qualified to do business in any state, (iii) an issuer of a publicly traded security, or (iv) a financial institution supervised by a state or federal agency; and (3) the covered service provider acts in good faith and does not know that the materials are incomplete or inaccurate, and furnishes the plan fiduciary with a statement to this effect. Thus, the final rule no longer focuses on whether the disclosure materials themselves are regulated, but rather on whether the institution issuing the materials is regulated. (Labor Reg § 2550.408b-2(c)(1)(iv)(F))

Format for initial disclosures. Although EBSA is not now requiring the use of a guide or index or other specified format for disclosures, EBSA is providing a sample guide to initial disclosures in the appendix to the final rule. This may be used on a voluntary basis by covered service providers to assist responsible plan fiduciaries with the required disclosures.

Timing of disclosures. A covered service provider generally must disclose investment-related information to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into, extended, or renewed (as provided in the interim final rule).

A covered service provider must disclose a change to required information as soon as practicable, but generally not later than 60 days from the date on which the covered service provider is informed of the change. However, this 60-day standard is now applicable only for specified information. In addition, the final rule provides an alternate timing standard for changes in investment-related information. Rather than furnishing notification of each change within 60 days, a covered service provider would have to disclose any changes to the investment-related information at least annually. This rule is intended to keep the reporting of minor changes in investment information from becoming burdensome. (Labor Reg § 2550.408b-2(c)(1)(v)(B)(2))

Timing of other requested information. Upon the request of the responsible plan fiduciary or covered plan administrator, a covered service provider must furnish any other information relating to the compensation received in connection with a contract or arrangement that the covered plan needs to comply with ERISA reporting and disclosure requirements. The final rule modifies the timing requirement for this change to base the timing on existing reporting and disclosure standards. Thus, requested information generally must be furnished reasonably in advance of the date on which the responsible plan fiduciary or covered plan administrator states that it must comply with applicable reporting and disclosure requirements. (Labor Reg § 2550.408b-2(c)(1)(vi)(B))

Definitions. The final rules modify how a description of compensation may be expressed, by providing for a description of "compensation or cost." Thus, a description of compensation or cost may be expressed as a monetary amount, formula, percentage of the covered plan's assets, or a per capita charge for each participant or beneficiary. The description may include a reasonable and good faith estimate if the covered service provider cannot otherwise readily describe compensation or cost, and the covered service provider explains the methodology and assumptions used to prepare the estimate. EBSA said that this modification is intended to make it clear that all covered service providers, not just those providing recordkeeping services, may provide estimates of monetary amounts, provided that the other requirements of the final rule are satisfied. (Labor Reg § 2550.408b-2(c)(1)(viii)(B))

Exemption of the responsible plan fiduciary. The final rule changes the language of one of the conditions required for relief under the class prohibited transaction exemption. Upon discovering that a covered service provider has failed to disclose certain information, a responsible plan fiduciary must in writing request the information from the covered service provider. If the covered service provider fails to comply with the written request within 90 days, the responsible plan fiduciary must determine whether to terminate or continue the contract or arrangement, consistent with the ERISA § 404 duty of prudence. If the requested information related to future services is not disclosed promptly after the end of the 90-day period, the final rule requires that the responsible plan fiduciary must terminate the contract or arrangement. (Labor Reg § 2550.408b-2(c)(1)(ix)(G))

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