Fee Transparency for 401(k) Plans – Are You Complying With Your Fiduciary Duties?
Kegler Brown Employee Benefits Update June 21, 2011
The Obama administration has made it clear that improving the transparency of 401(k) plan fees is a key policy objective. In accordance with these objectives, the Department of Labor (“DOL”) has issued three sets of regulations relating to fee disclosures.
In November of 2007, the DOL issued regulations relating to fee information that must be disclosed on Form 5500 Schedule C for large employers; these regulations have been in effect since 2009. In December of 2007, the DOL published proposed regulations on the subject of service provider fee disclosures. These regulations were finalized in July of 2010 and apply to a wide array of qualified plans, including, but not limited to, 401(k), defined benefit, and ERISA covered 403(b) plans (“Service Provider Fee Disclosures”). In December of 2010, the DOL published regulations on the subject of annual disclosure requirements for participant-directed defined contribution plans (“Participant Fee Disclosures”). It should be noted that these rules apply to all participant-directed defined contribution plans (whether or not they are 404(c) compliant) with the general exception being IRA-based plans.
The focus of this alert is the Service Provider Fee Disclosures and Participant Fee Disclosures. The Service Provider Fee Disclosure rules (due to a recent DOL extension) are effective January 1, 2012, and apply to both new and preexisting service contracts. The Participant Fee Disclosures rules apply for plan years commencing on or after November 1, 2011. However, there is a transitional rule. For participants or beneficiaries who, as of the applicable effective date, have the right to direct the investment of their individual accounts, the plan must furnish initial disclosures no later than 120 days after the rules are applicable. Therefore, for a calendar year plan, the initial annual disclosures must be made no later than April 30, 2012, and the quarterly statement of fees/expenses actually deducted must be furnished no later than May 15, 2012. These annual and quarterly disclosures are discussed below.
It is critical to understand the purpose of these new rules and to comply with the detailed requirements. (Please note that this alert does not contain all of the information necessary to comply with these rules.) Non-compliance with these rules can result in a breach of fiduciary duties and/or prohibited transactions. This could result in liability running to the plan fiduciary for plan losses, the imposition of excise taxes (which can be imposed on the service provider as well), and other sanctions and liability resulting from actions that might be taken by the government or by plan participants.
ERISA requires that fiduciaries act prudently and solely in the best interests of plan participants and the beneficiaries. Among other duties, fiduciaries must ensure that services provided to their plans are necessary and that the costs are reasonable. Unfortunately, understanding 401(k) plan fees is quite a challenge for the average person due in large part to the complexity of the underlying service arrangements. Multiple parties deliver technical and specialized services and their compensation for such services is often intertwined. In many cases, service providers utilize subcontractors to perform promised services and compensation is sometimes received indirectly from the plan’s investments or investment providers. Further, an assortment of different fees is earned by the various service providers to the plan.
The Service Provider Fee Disclosure rules are designed to give rise to a mechanism that will make it possible for the plan fiduciary(ies) to have the information necessary to make a determination as to the necessity of services and the reasonableness of the fees associated with the same.
It is beyond the scope of this alert to describe in detail the Service Provider Fee Disclosure requirements. Suffice it to say that service providers must disclose, in writing, in advance of any contract or arrangement with a qualified plan the compensation to be received, the services to be performed, and the manner in which the compensation is to be paid. It is then up to the plan sponsor to determine that the information is sufficient and, if not, to take steps to obtain sufficient information. With this information in hand, the plan fiduciaries must then engage in an objective process designed to assess the qualifications of the provider, the quality of the services offered, and the reasonableness of the fees charged in light of the services provided. Further, it is with this information that the plan administrator can comply with the Participant Fee Disclosure rules discussed below.
The Participant Fee Disclosure rules obligate the plan fiduciaries (in particular the plan administrator) to disclose “Plan Information” and “Investment-Related Information” to plan participants who participate or are eligible to participate in plans that allow them to direct the investments of their accounts.
“Plan Information” generally means information regarding the structure and mechanics of the plan, an explanation of fees and expenses for plan administration (e.g., legal, accounting, or recordkeeping services), and an explanation of any fees and expenses that may be charged to or deducted from the individual account of a specific participant or beneficiary based on the specific actions taken by that person (e.g., loans, QDROS, investment advice). This information must be disclosed on or before the date that the participant can first direct their investments and annually thereafter.
“Investment-Related Information” relates to performance and investment fee information for each investment option. This information must be given to the plan participant on or before the date a participant could first direct their investments, and annually thereafter. One year, five year, and ten year investment performance returns and applicable benchmark returns for each investment option that does not have a fixed rate of return must be disclosed. The fees and expenses associated with each investment option must be disclosed. Further, the plan participant must be given an internet address that provides the participant and beneficiaries access to additional information about each investment option. Finally, the disclosure to the participants must contain a glossary of investment-related terms so that the information is understandable.
In addition to the foregoing, at least quarterly, plan participants must be given statements that show the actual dollar amount of plan-related fees and expenses charged against their individual accounts. Services associated with these fees must be described and the fees must be broken out so that each participant can understand the impact of the fees on his or her account balance.
Although we have been put on notice about the promulgation of these rules (whether through legislation or regulations) for several years and the rules have been in place for quite some time, it appears that plan sponsors are not aware of these rules or if they are aware, they are not appreciating the gravity of these rules. If you have not started the process of complying with the transparency rules and instituting the “best practices” to so comply, it is imperative that you start now. You should contact your service providers immediately to make sure that they are in the process of providing you with the information needed for you to comply. Even with the extensions of time granted by the Department of Labor, the effective date of these rules is right around the corner, and there is no time to waste.
In light of the fact that ample time has passed since these rules have been promulgated, it is not likely that the Department of Labor, or even the courts, will show leniency to a noncompliant party.
Disclaimer: IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.