Writing on the wall for service providers

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The Department of Labor has issued the long-anticipated final service provider fee disclosure regulation, also known as the 408(b)(2) regulation.

The regulation requires most retirement-plan service providers — including pension, profit sharing, 401(k) and 403(b) plans subject to ERISA — to make written disclosure of their services, fiduciary and/or RIA status and total compensation. The regulation was first proposed in 2007, was issued as an “interim final” regulation in July 2010 and has now been finalized.

July 1, 2012, is a significant date for plan sponsors and their plan committees. By that date, they should have received — and will need to begin evaluating — information from their plan’s service providers. As a result, the plan sponsors will face heightened expectations and legal responsibilities.

The regulation initially imposes an obligation only on service providers to make written disclosures, and does not explicitly impose duties on plan sponsors or fiduciaries. However, as explained in the preamble to the regulation, under the general fiduciary rules of the Employee Retirement Income Security Act, once the responsible plan fiduciaries get the information, they will have a duty to evaluate it.

Plan sponsors have a fiduciary duty to know about the compensation of their service providers, including money received indirectly (like the 12b-1 fees and revenue sharing). However, in our experience, some plan sponsors are not aware of those payments or how they are calculated, much less the total amount actually being received by the providers. In addition, those payments may indicate conflicts of interest, which have the potential to hurt the plan and the participants. The responsible plan fiduciaries — typically, the plan committee members — have to be aware of those conflicts and mitigate any potentially harmful effects.

Historically, the DOL has taken the position that fiduciaries had the duty to obtain and evaluate information about the costs to the plan and the compensation of the service providers; but there was no parallel duty on the part of service providers to disclose the information. The DOL has now issued a regulation that requires your plan’s service providers to disclose information about their services, status and compensation.

The new requirements apply to “covered services” for “covered plans.” Without going into great detail, the definitions are:

**A “covered plan” is a retirement plan that is subject to ERISA and, as a practical matter, includes 401(k) plans, pension and profit-sharing plans, and many 403(b) plans (but it does not apply to government or most church plans).

**A “covered service” includes ERISA fiduciary services, RIA services, 40(k) record-keeper and brokerage services and, if they receive indirect compensation, the services of almost all other providers who work with plans, such as broker-dealers, third-party administrators and consultants.

What must be disclosed? There are three separate disclosure requirements: services, fiduciary status and compensation:

Services — The first requirement is that the service provider gives a description of its services to the plan.

Fiduciary status — The second disclosure requirement is whether your service provider is serving as an ERISA fiduciary and/or as a registered investment adviser. If the service provider “reasonably expects” to be a fiduciary to your plan, it must affirmatively say that it is.

Compensation — This is defined very broadly. It is anything of monetary value, such as gifts, awards, trips, etc. (However, non-monetary compensation totaling $250 or less does not need to be reported to you.)

The written disclosures for your current providers must be given by July 1. Thereafter, as you seek to hire new or additional providers, the disclosures must be given to you reasonably in advance of the time at which the arrangement is entered into. “Reasonably” means that you need time to study the materials and make informed decisions before you sign the agreement. For a straightforward arrangement, that may be just a few days.

Of course, the regulation and the disclosures are not the end of the story. When you receive the disclosures, you have a duty to review and evaluate them. Is the compensation reasonable in relation to the services being received? Are the services appropriate for the plan? Are they meeting the needs of the fiduciaries and the participants? Are there conflicts of interest and, if so, are they being managed properly? It is your fiduciary duty to engage in a prudent process to review the information and answer those questions. Those are difficult questions for plan sponsors to answer. After all, plan sponsors are not in the 401(k) business, and the process for evaluating this information may be somewhat different from the work your committee has done in the past. As a result, they should work with experienced consultants and lawyers who can help them understand the issues and reach informed decisions.

Terry Seely is president of Capital Ideas LLC in Grand Rapids. He can be reached at (616) 808-2307.

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