401(k) Plan Fee Disclosure and 5500 Reporting

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401(k) Plan Fee Disclosure and 5500 Reporting

• 2009 FIRMA National Risk Management Training
  Conference
• April 29, 2009
  Jennifer E. Eller
• jee_at_groom.com

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• Service Provider Fee Disclosure
• Participant Fee Disclosure
• Legislation
• Litigation

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Service Provider Disclosure - Background

• Retirement system shift to participant-directed
  defined contribution plans
• Development of fee structures relying on
  indirect and hidden direct compensation
  (retirement and welfare plans)
• New class action litigation against plan sponsors
  and plan service providers
• Media attention and legislative pressure to
  improve disclosure

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Service Provider Disclosure

• Two DOL regulatory projects address disclosure of
  fees and service provider conflicts.
• Disclosure of Fees Paid in a Plan Year -
  Amendment of Form 5500 Schedule C requires more
  disclosure of compensation paid directly and
  indirectly for plan services.
• Point of Sale Disclosure - Proposed amendment
  of ERISA section 408(b)(2) regulation (services
  exemption) will require disclosure by covered
  service providers.

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Service Provider Disclosure

• Amendments to the Form 5500 are final and
  effective for 2009 plan years.
• Proposed Amendments to ERISA section 408(b)(2)
  regulations were not finalized before January 20,
  2009.
• Obama Administration may propose or issue similar
  rules.
• Congress may act.

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Service Provider Disclosure Some Themes

• Disclosure burden shifts to non-fiduciary service
  providers, with enforcement mechanisms
• For service providers complex new requirements
  to interpret and implement
• disclosure of indirect compensation
• reporting relief for bundled arrangements
• coordination with other service providers
• For plan sponsors more information

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Service Provider Disclosure Form 5500

• Form 5500 is an annual report filed with the DOL
  for ERISA-covered plans.
• Significant new Form 5500 package published
  November 16, 2007
• Generally effective for 2009 plan year filing.
• Significant changes to Schedule C.
• Affects both pension and welfare plans.
• 72 Fed. Reg. 64710 and 64731.
• DOL FAQs issued July 14, 2008.

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Service Provider Disclosure Form 5500 -
Schedule C

• Report service providers receiving 5000 or more
  direct or indirect compensation paid by the plan
• Applies if plan has more than 100 participants.
• DOLs goal in revamping Schedule C was to expand
  reporting of indirect compensation.
• Key changes -
• New definitions - indirect compensation,
  bundle, investment fund
• Report source of indirect compensation
• Reporting relief for eligible indirect
  compensation and bundled arrangements

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Service Provider DisclosureSchedule C Indirect
Compensation

• Indirect compensation means payments from sources
  other than the plan or plan sponsor that are in
  connection with services to the plan or the
  persons position with the plan.
• Include compensation received if the persons
  eligibility for the payment or the amount of the
  payment is based, in whole or in part, on
  services rendered to the plan or transactions
  with the plan.
• Dont include compensation that would have been
  received had the service not been provided or the
  transaction had not taken place and that cannot
  be allocated to services.

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Service Provider DisclosureSchedule C Indirect
Compensation

• Examples provided by Schedule C
• Finders fees, float, brokerage commissions, soft
  dollars and other transaction-based fees
  received in connection with transactions or
  services involving the plan.
• Amounts charged to the plans investments and
  reflected in unit value, e.g., investment
  management fees, 12b-1 fees.
• Not included investment fund operating
  expenses, e.g., portfolio brokerage expenses.

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Service Provider Disclosure Schedule C
Mechanics

• Line 2 (Part I) of Schedule C requires for each
  service provider (receiving gt 5,000)
• Service Provider Name, EIN
• Amount of direct compensation
• Report of indirect compensation
• FAQs clarify that indirect compensation may be
  reported as a formula rather than an amount or
  estimate.
• Line 3 (Part I) requires identification of
  source of indirect compensation, if (a) over
  1,000, or (b) reported as a formula.

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Service Provider Disclosure Schedule C
Alternative Reporting

• If a Service Provider receives Eligible Indirect
  Compensation (EIC) and no other compensation in
  connection with the plan, plan reporting is
  limited.
• Plan administrator still receives detailed
  information.
• Schedule C identifies person who provided
  information.
• Even if other compensation received by a Service
  Provider (direct or ineligible direct) is
  reported, amount of EIC need not be reported.
• Line 3 source reporting not required for EIC.

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Service Provider Disclosure Schedule C
Alternative Reporting

• Eligible Indirect Compensation includes
• Fees charged against investment funds, e.g.,
  investment management fees
• Finders fees, float, brokerage commissions, soft
  dollars
• Other transaction-based fees paid for
  transactions or services involving the plan, if
  charged against the plans investment.
• Disclosure required for EIC
• The existence of indirect compensation, and
  service provided or other purposes of payment
• The amount or an estimate of, or the formula to
  calculate, the fee
• The identity of the parties paying and receiving
  the fee.

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Service Provider DisclosureSchedule C Bundled
Arrangements

• A bundled arrangement
• A service arrangement where the plan hires one
  company to provide a range or services either
  directly or indirectly from the company, through
  affiliates or subcontractors, or through a
  combination, which are priced to the plan as a
  single package rather than on a
  service-by-service basis.
• An investment transaction in which the plan
  receives a range of services either directly from
  the investment provider, through affiliates or
  subcontractors, or through a combination.

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Service Provider DisclosureSchedule C Bundled
Arrangements

• Payments received by the bundled providers
  affiliates or subcontractors are not reported
  unless these amounts are
• Set on a per transaction basis (e.g., brokerage)
• Fees charged against the value of the plans
  investments (e.g., management fees) or
• Finders fees, float, soft dollars, and
  non-monetary compensation earned by certain
  providers (fiduciary, investment manager or
  adviser, consultant, recordkeeper, broker).

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Service Provider Disclosure Form 5500
Schedule C

• Schedule C Implementation Issues
• Scope of covered indirect compensation
• EIC definition disclosure formats
• Defining a bundle
• Service provider disclosure obligations
• Disclosing fees received
• Disclosing fees paid to other persons in
  connection with plan services
• Duties of service providers responsible for Form
  5500 preparation

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Service Provider Disclosure Schedule C -
Responsibilities

• Plan administrators, not service providers, are
  obligated to complete Form 5500.
• Schedule C requires the plan administrator to
  report service providers who refuse to provide
  necessary information following a request.
• Illustrates DOLs intention to use the Form 5500
  as an enforcement tool.
• FAQs provide relief to service providers that
  notify plans trial they have made a good faith
  effort to collect information, but could not
  complete recordkeeping changes for 2009 plan year.

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Meals, Gifts and Entertainment Form 5500
Schedule C

• Direct and indirect compensation may include some
  compensation received by employees of plan
  sponsors and service providers.
• Not reported compensation, e.g., salary,
  received by a plan sponsor or service provider
  employee, from his or her employer.
• Reportable other compensation, including
  non-monetary compensation, received by a plan
  sponsor or service provider employee from a third
  party.

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Meals, Gifts and Entertainment Form 5500
Schedule C

• Indirect compensation may include meals and
  entertainment received by employees of sponsors
  and service providers.
• But, insubstantial non-monetary compensation
  (e.g., gifts and meals of insubstantial value)
  need not be reported if
• the compensation is tax deductible to the payor
  and excluded from taxable income for the
  recipient, and
• the gift is valued at under 50 and total gifts
  to the recipient from the same source during the
  year do not exceed 100.

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Service Provider Disclosure 408(b)(2) Amendment

• Proposed amendment to ERISAs services exemption
  regulation would
• require written service agreements.
• require detailed disclosure by service providers,
  before or at the time the plan enters a service
  arrangement and upon material changes in fees.
• apply to non-fiduciary service providers.
• 72 Fed. Reg. 70988 (Dec. 13, 2007).
• Final Rule was withdrawn from OMB on Jan 26,
  2009

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Service Provider Disclosure 408(b)(2) Amendment

• Proposed amendment only applies to covered
  service providers, including
• any provider of banking, consulting, insurance,
  investment advisory (plan or participants),
  investment management, recordkeeping, securities
  or other investment brokerage, or third party
  administration, and
• any provider that receives or may receive
  indirect compensation that provides one or more
  of the following services accounting,
  actuarial, appraisal, auditing, legal or
  valuation.

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Service Provider Disclosure 408(b)(2) Amendment

• Proposed regulations would require covered
  providers to disclose (before parties enter a
  service agreement)
• All services to be provided under the
  arrangement.
• The compensation or fees to be received by the
  service provider with respect to each service.
• Includes all indirect compensation and the
  manner of receipt of compensation.
• Primary provider under a bundle of services
  reports amounts received by affiliates,
  subcontractors and other parties in connection
  with bundle of services (but generally does not
  report the allocation of compensation among
  these parties).

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Service Provider Disclosure 408(b)(2) Amendment

• Proposed regulations also would require providers
  to disclose (before the parties enter into a
  service agreement)
• Whether provider will provide services as a
  fiduciary.
• Any participation or interest the provider may
  have in plan transactions.
• Any material financial, referral or other
  relationship that creates or may create a
  provider conflict of interest.
• Whether the provider will be able to affect its
  own compensation without prior approval of the
  plan fiduciary.
• The providers policies or procedures to address
  potential conflicts of interest.

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Service Provider Disclosure 408(b)(2) Amendment

• Indirect Compensation compensation received
  from any source (other than plan/plan sponsor) by
  service provider or its affiliate in connection
  with services provided or because of service
  providers or affiliate's position with the plan.

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Service Provider Disclosure 408(b)(2) Amendment

• If a provider offers a bundle of services
  priced as a package, rather than on a service by
  service basis, bundle provider must provide
  disclosures -
• aggregate of compensation received by
  subcontractors, affiliates or any other party
• need not disclose allocation among affiliates,
  subcontractors, other parties (subject to
  exceptions)

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Service Provider Regulation 408(b)(2) Amendment

• Covered service providers who do not comply with
  proposed regulation could violate ERISAs
  prohibited transaction rules.
• Potential liability for excise taxes under Code
  section 4975 (for pension plans)
• Potential section 502(i) penalty (for welfare
  plans)

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Meals, Gifts and Entertainment 408(b)(2)
Regulations

• Key providers must provide advance disclosure of
  compensation (amount, estimate)
• sufficient info for fiduciary to evaluate
  reasonableness
• Compensation includes "gifts, awards and
  trips for employees" received directly or
  indirectly either (1) in connection with services
  to be provided to the plan or (2) because of the
  provider's "position with the plan."
• Issues/Challenges
• Meals trigger heightened disclosure for a non-key
  provider?
• How to disclose in advance?

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Service Provider Regulation 408(b)(2) Amendment

• Next Steps?
• Could be re-proposed with new notice and comment
  period (similar to Investment Advice Rule and
  Exemption)
• Could be supplanted by legislation

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Participant Disclosure Proposed Regulations

• Proposed rules would enhance disclosures provided
  to participants in participant-directed
  individual account plans. 73 Fed. Reg. 43014
  (July 23, 2008).
• Only would apply to individual account pension
  plans would not apply to welfare plans or DB
  plans.
• Unlike existing 404(c) regulations, proposed
  rules would be mandatory.
• Proposed effective date of Jan. 1, 2009 but the
  rules must be finalized in order to be effective.

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Participant Disclosure Proposed Regulations

• Proposed regulations issued under ERISA section
  404(a) with conforming changes to 404(c)
  regulations.
• Incorporates DOL view that plan fiduciaries are
  responsible to prudently select and monitor
  service providers and investment options.
• Would identify a fiduciary duty under section
  404(a) to provide sufficient information
  regarding the plan, its expenses, and investment
  options to allow participants to make informed
  investment decisions.
• Proposed regulations describe four categories of
  information, to be provided on a regular and
  periodic basis.

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Participant Disclosure Proposed Regulations

• 1. Plan Information
• At eligibility and annually thereafter
• Circumstances where participants may give
  investment instructions and limitations or
  restrictions on these rights
• Plan rules regarding proxy voting rights
• Identification of designated investment options
  and investment manager.
• Can provide via SPD.

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Participant Disclosure Proposed Regulations

• 2. Plan Administrative Expenses
• At eligibility and annually thereafter
• Explanation of administrative fees that will be
  charged to the plan and the basis on which the
  fees will be allocated to or affect participant
  account balances (pro rata or per capita).
• Note Excludes expenses that are paid through
  expense ratio of investment options.
• Can provide via SPD.

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Participant Disclosure Proposed Regulations

• 3. Individual Participant Expenses
• At eligibility and annually thereafter
• Explanation of any fees that will be charged
  against the individual account of a participant
  (i.e, loan processing, QDRO expenses, investment
  advice fees).
• Can provide via SPD.

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Participant Disclosure Proposed Regulations

• Quarterly disclosure of
• The actual dollar amount of administrative
  expenses and individual service charges assessed
  against the participants account during the
  preceding quarter
• A description of the services provided for such
  fees.
• Can provide in quarterly benefits statement.

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Participant Disclosure Proposed Regulations

• 4. Investment Information
• A. Automatic Disclosures (provide in
  comparative form)
• Name of designated investment option
• Internet web address for further information
• Type of investment (e.g. money market fund)
• Type of management
• 1, 5, 10-year performance data for option and
  for an appropriate market index
• Any shareholder fees (sales loads, redemption
  fees, etc.)
• Annual Operating expenses expressed as

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Participant Disclosure Proposed Regulations

• 4. Investment Information (continued)
• B. Upon Request Disclosures
• Prospectuses
• Financial or shareholder reports, to the extent
  provided to the plan
• Value of a share or unit valuation date
• List of portfolio assets for plan asset
  vehicles

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Participant Disclosure Proposed Regulations

• A plan fiduciary must provide specific investment
  information in a chart or similar format that is
  designed to facilitate comparison of investment
  options.
• Use of model disclosure form provided by DOL will
  be deemed to satisfy the requirement to provide
  information in a comparative format.
• A plan fiduciary is not required to use the model
  disclosure form.
• Must also provide a statement that more current
  information may be available at listed Web site
  addresses, and a statement indicating who to
  contact for certain information made available
  upon request.

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Participant Disclosure Proposed Regulations

• Below is the Performance Information table from
  DOLs sample disclosure form at www.dol.gov/ebsa.

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Participant Disclosure Proposed Regulations

• Below is the Fees and Expense Information table
  from DOL sample disclosure form.

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Participant Disclosure Proposed Regulations

• Participant Disclosure Regulations have not been
  finalized, and will likely not be finalized as
  proposed.
• Could be re-proposed with new notice and comment
  period.
• Could be supplanted by Legislation.

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The 401(k) Fair Disclosure For Retirement
Security Act of 2007, H.R. 3185 (The Miller
Bill)

• The Miller Bill would amend ERISA to impose three
  new requirements with respect to the fees that
  401(k) and similar plans pay for services.
• Service Provider Disclosure Prior to entering
  into any contract for services for 1,000 or more
  plan administrator receive a service provider
  disclosure.
• Identification of all parties that would be
  performing services under the contract
• Description of services and total cost
• Itemized list of services and expenses (i.e.
  sales commissions, expenses for investment
  advice)
• Disclosure of any conflicts of interest
• If applicable, disclosure of impact of share
  classes and certain free, discounted or rebated
  services.

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Miller Bill Provisions

• Would require Plan Administrators of
  participant-directed plans to provide
  participants or beneficiaries with notice of
  investment options.
• Detailed information about each investment option
  (i.e. investment objectives, level of risk,
  historical returns)
• A Fee Menu relating to all options under the
  plan, disclosing potential service fees that
  could be assessed against participant accounts
• Disclosure of potential conflicts of interest.

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Miller Bill Provisions

• Would require Plan Administrators to provide
  participant-specific benefit statements within 90
  days of the close of the plan year.
• Require statement to disclose several
  subcategories of fees assessed from each
  participants account for each investment option
  selected.

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Miller Bill Provisions

• Participant-directed account investment menu must
  include at least one nationally-recognized index
  fund likely to meet retirement income needs at
  adequate levels of contribution.

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Miller Bill Provisions

• Would direct the DOL to enforce new requirements
  and create statutory penalties for failure to
  comply.
• Establishment of an Advisory Committee
• Creation of a penalty structure authorizing the
  DOL to assess a penalty against Plan
  Administrators of up to 100 per day for a
  failure.
• Authorize DOL to publicly disclose identity of
  noncompliant service providers.

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401k Plan Litigation

• Class Actions against Plan Sponsors (by
  participants)
• Class Actions against Recordkeepers (by
  participants and sponsors)

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Participants vs. Plan SponsorsThe Players

• What Class actions challenging 401k
  recordkeeping and investments
• Who
• Participants (by class action lawyers Schlicter
  Bogard)
• Plan sponsors Boeing Lockheed Martin Exelon
  Caterpillar General Dynamics United
  Technologies Bechtel International Paper
  Kraft Northrop Grumman Deere Co. and ABB

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Participants vs. Plan SponsorsThe Claims

• Procedural Prudence - Did the plan fiduciaries
  exercise due diligence in their consideration of
  the plans compensation arrangement with service
  providers, including any revenue sharing
  component?
• Reasonableness of Fees Did the plan fiduciaries
  cause the plan to pay excessive compensation to
  service providers because of revenue sharing or
  other circumstances?
• Disclosure Did the plan fiduciaries violate
  ERISA in how and what they disclosed to plan
  participants about revenue sharing and other fees
  charged to the plan?

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Participants vs. Plan SponsorsThe Claims

• Claims also include
• Failure to capture float and other revenue
  streams
• Participants investing in mutual funds pay more
  than their share of administrative fees
• Fiduciary favored its DB plan run by same manager
• Use of master trust results in fee layers
• Mutual funds vs. separate accounts, and retail
  mutual funds
• Actively managed funds functions as passive
  funds, so their higher fees not justified

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Participants vs. Plan SponsorsThe Claims

• Allegations regarding the plans company stock
  fund
• Cash component increases tracking error versus
  stock
• Investment management and other fees not
  justified
• Forcing participants to own company stock in
  order to participate in the 401k plan

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Participants vs. Plan SponsorsDisclosure of
Rev. Sharing to Participants

• Disclosure not required
• Hecker v. Deere (CA 7 2009) nothing in ERISA
  specifically requires disclosure of revenue
  sharing to participants.
• Taylor v. United Technologies (MSJ 2009) rev
  sharing info is not material to reasonable
  investor

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Participants vs. Plan SponsorsDisclosure of
Rev. Sharing to Participants

• Disclosure may be required (or advisable)
• Tussey v. ABB disclosure not required, but
  could affect participants control under
  404(c).
• Kanawi v. Bechtel failure to disclose could
  potentially support a fiduciary breach claim and
  affect 404(c) relief

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Participants vs. Plan SponsorsThe Section
404(c) Defense

• Some courts have held that 404(c) is a defense to
  claims that selection of plan investment options
  was imprudent.
• Langbecker v. Elec. Data Sys. Corp (CA 5 2007)
• Hecker v. Deere Co. (CA 7 2009)

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Participants vs. Plan SponsorsThe Section
404(c) Defense

• Other courts disagree
• Tussey v. ABB, Inc. (2008)
• Tittle v. Enron Corp. (S.D. Texas 2003) (whether
  404(c) shields fiduciaries is a question of
  fact).

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Participants vs. Plan SponsorsThe Section
404(c) Defense

• Hecker v. Deere Co (CA 7 affirms motion to
  dismiss 2/09)
• Plan offered a sufficient mix of investments so
  that inclusion of expensive funds did not
  constitute a breach (plan had brokerage window)
• even if there was a breach as to fund selection,
  section 404c precluded liability
• Rehearing sought
• Suggests that sponsors have no duty to review
  fees so long as participants have thousands of
  choices (brokerage window)
• DOL disagrees

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Participants vs. Plan SponsorsRevenue Sharing

• Taylor v. United Technologies (MSJ for UT granted
  3/3/09)
• Properly selected mutual funds
• Recordkeeping fees were reasonable when compared
  to market
• Not required to disclose to participants that
  revenue sharing was used to reduce amount UT paid
  to recordkeeper in fees
• UT properly monitored cash in stock fund

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Suits vs. Recordkeepers

• Participants vs. Recordkeepers Included as
  defendants in participant suits vs sponsors
• See ABB, Deere complaints
• Adds - an opportunity to allege self-dealing
  based on recordkeepers receipt of revenue
  sharing
• Plan Sponsors vs. Recordkeepers
• Defendants Nationwide, Principal, Hancock, ING,
  American Skandia, Paychex, Fidelity
• Sponsors allege that recordkeeper was a fiduciary
  and that receipt of revenue sharing involved a
  conflict of interest

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Suits vs. RecordkeepersRecordkeepers Fiduciary
Status

• Is recordkeeper a fiduciary in plans selection
  of investment funds?
• Hecker v. Deere Co. (2007)- Fidelity not a
  fiduciary
• Columbia Air Services v. Fidelity (2008) -
  Fidelity dismissed
• Tussey v. ABB (2008) - Fidelity could be a
  fiduciary

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Suits vs. RecordkeepersRecordkeepers Fiduciary
Status

• Does recordkeeper have fiduciary discretion to
  add/delete investment funds?
• Charters v. John Hancock (2008, plaintiffs MSJ
  partially granted) - Hancock could be a fiduciary
• Phones Plus v. Hartford (2007, MTD denied)
  Hartford could be a fiduciary based on ability to
  change funds available under annuity contract.
• Haddock v. Nationwide (2006) Nationwide may be a
  fiduciary

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Questions?

• Jennifer E. Eller, Esq. - [phone]
• Groom Law Group, Chartered
• 1701 Pennsylvania Avenue, NW
• Suite 1200
• Washington, DC 20006
• jee_at_groom.com