Participant-Level Fee and Investment Disclosures are Greatly Expanded
Who Should Read this Advisory?
The discussion below applies only to employers who sponsor a retirement plan that has individual participant accounts over which participants have investment discretion.
If an employer sponsors a defined benefit plan, a plan that is not subject to ERISA (e.g., a governmental plan) or has an individual account plan over which participants do not have any investment control, these rules are not applicable. These rules also do not apply to a simplified employee pension or SIMPLE IRA-based plan.
However, employers of many of these other sorts of plans—if subject to ERISA—should keep in mind that they are still required to assess the reasonableness of contracts and investment arrangements with vendors. Beginning July 1, 2012, failure of an employer to require, and a vendor to supply, certain information about the vendor's service and compensation arrangement, will result in both parties being subject to excise taxes under ERISA's prohibited transaction rules. See our related article"Retirement Plan Service Providers Have New Fee and Service Disclosure Requirements (the '408b-2 Rule')"
Background and Compliance Dates
In October 2010 the Department of Labor's Employee Benefits Security Administration (EBSA) issued final rules on disclosure of plan investment options and related fees and expenses for participant-directed individual account plans. These rules were initially intended to be effective before the beginning of 2012, but the EBSA delayed the effective date several times and finally coordinated the effective date of these participant-level disclosures about fees and expenses with the effective date of the 408b-2 Rule mentioned above.
- For calendar year plans, the initial disclosure of plan level and investment level information must now be distributed no later than August 30, 2012.
- The first quarterly statement under the new rules must be furnished no later than November 14, 2012.
- Annual notices
(about the plan generally, and investment funds in particular) must be
provided again by August 30 in all future years.
For fiscal year plans, the participant-level disclosures can be delayed until 60 days into the next plan year if that date is later than August 30, 2012, and the first quarterly disclosures will be required 45 days after the first quarter in that plan year. For example, an employer plan with plan year of September 1 will have to provide the first annual notice by October 30, 2012, and the first quarterly disclosure on February 14, 2013, with respect to the quarter ending December 31, 2012.
Action Needed: Employers will find it very difficult to comply with the August 30, 2012 initial disclosure deadline if they wait until July 1, 2012 to get the needed information from their vendors. Therefore, employers should begin to ask questions now and see which aspects of the participant-level disclosure requirements the vendor will handle.
Why Are There New Disclosure Requirements?
These participant-level disclosures are actually the third step in DOL efforts designed to improve the transparency of fees and expenses indirectly related to retirement plans. First, plan sponsors were required to obtain information about and report certain indirect compensation received by plan vendors on the annual Form 5500. The next step was issuance of 408b-2 Rules that require detailed disclosure of direct and indirect compensation data and investment information by plan vendors to employers. See our related article"Retirement Plan Service Providers Have New Fee and Service Disclosure Requirements (the '408b-2 Rule')" The third requirement--for participant-level disclosures--is the most comprehensive of the three, and is described below.
Transparency is a Laudable Goal—Will it Work?
Whether the detailed investment and fee disclosures and the specific comparative chart that these rules require will improve participants' understanding of their investment choices and their relative costs is yet to be seen. Many commentators believe that the sample format provided will only serve to highlight the history of an investment fund's performance, which is not an indicator of likely future performance, and may place undue focus on funds' expense ratios. For example, if a participant concludes by looking at the comparative chart that the "cheaper" fixed income fund is more appropriate than a stock fund or a broadly-allocated fund with a higher expense ratio, then the plan participant may be encouraged by the new rules to invest too conservatively.
Warning— Vendors can comply with the 408b-2 Rule by pointing the employer to sources of information in a fashion that is not particularly organized or designed to neatly mesh with the participant-level disclosure requirements. In that case, most of the burden will be on the employer to translate reams of information that vendors can literally "dump" on their doorstep (or in their email in-box). Only the most sophisticated employers will be able to construct the participant-level disclosures on their own; if you anticipate needing an advisor to assist, you should quickly secure the necessary help.
General Description of Disclosures Required
The new disclosure requirements applicable to participant-directed individual account plans can be divided into three categories:
- Disclosure of general plan-related information in a summary document.
- Disclosure of investment-related information in a comparative chart.
- Disclosure of specific fees and
expenses charged participants during the preceding quarter, generally on quarterly
participant account statements.
In addition, plans that permit annuities to be purchased must provide each participant specific information about the annuities that are available, including a contract name, its objectives, the benefits and factors that determine the price of the annuity and any limitations on the participant's ability to withdraw or transfer amounts allocated to the annuity contract, among other information.
The first two disclosures are required to be delivered on or before August 30, 2012 for calendar year plans, or, if later, the date a participant can first direct investments, and at least annually thereafter; supplemental information must be available on an internet website. Specific quarterly fee information will generally be on or with quarterly account statements and must be delivered within 45 days after the end of each quarter. Changes to any of the information (for example, because of replacement of one investment fund with another) must be disclosed to participants at least 30 days (and not more than 90 days) in advance of the effective date of any change.
How the Information Can be Provided
While some of the information (for example, the summary document on general plan-related information) could be provided as part of the plan's summary plan description, this is impracticable. SPDs are not required to be distributed in advance, and are not re-distributed annually.
The DOL recently released an interim policy [Technical Release 2011-3, September 13, 2011; http://www.dol.gov/ebsa/newsroom/tr11-03.html] on electronic disclosure to clarify which of the new disclosures may be provided electronically to participants and beneficiaries. In general, under this interim policy, the fee disclosures that are required to be made quarterly may be made electronically if sent with an account statement that can be sent electronically under prior rules. Most employers have relied on vendors with more sophisticated systems and security measures to meet the fairly high standards for when electronic delivery is allowed for account statements or other documents that include personal information.
The initial notice of general plan and investment–related information can generally only be sent electronically if the participant or beneficiary voluntarily provides an e-mail address after having been told that they have the right not to provide an e-mail address, and that they may opt out of electronic disclosures and instead obtain a paper copy of any related disclosure. Because this notice will also need to include a summary of the types of information that will be provided electronically if voluntary permission is given, past consents given by participants to receiving some plan information via e-mail will generally not be sufficient to allow the first annual disclosures to be provided electronically, so many vendors will be providing them in hard copy.
Annual Notices--General Plan and Investment-Related Information
The initial/annual notice requires general plan-related information and is designed to give participants information about the structure and mechanics of the plan. In particular it must include
- A description of the means by which participants can give investment instructions, and any restrictions (short term trading restrictions or an equity wash provision, for example).
- Description of any brokerage windows or other arrangements that may be allowed as an alternative to specific investment options.
- A description of plan provisions regarding the exercise of voting or other rights related to an investment.
- Identification of any designated investment manager.
- Explanation of the fees and expenses for general administrative services that could be charged or deducted from individual accounts (as opposed to those paid from fund expense ratios or via revenue sharing) and how those expenses are charged as among participant accounts (pro rata or per capita, for example), as well as any individual expenses that could be charged based on participant activity (e.g., loan fees).
- If some fees and expenses will be
paid from revenue sharing, a general statement to that effect.
The initial and annual notice of investment information—in the chart format dictated by the DOL—gives very specific investment-related information, including historical performance data on the plan's specific funds, comparison to a broad-based securities market index (not one run by an affiliate of a vendor), actual fund expense ratios, and other fund-based charges (loads, redemption fees, etc.), along with some "boilerplate" statements about the relevance of historical performance and fees to making investment decisions. The EBSA has issued a model for this chart which can be found at www.dol.gov/ebsa/participantfeerulemodelchart.doc
The investment notice must also reference an Internet website for obtaining more information on specific funds and accessing a general glossary of terms to assist participants and beneficiaries in understanding the plan's investment options. Additional information will be required if a plan offers target date retirement funds.
Detail about investment options available under brokerage windows or self-directed brokerage accounts are excluded from these investment disclosure rules, since providing detailed information about a broad range of investments available in those brokerage structures would be impossible although general information about these options and fees related to having such an account must be included in the general plan-related notice.
Disclosure of Fees and Expenses Debited to Plan Accounts
Quarterly account statements must include specific disclosure of the dollar amount of any fees for plan administrative services, but only to the extent that those fees are not already included in (or paid via) the investment-related fees and expenses. For example, if part of the revenue the mutual fund company receives is paid to the administrative service provider to help defray the costs of communicating mutual fund information to plan participants and for administering the plan, that part of a plan's administrative expenses that are paid through revenue sharing are not again reflected as specific fees on a participant statement. But, if there are separately-charged fees for administrative functions or if the Plan pays for legal, accounting, record keeping, or investment advisory services that the employer believes reasonable and necessary for the plan's administration, each quarterly statement received by a participant must indicate the dollar amount actually charged to the participant's account for administrative services in the preceding quarter and a general description of the services to which the charges relate.
There might also be some participant-driven expenses, like a fee to take a loan, a charge for implementing a qualified domestic relations order, or charges for investment advice services that are optionally elected by a participant, to be reflected and described on quarterly participant statements.
Information Provided Upon Request
In addition to all of the specific investment information provided above, plan fiduciaries must provide participants and beneficiaries, upon request, copies of prospectuses, financial statements, reports, a statement of the value of the share or unit of each investment alternative and, in some cases (for example, for a collective investment fund), a list of assets held by each designated investment vehicle.
The More Difficult Situations
Some aspects of these new rules will be difficult for employers to address independently, and plans with more unusual types of investments (hedge funds, partnerships, company stock, etc.) will need much more employer involvement to supply the required disclosures.
Many vendors will be prepared to provide an investment performance and disclosure chart in the form dictated by the EBSA, but few will be able to draft the general plan information notice without specific employer input. Because this notice must indicate which administrative fees are going to be allocated pro rata based on relative account balances and which will be allocated per capita or in another fashion, plan sponsors will need to make decisions and be prepared to address participant questions as to why they chose one method over another. Administrative costs that are typically assessed only once a year (the bill for having the plan audited, for example) will "bunch up" on an account statement or may be debited against a specific fund (generally, the most conservative one), which may require additional explanation. As these disclosures become more common, participants will become more sophisticated and begin asking additional questions.
Employers may not have personnel who are equipped to determine whether investment information is accurate or whether the benchmarks used to compare a particular fund to a broader market are the appropriate ones for a particular fund. Employers should at least ask numerous questions of their vendors, and may want to consider having an independent fiduciary or consultant review the first disclosures.
Another area that will be difficult for employers is confirmation of fees that could be assessed against plan participant accounts but that are only described at the investment fund level, perhaps in prospectuses or other securities documents or in a group annuity contract, none of which make finding (or interpreting) the information easy. For example, unless an employer knows the share class the plan owns, the employer cannot determine from a prospectus which expense ratio is accurate or what front-end, back-end or short term trading charges might apply to the participant's investment.
Clearly, plan sponsors need to coordinate with their vendors to determine whether the vendors will be preparing all of these disclosures for their review and final approval, sending those disclosures to participants, or posting the disclosures on a website and leaving it to the employer to approve and send the disclosures at the time and in the manner required by the rules.
Some types of arrangements will provide unique challenges under the disclosure rules. For example:
- Since the rules require enhanced disclosures with respect to annuities the plan might purchase, and since few individual account plans provide for annuity forms, those plans that have an annuity payment option may find it difficult to obtain all of the information required about annuities for general disclosure and therefore may want to consider eliminating an annuity option if legally allowed to do so.
- Plans with employer stock need to calculate (and continually update) total return figures similar to those regularly published for other investments. For privately-held stock, this data assembly will take an enormous amount of time.
- Plans that have managed accounts or allow
participant allocation among portfolios that an investment advisor constructs
from other investment funds have interpretative challenges—the rules were not
written with these types of arrangements in mind.
Good Faith Efforts
The new participant-level disclosure rules provide that plan sponsors will not be liable for reasonable good faith reliance on information received from plan service providers or investment advisors, but plan sponsors are responsible for the prudent selection and monitoring of plan investment options and service providers.