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What Advisors Need to Know About New Disclosure Requirements
Wednesday, September 5, 2012
Partner Insights

The Employee Retirement Income Security Act (ERISA) requires plan sponsors and other plan fiduciaries to act prudently and solely in the interest of plan participants when selecting and monitoring service providers and plan investments. Service provider arrangements and compensation in employee benefit plans have become increasingly complex.

Despite improved efficiencies and reduced costs, this increased complexity has made it more difficult for plan sponsors and ERISA fiduciaries to understand how and how much compensation should be paid to service providers.

Accordingly, the U.S. Department of Labor (DOL) published final regulations under ERISA Section 408(b)(2) effective as of July 1, 2012, that require service providers, including investment advisors, to disclose detailed information about services and compensation, as well as possible conflicts of interest. The final regulations also require plan sponsors to assess services and compensation to determine reasonableness as well as actual or potential conflicts of interest that may affect service quality.

Service providers subject to the new disclosure requirement include ERISA fiduciary service providers, registered investment advisors, brokers, record-keepers, platform providers, and third-party administrators. Covered service providers may also include accountants, auditors, actuaries, custodians, lawyers, bankers, appraisers, consultants, and insurance agents who receive indirect compensation. ERISA requires that the payment of direct compensation to professionals be necessary and reasonable.

The required disclosures are of particular interest to 401(k) plan sponsors because these plans are primarily funded by employee contributions and plan costs are customarily charged to employee accounts. In addition, participants will be receiving a quarterly disclosure of fees and expenses actually deducted from their 401(k) accounts.

The DOL encourages, but doesn't require, the voluntary use of a sample guide or uniform format to assist plan sponsors in their review of the required disclosures. Plan sponsors will need to locate compensation information in multiple and complex documents, in a variety of formats, making it difficult for them to determine if they have enough information to determine reasonableness and assess actual or potential conflicts.

Professional Advisors

Many plan sponsors are unaware of their responsibilities as ERISA fiduciaries. Most are neither trained nor skilled to interpret vendor reports, monitor vendor services and fees, ask probing questions, and negotiate effectively on behalf of plan participants. Plan sponsors need to retain professional advisors to implement a strategy of compliance and procedural prudence to manage their plans.

ERISA permits a plan sponsor to use professional advisors and encourages the retention of experts to interpret service and fee disclosures. A plan sponsor will want to prudently investigate, document, and monitor all plan decisions. As a necessary corollary, ERISA permits plan sponsors to compensate professional advisors from plan assets. Plan sponsors are encouraged to retain a registered investment advisor to take advantage of ERISA's exculpatory relief provisions.

Section 408(b)(2) Audit

The DOL and the Internal Revenue Service have a long history of encouraging the self-audit of employee benefit plans and the self-correction of ERISA violations. A 408(b)(2) audit by an independent fiduciary provides a plan sponsor with an objective examination of vendor processes, performance, services, compensation, and conflicts.

Though a plan sponsor may conduct the audit with in-house staff, outsourcing the audit permits the independent fiduciary, rather than the financial manager or human resource manager, to assume responsibility for ensuring that the plan sponsor complies with the final regulations and properly interprets the disclosures.

Plan sponsors will want to corroborate the compensation paid to key service providers set forth in Schedule C, made part of the Annual Report Form 5500, with the disclosure of compensation paid to covered service providers under the final regulations. Disclosures aren't required for agents who earn commissions from the sales of annuities but provide no consulting services. Accordingly, plan sponsors will want to conduct due diligence and go beyond the scope of the final regulations.

Independent Named Fiduciary Structure

An investment advisor who assumes no discretion under ERISA offers limited value to a plan sponsor who wishes to delegate fiduciary and decision making responsibility. Such an advisor is not an ERISA fiduciary for any other plan purpose. A limited-scope fiduciary may not accept a delegation of fiduciary responsibility from the plan sponsor for matters other than investment advice.

The plan sponsor should appoint a full-scope ERISA Section 3(21) investment advisor who is therefore an ERISA Section 3(38) investment manager to select, monitor and replace investment options, as well as hire and monitor other investment related service providers. The plan sponsor should also appoint an ERISA Section 3(16) Plan Administrator to select, monitor and replace service providers.

Plan Sponsor Fiduciary Duties

(1) Comment
Just more typical big government. I wrote this in response to a Finra article. Just take out Finra and insert DOL:

There are several issues with Finra that need to be addressed. One seems to be the over burdensome regulations they keep layering on top of one another. The most recent being the new suitability rules. What I love about these new rules is that when you look at the executives of Finra they are either what appears to be lawyers who couldn't handle lawyering or ex-government regulators. What that tells me is that none of those people have any real world experience when it comes to dealing with the people that matter, the clients. All you seem to see now is Finra pushing more regs in order to justify their fees, fines and existence. More regs means more fines. So based on their lack of apparent ability to run their own business efficiently, they are going to try and live off the backs of real people in the real world doing real work. And they will say that they exist to protect the clients and that is why they are needed. Here is the problem; neither Finra nor any other regulator will be able to protect all clients. Reason being is pretty simple. If someone is intent on defrauding someone, they will find a way to do it. What Finra cant regulate is the human element. No one can regulate the human element. As a former police officer myself, I know that there are thousands of laws telling us what we can not do. But do you think Robber really cares about some words written on a piece of paper telling him he can't rob someone? Madoff knew the rules and do you think he cared? The answer in both of those situations is, obviously not. Rules and regs do not mean anything to those people. The regs now are only hampering good reps from efficiently helping their clients. We do not need more made up rules so Finra can levy more fines, so they can stay afloat. I mean that is really what it comes down, Finra needs revenue to stay viable. For a quasi "private non-profit organization" that Finra is supposed to be, I find it interesting that they have an investment account and 13 people making over $1,000,000 a year each in comp. So now when I see that, it seems that they are upping their fees and fines in a more self serving manner. Which again either way you look at it, it is about the money. I am very disappointed in the broker/dealer community. I would have thought that the larger houses would have come together, go to Finra and to the SEC about Finra and say enough is enough. Quite frankly, the B/D's know the rules and can enforce the rules on their on reps, so why do we really need Finra anymore? The B/D's of today should maybe be able to police themselves. They all have a team of lawyers that can interpret rules. They all know right from wrong. Like with any business there are going to be a couple bad apples and that you can not stop.

Posted by J H | Wednesday, September 05 2012 at 2:08PM ET
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