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Regulation and Compliance > Federal Regulation > DOL

Time’s Up on DOL’s 408(b)(2) Deadline

By Melanie Waddell

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The July 1 compliance date for the Department of Labor’s (DOL) final 408(b)(2) fee disclosure rule has finally arrived, and even though the final rule was a long time coming, covered service providers have been ramping up their compliance efforts for months.

The final rule on 401(k) fee disclosures requires service providers to furnish information that will enable pension plan fiduciaries to determine both the reasonableness of compensation paid to service providers and any conflicts of interest that may affect a service provider’s performance under a service contract or arrangement.

When the final rule was released on March 1, Phyllis Borzi, assistant secretary for DOL’s Employee Benefits Security Administration (EBSA), said that with the final 408(b)(2) rule, businesses that sponsor retirement plans as well as the workers who participate in those plans will now be able to “get better information on associated fees and expenses,” allowing them “to shop around and make informed decisions that will lead to cost savings and a larger nest egg at retirement.”

Borzi warned, however, that service providers not in compliance as of July 1 will be in violation of the Employee Retirement Income Security Act’s (ERISA) prohibited transaction rules and subject to penalties under the Internal Revenue Code.

The 408(b)(2) regulation applies to “covered plans,” that is, all ERISA-governed retirement plans other than SEP IRAs and SIMPLE IRAs. Individual retirement accounts are also excluded. All 401(k) plans, ERISA-covered 403(b) plans, defined benefit pension plans and profit sharing plans are subject to the regulation.

“408(b)(2) imposes a legal obligation on service providers that was always expected to be met since ERISA was passed,” says David Witz, managing director of Fiduciary Risk Assessment (FRA)/PlanTools. However, “failure to meet the historic expectation [under 408(b)(2)] is due in large part [to] a lack of enforcement.”

Under 408(b)(2), Witz explains in a recent PlanTools white paper on the topic, covered service providers (CSP) will be required to deliver a written disclosure to the responsible plan fiduciary of their status as a fiduciary, the services they will render, fees charged for services rendered and a description of the arrangement between the payer and the CSP.

Once this information is received, the fiduciary has an obligation to:

  • Read the disclosures
  • Determine if there are conflicts of interest
  • Determine if fees are reasonable
  • Determine if the disclosures meet the 408(b)(2) regulatory requirements

All may go smoothly come July 2. However, Witz points to three reasons why a fiduciary may find that on July 2 they are busy preparing three written requests for information from their CSP. They include:

  • The CSP failed to provide any disclosures.
  • The CSP provided incomplete disclosures.
  • Additional information is necessary to determine if the contract or arrangement is prudent and conflict free.

To clarify areas where plan administrators and service providers needed help, EBSA issued in early May guidance to help them comply with the requirements of new rules 408(b)2 and 404(a)5, EBSA’s final regulation on conflicted investment advice to plan participants, which becomes effective in September.

The guidance—Field Assistance Bulletin No. 2012-02—included a set of frequently asked questions and answers. At press time in late May, a DOL spokesman told Investment Advisor that another set of guidance—which would focus more closely on just 408(b)(2)—would be out before the July 1 compliance date.

Craig Hoffman, general counsel and director of regulatory affairs for the American Society of Pension Professionals and Actuaries (ASPPA), told DOL in a recent comment letter that the Department needed to clarify the proper treatment of asset allocation strategies under the new rules—408(b)(2) and 404(a)—and a transitional period of relief was needed for practitioners and plan sponsors as they move forward with the implementation process.

Some transitional relief was provided in the guidance DOL issued in its early May Field Assistance Bulletin, Hoffman says, however ASPPA would have liked it to be “stronger.” DOL said in its Bulletin that while “further broad-based extensions” for compliance with both rules are not needed, for enforcement purposes, the Department will take into account whether covered service providers and plan administrators “have acted in good faith based on a reasonable interpretation of the new regulations. If they have acted in good faith based on a reasonable interpretation of the new regulations, enforcement actions generally would be unnecessary if the covered service provider or plan administrator, as applicable, also establishes a plan for complying with the requirements of this Bulletin in future disclosures.”

Hoffman questions what the DOL means by stating that “enforcement actions generally would be unnecessary” if the provider or plan administrator has acted in good faith. “There’s a lot of equivocation in that sentence,” he says. “What does ‘generally’ mean?”

While the guidance provided much needed assistance, to the surprise of many it also ushered in a new requirement involving brokerage windows. “The DOL has chartered some very new ground on brokerage windows that nobody expected,” Hoffman says. What the DOL essentially says in its Field Assistance Bulletin is that if a “plan offers only a brokerage window or similar arrangement then the plan fiduciary may be obligated to monitor the investments that are selected through the brokerage window by participants and beneficiaries and potentially treat it as a designated investment alternative.”

Indeed, while industry officials applaud DOL’s fee disclosure rules, they also cite the myriad challenges that the rules bring.

Witz with PlanTools says that 408(b)(2) creates the biggest challenge for BDs that receive non-monetary compensation. “Many [BDs] are struggling with the ability to capture all the data to allocate the non-monetary [compensation] accurately to retirement plan assets,” he says. “Few BDs have the technology in place to address this and will most likely fail to be ready by July 1. At best, they can disclose what they have and make a correction to it within 90 days to avoid being reported to the DOL.”

Fred Reish, partner and chair of the financial services ERISA team at Drinker Biddle & Reath in Los Angeles, issued several alerts with his colleagues regarding potential impacts of the fee disclosure rules. In an alert focusing on registered investment advisors, Reish and his partners note that the final 408(b)(2) rule raises two issues which may come as a surprise to RIAs.

First is that asset allocation models may be treated as designated investment alternatives (DIAs), resulting in a number of disclosure requirements (both under 408(b)(2) and the participant disclosure regulation), he says.

Second, Reish says, is that DOL has interpreted “indirect compensation” very broadly in a way that could require additional disclosures from RIAs. “That would apply, for example, where investment providers (like mutual funds) or service providers (like independent recordkeepers or bundled providers) provide financial assistance to RIAs,” he says. “One specific example would be a conference put on by an RIA for its plan sponsor clients. Another example would be where an investment provider or a service provider offers ‘free’ services to RIAs for their plan sponsor clients.”

Reish and his colleagues note in other alerts on 408(b)(2) their concern about the lack of awareness of discretionary investment managers concerning 408(b)(2) disclosures, and 408(b)(2) disclosures by advisors who refer investment managers and receive solicitor’s fees.

As Reish explains, it’s common that when an advisor refers an investment manager to an ERISA plan, the advisor will receive a referral fee, which is called a solicitor’s fee. In most cases, he says, “the advisor will receive a fee for the referral that often continues so long as the plan uses the investment manager. Under the securities laws, the advisor provides a solicitor’s fee disclosure statement to the investors.”

From an ERISA perspective, Reish continues, “the advisor has provided a service to the plan and, interpreting the 408(b)(2) regulation, the advisor has become a ‘covered service provider’ for two reasons.”

First, “in making the referral, the advisor, both the firm and the individual, are acting as a registered investment advisor and as a representative of the RIA, respectively,” he says. “An RIA that provides services directly to a plan is a covered service provider.”

In addition, he says, “it appears that the advisor has provided consulting services (that is, consulting on the selection of service providers) and has received indirect compensation from the investment manager (that is, the solicitor’s fee). If that is the case, the advisor is considered to be a covered service provider.”

No doubt service providers and plan administrators can expect other compliance-related issues concerning 408(b)(2) and 404(a) to surface long past the rules’ compliance dates. Reish with Drinker Biddle says he worries about some types of services providers’ non-compliance more than others.

While 408(b)2 primarily impacts 401(k) recordkeepers, broker-dealers and registered investment advisors, Reish says, the business model of RIAs is more straightforward than the other two because generally there is no indirect compensation. As a result, he says, “advisors who are focused on retirement plans and, therefore, are aware of the 408(b)(2) requirements, have by and large completed their preparation of the documents and disclosures and will be distributing them” before July 1. However, Reish says he worries that “the ‘occasional’ RIA who provides services to a limited number of plans may not be aware of these new requirements and may, therefore, inadvertently have their relationships with ERISA plans converted to prohibited transactions on July 1.”

The disclosures for recordkeepers, Reish explains, are complex, because of the indirect compensation and because of the services that they provide to ERISA plans. However, he says, “recordkeepers are, by definition, focused on ERISA retirement plans. As a result, they—more than any other type of service provider—have been working on these disclosures for years. I expect that recordkeepers will universally be in compliance by July 1.”

For broker-dealers, Reish says, the issues are more complex. “For example, they receive the greatest variety of forms of indirect compensation […] and some of those are difficult to identify and quantify.” Also, “some broker-dealers have difficulty even identifying all of their ERISA plan customers. As a result, I am concerned that some broker-dealers—and particularly the smaller ones—will inadvertently fail to make the disclosures to some of their ERISA plan customers.”

Another concern, he says, is that “some of the less obvious forms of compensation will not be disclosed. That could include, for example, transactional compensation paid to subcontractors and indirect compensation, such as revenue sharing from other service providers [or] investments.”

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