On the surface, it may seem like just another onerous, costly government drill: The Department of Labor’s new ERISA (Employee Retirement Income Security Act of 1974) 408(b) (2) disclosure rule. It mandates that 401(k) plan service providers and others furnish plan sponsors with highly detailed transparency disclosures, especially concerning fees—or face enforcement consequences.
But the impact of the new regulations could be market-changing for the entire 401(k) industry.
Though service providers have long been required to disclose fees to participants, many obscured them by burying what employees paid in opaque disclosures. To be sure, many plan sponsors and certainly the majority of participants have been unaware of any “hidden fees.”
Also see sidebar: “Public Impact.”
The new fee transparency regulation is based largely on a 2007 AARP study of 1,581 participants that found 83% of them unaware of how much they were paying in plan fees and expenses.
The onus of the new rule is chiefly on the extremely competitive service provider space, which for decades has sustained strong price pressure. The fee transparency requirements will only serve to increase that fierce competition.
“The new regulations opened the door for industry leaders to benefit by providing a more compelling case for doing business with them and for laggards to keep their plan sponsor clients in the dark.” So declares an in-depth study conducted by Dalbar, the Boston-based financial services consulting firm, which teamed up with Research to present its findings.
In the extensive study, Top Honors for recordkeepers went to BB&T Retirement and Institutional Services, Great-West Retirement Services, John Hancock Retirement Services, Fidelity Investments and TIAA-CREF Financial Services. The five ranked lowest were First Mercantile, Ascensus, The Guardian Insurance & Annuity Corp., Morgan Stanley (Nationwide) and last, MassMutual.
Fidelity’s disclosure stands out as one of the best in overall presentation by, for instance, using language that a typical plan sponsor would understand. It is apparent that the firm’s approach wasn’t merely to fulfill a paperwork obligation.
“We designed the disclosure to give us a competitive advantage. We’re using it to continue to obtain new business and retain the business we have,” says Krista D’Aloia, vice president-associate general counsel, Fidelity Investments, in Boston. “We tried to make it as intuitive as possible and provide things that aren’t required in order to make it a useful tool.”
The new regulatory regime, which went into effect July 2012, not only mandates transparent disclosures but requires plan sponsors to assess whether or not fees are reasonable for services provided.
Should they be judged unreasonable, plans must notify the provider. If the issue goes unresolved for 90 days, sponsors must then file complaints with the DOL and Internal Revenue Service.
Under the new regulations, enforcement is expected to become aggressive, a big change from the spotty activity of the past. Whistle-blowing is encouraged, and those not complying will be penalized. Sponsors are exempt from “regulatory action,” Dalbar notes, “merely by reporting service provider failures.” That can be conveniently accomplished via an online reporting system.
Based on the technical requirements of 408(b) (2), Dalbar’s Transparency Analysis evaluated and ranked recordkeepers and others according to parameters of: overall usefulness, cost estimates, description of services, fiduciary status and conflicts of interest.
Estimating fees that plans can anticipate paying is of course crucial to sponsors’ assessments. Recordkeepers that expressed estimated costs as an aggregate figure in dollars and showed the bottom line—“the best way to present cost estimates,” Dalbar says—include Principal Financial, TIAA-CREF and Charles Schwab & Co.
The new requirements are intended to protect investors by allowing employers to scrutinize fees on an apples-to-apples basis and help advisors recommend plans. Data drawn from many unconnected areas must be set forth in a single document and sent to the IRS, DOL and Pension Benefit Guarantee Corp., in addition to plan sponsors.
Participants as well as employees eligible to join plans are sent a different disclosure, not as detailed as the plan document but which puts greater focus on investments. (See sidebar “Public Impact.”)
The new regulation could have major impact on advisors, who “must help plan sponsors determine whether or not the fees are reasonable. We hope that when [plans] match up services with fees, they’re not just going to say, ‘Hey, cheaper is better!,’” says Sara Richman, vice president-product management, Great-West Retirement Services, which hired Dalbar to verify that its disclosure meets the new rule.
Joe Ready, executive vice president-director of Institutional Retirement and Trust at Wells Fargo, stresses that “assessing reasonableness is a big to-do for plan sponsors and/or the financial advisors that assist in the process.”
While the regs are forecast to result, over time, in a shift of service providers, such changes aren’t likely to occur at the initiation of plan sponsors themselves.
“They see the expanded powers as a burden that detracts from their primary business,” says Louis S. Harvey, Dalbar’s president-CEO. “But advisors will come knocking at the door, and regulators will soon follow. These forces will certainly lead to changing plans because of fees.”
He continues: “Becoming embroiled in a regulatory hassle holds little appeal for a human resources manager, benefits manager or CFO. Only concern over liability will force them to take steps to enforce the DOL regulations.”
So far, “there has not been a mass exodus” from providers, says Kevin Crain, head of institutional retirement and benefits services at Bank of America-Merrill Lynch, based in Hopewell, N.J. “But in two or three years you could see a pickup in activity of plans making provider changes.”
This means that sponsors will be relying more heavily on financial advisors to justify fees, and to compare and choose service providers.
ERISA’s 408(b) (2) has been years in the making. It was prompted partly by class action lawsuits against plan sponsors and service providers brought since 2006. These suits focused largely on revenue sharing. In the new disclosure requirements, revenue sharing is included under “Conflicts of Interest.”