4140 / What are the general (or “initial”) required 408(b)(2) disclosures?
All covered service providers must provide certain general disclosures that are referred to in the regulations as the “initial disclosures.” There are four categories of initial disclosures. These disclosures are provided to a responsible plan fiduciary. There also are three classes of covered services requiring certain additional disclosures.
The four disclosures required of all covered service providers are a description of services provided, fiduciary status, compensation, and a description of how the compensation will be received.
(1) The first disclosure is a description of the services to be provided to the plan pursuant to the contract or arrangement. The regulations provide no bright line guidance other than that the description should be sufficient for the responsible plan fiduciary to understand what is to be done so that the responsible plan fiduciary can evaluate the reasonableness of the arrangement’s fees and services.
(2) The second disclosure is fiduciary status. If applicable, the disclosure must state whether the service provider will provide or expects to provide services as a fiduciary. This notice is required if the services are to be provided directly to a plan or to an investment or entity in which the plan has a direct investment. A separate, additional statement is required if a provider expects to provide services directly to a plan as an investment advisor registered under either the Investment Advisors Act of 1940 or any state law.1
Planning Point: There have been several appeals court decisions on breach-of-fiduciary-duty lawsuits relating to fees paid by a plan. In some of the cases, the court looked to the agreements between the service provider and the plan to help determine if the service provider was a fiduciary. Almost all agreements today between service providers and plans have statements where the responsible plan fiduciary recognizes that the service provider is not a fiduciary to the plan. In at least one lawsuit involving a covered service provider, the court relied in part on that statement to dismiss the suit. In light of that, individuals and service organizations not acting in a fiduciary role generally will want to include in the contractual arrangement a statement that they are not acting as fiduciaries. Where a service organization is acting as a fiduciary, the disclosures in these regulations are required, including a statement that the service provider is a fiduciary.
(3) The third disclosure is a statement that describes all of the compensation the service provider expects to receive as either direct compensation, indirect compensation, compensation paid among related parties, or compensation payable on termination of the arrangement. For purposes of meeting this threshold, compensation is defined to mean anything of monetary value. A de minimis exception applies to non-monetary items of $250 or less received during the term of the contract or arrangement, and to total payments including direct and indirect compensation of less than $1,000.
Certain disclosures are required of specific types of compensation as described below.
With respect to direct compensation, the disclosure must describe all direct compensation, either in the aggregate or by service that the service provider reasonably expects to receive. In general, direct payments include payments made directly from a plan to a service provider in any form.
With respect to indirect compensation, the disclosure must describe the indirect compensation that the service provider expects to receive. This includes both an identification of the services for which the indirect compensation will be received and the identification of the payer of the indirect compensation. Indirect compensation is compensation that is received from any source other than the plan, the plan sponsor, the covered service provider, an affiliate of the service provider, or a subcontractor of the covered service provider.
With respect to compensation paid among related parties, the disclosure must describe all compensation that will be paid to the service provider or an affiliate or subcontractor if it is set on a transaction basis or charged directly against the plan’s investments and reflected in the net value of the investments (for example, 12b-1 fees). Compensation paid on a transaction basis includes commissions, soft dollars, finder’s fees, or other similar incentive compensation based on business placed or retained. This description must include an identification of the services for which such compensation will be paid and identification of the payers and recipients of such compensation. The latter must include the status of a payer or recipient as an affiliate or a subcontractor.
Bundled providers that provide multiple services under one arrangement will be able to disclose their revenues on a bundled, or aggregate, basis. As described below, however, if a service provider agreement includes recordkeeping as part of its bundled services and the expected cost of those services is not part of the disclosure agreement, additional disclosures must be made, including a good faith estimate of the explicit cost to provide those services and a description of how that estimate was developed.
With respect to termination compensation, the disclosure must describe any compensation that the service provider reasonably expects to receive in connection with termination of the contract or arrangement. The statement must include a description of how any prepaid amounts will be calculated and refunded on termination. The regulations go on to say that “[a] provision that reasonably compensates the service provider for loss of early termination of the contract is not a penalty.”
Planning Point: At the end of the regulations is a statement that “no contract or agreement is reasonable within the meaning of ERISA [S]ections 408(b)(2) and DOL regulations 2550.408b-2(a)(2) if it does not permit termination by the plan without penalty to the plan on reasonably short notice under the circumstances to prevent the plan from becoming locked into an arrangement that has become disadvantageous.” These provisions could have a significant impact on certain insurance contracts and mutual funds that impose back end charges that are triggered on termination or early sale of an investment. Look for additional guidance on the application of this component of the regulations.
(4) The fourth disclosure is a description of how the expected compensation will be received by the service provider. For example, the disclosure must explain whether revenues will be billed directly to the plan, whether amounts will be deducted directly from the plan’s investments, or whether the service provider will impose a basis point charge on assets under its direction.