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5500 Preparer's Manual for 2012 Plan Years

5500 Preparer's Manual for 2012 Plan Years
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CCH® PENSION AND BENEFITS — 8/4/08

Proposed DOL regs would require enhanced disclosure to 401(k) plan participants

The Department of Labor’s Employee Benefits Security Administration has issued proposed regulations that would require employers and plan administrators, in satisfaction of their fiduciary duties under ERISA, to provide (on generally an annual basis) participants and beneficiaries in participant-directed plans with plan and investment-related information, including details of fees and expenses assessed to their individual accounts. The proposed rules, which, when finalized, would apply to plan years beginning on or after January 1, 2009, would specifically require the disclosure of investment-related fee and expense information (e.g., sales loads, deferred sales charges, redemption fees, service charges, exchange fees, account fees, purchase fees, and the expense ratio for the total operating expenses of the investment) to be made in a chart or similar format that would allow for a comparison of the plan’s investment options. The DOL has provided a model chart for this purpose.

The proposed rules would effectively extend the disclosure requirements applicable to ERISA §404(c) plans to all 401(k) plans. Thus, the proposed rules represent an effort by the DOL to impose a uniform disclosure framework for all participant-directed individual account plans. However, the proposed rules would not expand ERISA or the governing regulations under ERISA §404(c) to explicitly require the disclosure of revenue sharing arrangements.

Written comments on the proposed regulations must be received by the DOL on or before September 8, 2008.

Fiduciary duty to provide information sufficient to enable informed investment decisions

The proposed regulations are premised on the position of the DOL that fiduciaries under plans that allocate investment responsibilities to participants and beneficiaries have a duty under ERISA §404(a) (1)(A) and (B) to ensure that participants and beneficiaries, on a regular and periodic basis, are made aware of their rights and responsibilities with respect to the investment of assets held in or contributed to their accounts. In satisfaction of this obligation, fiduciaries must provide participants and beneficiaries with sufficient information regarding the plan (including plan fees and expenses) and designated investment alternatives available under the plan (including attendant fees and expenses) to enable them to make informed decisions with respect to the management and investment of their individual accounts.

However, currently many fees remain hidden because, while plan sponsors must provide participants with summary plan descriptions, account statements, and summary annual reports, ERISA does not require these documents to include information on the fees incurred by individual participants. In addition, plan sponsors often provide fee information in a piecemeal fashion or in a way that makes a comparison of fees among investment options difficult. Particularly problematic is the fact that employers, other than sponsors of ERISA §404(c) plans, are not required to provide expense ratios to participants, although such fee measures are an efficient means of comparing fees among investment options.

The proposed regulations represent a balanced effort by the DOL to address the issue of hidden fees and inadequate disclosure of plan and investment related information, while not imposing onerous and expensive reporting requirements on plan administrators. Compliance with the proposed rules would enable fiduciaries who provide specific plan-related information and investment-related information at the required time and in the prescribed format to comply with the fiduciary duty to make regular and periodic disclosures, while also preserving participants’ retirement accounts from potentially substantial erosion caused by excessive fees.

Plan-related information

The proposed rules would require disclosure of three types of plan-related information.

General plan information. Fiduciaries would need to inform participants and beneficiaries of: the procedures for giving investment instructions; limitations applicable to investment instructions, including restrictions on the transfer to or from a designated investment alternative; procedures for the exercise of voting, tender, and similar rights with respect to a designated investment alternative (including restrictions on those rights); the specific designated investment alternatives offered under the plan; and any designated investment managers to whom participants and beneficiaries may give investment instructions.

The general plan information would need to be furnished to an individual on or before the date of eligibility and on an annual basis thereafter. However, participants and beneficiaries could be provided with a description of any material changes to the required information within 30 days after the adoption date of the changes. The disclosures could be incorporated into the plan’s summary plan description. However, the applicable timing requirements would still need to be met.

Administrative expenses. Participants and beneficiaries would need to be furnished with an explanation of any fees and expenses assessed for plan administrative services (e.g., legal, accounting, and recordkeeping) that may be charged against their individual accounts. Participants would further need to be informed as to whether the charges would be allocated to, or affect the balance of, their individual accounts, on a pro rata or a per capita basis.

This requirement is designed to ensure disclosure of the day-to-day operational expenses of the plan that are charged against a participant’s individual account. Accordingly, fees and expenses included in the disclosure of investment fees and expenses (see below) would not also need to be reported as administrative expenses.

The general description of a plan’s administrative expenses would need to be made on or before the date of participant eligibility and at least annually thereafter. The information could also be included as part of the plan’s SPD, if the applicable timing rules were met. However, participants and beneficiaries would need to be furnished with: (1) a quarterly statement of the dollar amounts actually charged during the preceding quarter to the participant’s or beneficiary’s account for administrative services, and (2) a general description of the services to which the charges relate.

The statement would need to be sufficiently specific to enable participants and beneficiaries to distinguish the administrative services from other charges and services that may be assessed against their accounts. However, the statement could identify only the total administrative fees and expenses assessed during the quarter, and need not include a break down of the administrative charges on a service-by-service basis. The required information could be incorporated into the quarterly benefit statement required under ERISA §105(a)(1).

Individual expenses. Participants and beneficiaries would need to be provided (upon plan eligibility and annually thereafter) with information relating to expenses that may be assessed on an individual, rather than on a plan-wide basis. Accordingly, participants would need to be informed of expenses that may be incurred incident to obtaining qualified domestic relations orders, plan loans, or investment advice services. In addition to the annual disclosure of expenses that might be charged to an individual account, fiduciaries would need to provide a quarterly statement that (a) discloses the amount actually assessed to the account and (b) identifies the service to which the expense relates.

Investment-related information

On or before the date of eligibility, and at least annually thereafter, participants and beneficiaries would need to be furnished with basic information regarding each designated investment alternative offered under the plan. A designated investment alternative, for purposes of the proposed regulations, does not include brokerage windows, self-directed brokerage accounts, or similar arrangements that allow participants and beneficiaries to select investments beyond those designated by the plan.

Information that would need to be disclosed for each investment alternative would include: the name of the investment, the type of investment (e.g., money market, mutual fund, balanced fund, index fund), form of management (i.e., active or passive), and an Internet Web site address that would allow participants and beneficiaries to find supplemental information about the option (e.g., principal strategies, risks, performance, and costs).

The specific performance data that must be disclosed varies depending on whether the designated investment alternative provides a fixed return (e.g., guaranteed investment contract) or does not offer a fixed return (e.g., equity index fund). With respect to investment alternatives that do not provide a fixed return, the fiduciary would need to disclose the average annual total return (expressed as percentage) of the investment for 1-year, 5-year, and 10-year periods (as applicable), measured as of the end of the calendar year. The disclosure would further need to include a statement cautioning participants that the investment’s past performance is not necessarily indicative of the investment’s future performance. With respect to investment alternatives for which the return is fixed for term of the investment, the fiduciary would be required to disclose the fixed rate of return and the term of the investment.

In providing performance data for an investment alternative that does not provide a fixed return, the fiduciary would also need to provide performance data for an appropriate broad-based benchmark (i.e., securities market index) over the 1, 5, and 10-year time periods. The securities market index selected as a benchmark, however, could not be administered by an affiliate of the investment provider, its investment adviser, or a principal underwriter, unless the index was widely recognized and used.

Fee and expense disclosures

The centerpiece of the proposed regulations are the rules governing the disclosure of fees and expenses that arise attendant to the purchase, holding, and sale of each of the plan’s designated investment alternatives. Note, more comprehensive disclosure requirements would apply to investment alternatives for which the return is not fixed. According to the DOL, because fees are factored into the contractual interest rate under an investment alternative that provides a fixed return, the additional fee disclosure requirements that apply to investments that do not provide a fixed return would be little additional benefit to participants.

A fiduciary would need to disclose for each designated investment alternative for which a return is not fixed:

(1) the amount and a description of each shareholder-type fee (i.e., fees charged directly against a participant’s; or beneficiary’s investment), such as sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, purchase fees, and mortality and expense fees;

(2) total annual operating expenses of the investment expressed as a percentage (e.g., expense ratio);

(3) a statement indicating that fees and expenses are only one of several factors that participants and beneficiaries should consider when making investment decisions.

Fiduciaries would also need to disclose, with respect to investment alternatives that provide a fixed return, the amount and description of any shareholder-type fee that may apply to a purchase, transfer, or withdrawal of the investment in whole or in part.

The required information would generally need to be provided to participants and beneficiaries on or before the date of eligibility. Plan fiduciaries would be able, however, to provide participants with the most recent annual disclosures furnished to participants and beneficiaries, in addition to any material changes to the information. Thus, fiduciaries would not need to update the required disclosures for each new plan participant.

Disclosure in chart or similar format. Much of the information that would need to be disclosed under the proposed regulations is currently required of ERISA §404(c) compliant plans. However, the rules implementing ERISA §404(c) do not require investment-related information to be provided in a comparative format that allows for a review of investment options by participants and beneficiaries. By contrast, the proposed regulations under ERISA §404(a) would require the specified investment-related information to be furnished in a chart or similar format that is designed to facilitate a comparison of the information provided for each designated investment alternative under the plan. The chart or similar document would also be required to include a statement informing participants and beneficiaries that more current information (i.e., fee, expense, and performance information) may be available on the Web site for the investment alternative. The fiduciary could provide additional information that would allow for comparisons of investment options, as long as the information was not inaccurate or misleading.

Model disclosure form. The DOL has developed a model disclosure form that may be used by fiduciaries to satisfy the proposed disclosure requirements. However, the model form would not be the exclusive means by which the required information could be provided in a comparative form. The DOL also cautions fiduciaries of their responsibility to ensure that the information contained in the disclosure statement is complete and accurate. Fiduciaries, however, would not be liable for good faith reliance on information furnished by service providers with respect to the required disclosures.

Information to be provided on request

Fiduciaries would be required, upon the request of a participant or beneficiary (or upon plan eligibility and annually thereafter) to provide other investment-related documents, including: copies of prospectuses (or summary prospectuses (in a SEC-approved form)); copies of financial statements or reports; a statement of the value of a share or unit of each designated investment alternative (including the valuation date); and a list of the assets comprising the portfolio of an investment alternative and the value of each asset or its proportion in the total portfolio.

Duty to prudently select and monitor service providers

The proposed regulations under ERISA §404(a) stress the DOL position that a fiduciary in compliance with the proposed disclosure requirements remains subject to a duty under ERISA to prudently select and monitor providers of services to the plan or designated investment alternatives under the plan. Similarly, the DOL has proposed an amendment to ERISA Reg. §2550.404c-1 , emphasizing that compliance with ERISA §404(c) does not relieve a fiduciary of the duty to prudently select and monitor a designated investment manager or designated investment alternative under the plan. The amendment reflects the DOL view that ERISA §404(c) does not shield a fiduciary from liability for an investment loss incurred in connection with the plan’s selection of a designated investment alternative because the loss is not the result of the participant’s or beneficiary’s exercise of control.

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