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5500 Preparer's Manual for 2012 Plan Years

5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.


DOL proposed regs require service providers to furnish detailed fee disclosures to plan fiduciaries

The Department of Labor’s Employee Benefits Security Administration has issued proposed regulations that are designed to provide plan fiduciaries with sufficient information to evaluate the reasonableness of compensation and fees directly and indirectly paid to certain service providers (including affiliates), and assess the potential for conflicts of interest that may affect the performance of a service provider. A service contract or arrangement would not be reasonable, for purposes of the prohibited transaction exemption authorized under ERISA for necessary plan services, unless its terms specifically required compliance by a designated service provider (including fiduciary service providers, banks, consultants, investment providers, and third party administrators) with a series of new disclosure requirements.

Absent compliance by the service provider with the disclosure requirements, both at the time the agreement was entered into and on a continuing basis, the plan fiduciary would be subject to liability for engaging in a prohibited transaction. However, concurrent with the proposed regulations, the DOL has issued a Proposed Prohibited Transaction Class Exemption that would relieve a fiduciary of liability for a prohibited transaction resulting from a service provider’s failure to comply with the notice requirements. The fiduciary may not have had knowledge of the service provider’s compliance failure and would be required to take actions upon discovering the failure, including possible notification of the DOL.

The proposed rules will not apply until 90 days after they are issued in final form. The requirements may be modified following what may prove to be a rather lively comment period. Written comments on the proposed regulations and the Proposed Class Exemption must be received by the DOL on or before February 11, 2008.

ERISA 408(b)(2) allows the fiduciary of an ERISA employee benefit plan to make “reasonable” contracts or arrangements with a party in interest for the performance of services necessary for the establishment and operation of the plan. However, in order for this exemption from the generally applicable prohibited transaction rules to apply, no more than reasonable compensation may be provided for the services.

In addition, the exemption will not apply to transactions that involve a conflict of interest on the part of fiduciaries. Specifically, a fiduciary may not use its authority, control, or responsibility over and for plan assets to cause the plan to enter into a transaction involving the provision of services if it has an interest in the transaction that may affect the exercise of its best judgment as a fiduciary.

The governing regulations do not currently define a “reasonable contract or arrangement” generally beyond stating that no contract or arrangement may be reasonable, for purposes of the PT exemption, unless it permits termination of the arrangement 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.” The proposed regulations would retain the termination provision, but further condition the exemption authorized for a reasonable contract or arrangement for necessary services on compliance by certain service providers with specified disclosure requirements regarding compensation and fees and potential conflicts of interest.

Covered service providers

Not every entity providing services to the plan would be covered by the new rules. Accordingly, the threshold determination under the proposed rules would be whether a service provider is subject to the disclosure requirements.

The proposed regulations would designate the following three categories of service providers as being subject to the disclosure requirements.

  1. Service providers who provide services to the plan as a fiduciary under ERISA 3(21) or under the Investment Advisers Act of 1940.
  2. Service providers who provide or may provide banking, consulting, custodial, insurance, investment advisory (to the plan or participants), investment management, recordkeeping, securities or other investment brokerage, or third party administration services.
  3. Service providers who receive or may receive indirect compensation or fees in connection with accounting, appraisal, auditing, legal or valuation services provided to the plan pursuant to the contract or arrangement.

CCH Note: The proposed disclosure requirements apply only to the enumerated service providers. However, the DOL cautions plan fiduciaries that they must continue to satisfy their general fiduciary obligations to prudently select and monitor all service providers. Accordingly, a plan fiduciary may need to obtain and consider “appropriate disclosures” prior to contracting with service providers who do not fall within the specified categories. The DOL seems to be suggesting that an “appropriate disclosure” would provide information similar to that required under the proposed rules.

Provide disclosures with written document

In the event the service provider is subject to the disclosure rules, the service contract or arrangement must be set forth in writing. The terms of the contract or arrangement (including an extension or renewal of the contract or arrangement) must specifically require the service provider to comply in writing with the disclosure requirements. In addition, the written contract or arrangement would need to include a representation by the service provider that, before the contract was entered into (or extended or renewed) all required information was provided to the plan fiduciary with the authority to cause the plan to enter into (or extend or renew) the contact (i.e., the “responsible plan fiduciary”).

CCH Note: The proposed rules would require the information to be provided to the responsible plan fiduciary, and not directly to plan participants or beneficiaries. However, the DOL has indicated that it will be releasing guidance under ERISA 404(c) governing disclosures that must be made by plans (but not service providers) to participants, early in 2008.

Incorporation by reference. The DOL explains that not all of the required disclosures need to be contained in the same document, as long as all of the specified information is presented to the responsible plan fiduciary in writing before the fi duciary enters into the service contract. Thus, written disclosures may be provided in separate documents from separate sources. For example, information contained in a prospectus or in a Form ADV filed by a registered investment adviser may be incorporated by reference in a written disclosure by a service provider.

The DOL also advises that the disclosures may be provided in an electronic format.

Disclosure of services provided

The service provider would be required to disclose all services to be provided to the plan pursuant to the contract or arrangement. The service provider would further need to describe the services to be performed, regardless of whether the services were specifically incorporated in the applicable scope provision of the proposed regulations. Thus, a consultant would need to disclose appraisal or legal services that it would provide in addition to consultant services.

Disclosure of compensation and fees

The primary focus of the proposed rules is on highlighting the compensation or fees received by service providers and their affiliates in connection with service providers to the plan.

Compensation or fees would be expansively defined to include “money or any other thing of monetary value,” received or to be received directly from the plan or plan sponsor, or indirectly (i.e., from a source other than the plan, plan sponsor, or service provider) by the service provider or its affiliate in connection with services to be provided under the contract or arrangement or because of the position of the service provider or affiliate with the plan. Items of monetary value that would need to be disclosed include: gifts, awards, trips for employees, research, fi nder’s fees, placement fees, commissions or other fees related to investment products, sub-transfer agency fees, shareholder servicing fees, Rule 12b-1 fees, soft dollar payments, fl oat income, fees deducted from investment returns, fees based on a share of gain or appreciation of plan assets, and fees based on a percentage of plan assets.

Format for disclosing compensation. Compensation or fees may be expressed in monetary terms. Alternatively, if a service provider cannot furnish a specific monetary amount, it may disclose compensation or fees by using a formula, a percentage of the plan’s assets, or a per capita charge for each plan participant or beneficiary. However, the compensation or fees must be described in a manner and with sufficient detail (e.g., by disclosing assumptions used in a formula) that will allow the responsible plan fiduciary to determine whether the fees are reasonable.

Disclosure under bundled service arrangements

In the event a service provider offers a bundle of services (either directly or through affiliates or subcontractors) to the plan that are priced as a package, only the provider offering the bundle would be required to make the service and compensation disclosures. The bundled service provider would need to disclose all service providers in the bundle, as well as the aggregate direct compensation or fees to be paid for the bundle and the indirect compensation to be received by the provider (or its affiliate and subcontractors) from third parties.

A bundled service provider would not generally be required to disclose the allocation of revenue sharing and other payments among affiliates or subcontractors within the bundle. However, a service provider would be required to separately disclose the compensation or fees of any party providing services under the bundle for which a separate fee is assessed that is: (1) charged directly against the plan’s investments reflected in the net value of the investment (e.g., management fees paid by mutual funds to investment advisers and float revenue), or (2) set on a transaction basis (e.g., finder’s fees, brokerage commissions, or soft dollars (research or other products or services other than execution in connection with securities transactions). Note, compensation or fees that are charged on a transaction basis would need to be separately disclosed even if they were paid from mutual fund fees or similar fees.

Payment arrangements

The service provider would be required to describe the manner in which compensation or fees are to be received. Accordingly, the service provider would need to disclose whether it will: bill the plan, deduct fees directly from plan accounts, or reflect a charge against the plan investment. In addition, the service provider would need to explain how pre-paid fees would be calculated and refunded in the event the contract or arrangement is terminated.

Disclosure of conflicts of interest

In addition to services and compensation, the service provider would be required to disclose specific information that is intended to enable the responsible plan fiduciary to assess any real or potential conflicts of interest. Initially, the service provider would need to indicate whether it (or an affiliate) will provide any services to the plan as a fiduciary under ERISA or the Investment Advisers Act of 1940.

The service provider would next be required to disclose whether it (or any affiliate) is expected to participate in, or otherwise acquire a financial or other interest in, any transaction to be entered into by the plan in connection with the contract. The transaction and the service provider’s participation and interest therein would need to be detailed.

A service provider, under a reasonable contract or arrangement, would need to further disclose any material financial, referral or other relationship or arrangement with a money manager, broker, other client of the service provider, other service provider to the plan, or other entity that “creates or may create’’ a conflict of interest for the service provider in performing services under the contract.

The service provider must disclose whether it (or an affiliate) will be able to affect its own compensation or fees, without the prior approval of an independent plan fiduciary. For example, the service provider would need to describe the circumstances under which it would receive incentive, performance-based, float, or other contingent compensation.

Finally, the service provider would need to explain any policies or procedures it may have in place to address actual or potential conflicts of interest. Thus, for example, a service provider would need to describe any procedure for offsetting fees received from third parties (through revenue sharing or other indirect payment arrangements) against the amount that would otherwise be charged to the plan account.

Material changes to disclosed information

The terms of the service contract would need to require a service provider to disclose to the responsible plan fiduciary any material changes to a required disclosure. A change in previously provided information would need to be disclosed if it would be viewed by a reasonable plan fiduciary as “significantly altering the total mix of information made available to the fiduciary, or as significantly affecting a reasonable plan fiduciary’s decision to hire or retain the service provider.”

The service contract must specifically require the service provider to notify plan fiduciaries of such material changes no later than 30 days from the date on which the service provider acquires knowledge of the change.

Compliance with ERISA Title I reporting requirements

The service provider would be required to disclose all information related to the service contract and any compensation or fees received thereunder that may be requested by the responsible plan fiduciary or plan administrator in order to comply with the reporting and disclosure requirements under ERISA Title I and the regulations, forms, and schedules issued thereunder (e.g., Form 5500 annual report).

CCH Note: It is important to note that service providers under plans that are not subject to the full annual reporting requirements (i.e., small plans) would still need to comply with the new disclosure requirements. The proposed regulations do not provide an exception from the disclosure rules based on the size of the plan for which services are being provided. Similarly, compliance with the disclosure requirements would not constitute compliance with the new requirements.

Actual compliance by service provider

A contract or arrangement that contains the terms and conditions required by the proposed regulations would not be reasonable, for purposes of the applicable exemption, unless service providers actually furnished all of the specified disclosures. Similarly, a service provider may not merely commit to notifying the plan fiduciary of material changes to prior disclosures at a later date, but must in fact provide such notification.

Proposed PT Class Exemption provides fiduciary relief

In order for the relief under the Proposed Class Exemption to apply, the responsible plan fiduciary must, at the time the contract was entered into, extended or renewed, have reasonably believed that the contract complied with the governing requirements and must not have known or had reason to know that the service provider failed or would fail to comply with the disclosure requirements.

The Proposed Class Exemption would further require the plan fiduciary to take specified actions once it discovered the service provider’s compliance failure. The plan fiduciary would need to:

  1. make a written request to the service provider for information that has not been disclosed (or that the fiduciary has not received);
  2. notify the DOL if the service provider fails to provide the required information within 90 days of the request; and
  3. make a determination of whether to terminate or continue the contract with the service provider.

CCH Note: The Proposed Class Exemption does not require the termination of the contract with the service provider. Thus, a fiduciary may, after evaluating the nature of the disclosure failure; the availability, qualifications, and cost of replacement service providers; and the responsiveness of the service provider in furnishing the missing information, decide, consistent with its general fiduciary obligations under ERISA 404(a) , to elect to retain the service provider.

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