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Fee Disclosures and Fiduciary Responsibilities Under ERISA

February 5, 2018

By Sarah Kalish

*Reprinted with permission of the New Jersey Society of CPAs

The Employee Retirement Income Security Act (ERISA) Section 401(a)(1) requires fiduciaries of retirement plans to make decisions that are in the best interests of the participants of the plan. To assist fiduciaries in selecting and monitoring service providers, the Department of Labor passed regulations under ERISA Section 408(b)(2) that have been effective since July 1, 2012.

Under these regulations, prior to entering into a contract with a covered plan, covered service providers must make certain disclosures in writing to the plan’s fiduciaries regarding the service provider’s compensation and potential conflicts of interest. These disclosures enable fiduciaries to understand the services to be provided, evaluate the reasonableness of the compensation paid and determine whether the service providers have any conflicts of interest.

An entity that provides services to a plan is considered a party in interest to the plan, and any compensation received would be considered a prohibited transaction under ERISA Section 406(a)(1)(C). In order to not be a prohibited transaction, three requirements must be met:

  • The contract must be reasonable.
  • The services must be necessary for the operation of the plan.
  • The compensation paid must be reasonable.

In order for a contract to be reasonable, the service provider must disclose certain information to the plan fiduciaries. By following the regulations in Section 408(b)(2), the transaction will not be a prohibited transaction and the plan fiduciaries will be able to make informed decisions regarding the selection of service providers.

Under Section 408(b)(2) a “covered service provider” is any service provider that expects to receive direct or indirect compensation of $1,000 or more for services provided to the plan. A covered service provider must disclose:

  • The nature of the services to be provided.
  • Whether the service provider will perform services as an ERISA fiduciary, a registered investment adviser or both.
  • Direct and indirect compensation expected to be received.
  • The services that will be provided in exchange for the indirect compensation and the payer of such compensation. The arrangement between the payer and the covered service provider must also be disclosed. These disclosures are intended to assist the plan fiduciaries in determining whether any conflicts of interest exist from the indirect compensation.
  • The compensation to be paid between related parties of the service provider that is transaction based, such as commissions, and any compensation that is charged directly to the investments in the plan. The services related to such compensation must be described along with the payer and recipient of this compensation.
  • The compensation expected to be received upon termination of the contract and how any prepayments will be calculated and refunded.
  • The cost of recordkeeping services to be provided to the plan. Even when there is no explicit compensation for those services, an estimate of costs to the plan must be disclosed. Detailed explanations of the recordkeeping services to be provided must also be disclosed.
  • How compensation for services will be received. For example, whether the plan will be billed or whether the fees will be deducted from the plan’s investments.
  • Any other information requested in writing to enable the plan fiduciaries or plan administrator to comply with reporting and disclosure requirements of ERISA.

Additionally, a service provider that is “a fiduciary to an investment contract, product or entity that holds plan assets and in which the covered plan has a direct equity investment” must disclose the following for each investment offered by the plan:

  • Compensation that is expected to be charged directly against investments.
  • Annual operating expenses if the return on the investment is not fixed, and any additional continuing expenses.
  • For designated investment alternatives, the total annual operating expenses and any information that is required for the plan administrator to comply with its disclosure obligations.

Compliance with Section 408(b)(2) is crucial since non-compliance will most likely cause the contract to be considered unreasonable and the transaction to be a prohibited transaction. Plan fiduciaries will have violated ERISA and the service provider will be considered a “disqualified person” and will be obligated to pay excise taxes ranging from 15 percent to 100 percent of the amount of the prohibited transaction.

Compensation arrangements with service providers can be complex. The disclosures required under Section 408(b)(2) help plan fiduciaries compare service providers, evaluate the reasonableness of compensation and determine whether conflicts of interest exist. This will enable plan fiduciaries to make decisions that are in the best interests of the plan participants and beneficiaries.

 


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