Final DOL Regulations Require Compensation Disclosure By ERISA Service Providers

Friday, February 24, 2012 - 12:36
Ian L. Levin
Michael A. Katz
Jason R. Ertel
Jennifer E. Long

Ian L. Levin

Michael A. Katz

The Department of Labor has issued final regulations under Section 408(b)(2) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  Often referred to as the “Necessary Services Exemption,” Section 408(b)(2) of ERISA provides relief from ERISA’s prohibited transaction rules for service contracts or arrangements between a pension plan and a party in interest if the contract or arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable compensation is paid for the services.  The regulations impose numerous requirements on a service provider to disclose its compensation as a condition to relying upon the Necessary Services Exemption.  Absent compliance, a transaction, including the payment of compensation, between a plan and a service provider is generally prohibited under ERISA.

The disclosure requirements under the regulations apply to service providers that reasonably expect to receive $1,000 or more in compensation from a plan, regardless of whether the services are performed, or the compensation is received, by the service provider itself or by an affiliate or subcontractor, including

  • ERISA fiduciaries that provide services directly to a plan;
  • Registered investment advisers under the Investment Advisers Act of 1940 that provide services directly to a plan;
  • Recordkeepers and brokers to a participant-directed individual account plan
  • Managers of an ERISA “plan asset” fund;
  • Accountants, auditors, actuaries, appraisers, banks, consultants, custodians, insurers, investment advisers, lawyers, recordkeepers, brokers, third-party administrators; and valuation providers, in each case that receive indirect compensation from a plan.

The regulations are effective with respect to existing and new contracts and arrangements in effect on or after July 1, 2012.

Although compliance with the regulations is required to satisfy the Necessary Services Exemption, such compliance does not guarantee that a contract or arrangement will be considered reasonable.  Furthermore, even though a contract or arrangement may not be subject to the regulations because it does not involve a “covered plan,” such as an employee welfare plan, and a “covered service provider,” the contract or arrangement must still be reasonable in order to satisfy the Necessary Services Exemption.

Similarities To “Schedule C” Reporting

It is important to understand that the regulations under Section 408(b)(2) are separate from the obligation to report service provider compensation on Schedule C of a benefit plan’s Form 5500, Annual Return/Report of Employee Benefit Plan.  Whereas Schedule C requires a plan administrator of a benefit plan to report the compensation paid to the service providers of a plan with respect to a particular year, the compensation disclosure required under Section 408(b)(2) must be provided by a service provider in advance of entering into an arrangement with a plan.  In addition, the most significant difference between the two requirements is that a service provider for purposes of the final regulations is limited to those persons and their affiliates that perform services directly for a plan, whereas Schedule C expands the scope of a service provider to include various investment funds (such as mutual funds and hedge funds) regardless of whether they are deemed to hold “plan assets” of benefit plans.

New Disclosure Requirements

Generally, covered service providers must make certain disclosures in writing (although the arrangement itself does not need to be formalized in writing) to responsible plan fiduciaries “reasonably in advance” of the date that the plan fiduciaries enter into, extend, or renew the contract or arrangement for services, or, with respect to contracts or arrangements for recordkeeping or brokerage services relating to an investment alternative under a participant-directed individual account plan (such as a 401(k) plan), prior to the date the investment alternative is designated under the plan.  A fiduciary to a non–plan asset fund, however, has up to 30 days following the date on which the fund becomes a plan asset fund (e.g., by exceeding the so-called “25% test” under ERISA’s plan asset regulations) in order to provide the disclosures.  Among the types of key information that must be disclosed pursuant to the regulation are the following:

  • A description of the services provided;
  • If applicable, a statement that the service provider’s status relative to the plan is that of a fiduciary under ERISA or a registered investment adviser under the Investment Advisers Act of 1940 or any state law;
  • A description of the following types of compensation:
    • direct compensation to be received in connection with the services (i.e., compensation received directly from the plan);
    • indirect compensation to be received in connection with the services (i.e., compensation received from any source other than the plan, the plan sponsor, the covered service provider, or an affiliate), including an identification of the services for which the compensation will be received, an identification of the payer, and a description of the arrangement between the payer and the covered service provider, an affiliate, or a subcontractor, as applicable;
    • with respect to services provided as an ERISA fiduciary or as a registered investment adviser directly to a plan or a plan asset vehicle, transaction-based compensation
    • (e.g., commissions, soft dollars, finder’s fees, or other similar incentive compensation) or fees charged directly against the plan’s investment (e.g., Rule 12b-1 fees), in either case that are paid among the covered service provider, an affiliate, or a subcontractor, including an identification of the services for which the compensation will be received, as well as the payers and recipients of the compensation, and the status of the payers or recipients as affiliates or subcontractors; and
    • compensation reasonably expected to be received in connection with the termination of the contract or arrangement, and how any prepaid amounts will be calculated and refunded upon such termination (although non-monetary compensation, such as gifts and entertainment valued at $250 or less over the duration of the contract or arrangement need not be disclosed);
  • With respect to recordkeeping services, a description of all direct and indirect compensation that is reasonably expected to be received by the recordkeeper, or a reasonable and good-faith estimate of such cost, including an explanation of the methodology and assumptions used to prepare such estimate, and a detailed explanation of the recordkeeping services that will be provided to the covered plan; and
  • With respect to services provided by a fiduciary to a plan asset fund, or by a record keeper or broker to a designated investment alternative in a participant-directed individual account plan, a description of (i) all compensation that will be charged directly against the plan’s investment and that is not included in annual operating expenses, (ii) the annual operating expenses and any ongoing expenses in addition to annual operating expenses, and (iii) for designated investment alternatives, all other information within the control of, or reasonably available to, the covered service provider that is required for the service provider to comply with DOL regulations requiring the disclosure of certain plan and investment-related information to participants and beneficiaries in participant-directed individual account plans.  With respect to a designated investment alternative, such disclosure may be provided in the form of current disclosure materials of the issuer of such designated investment alternative.

A table that summarizes the disclosure requirements can be found here.

The regulations also provide some clarity regarding the disclosure obligations of certain types of specific service providers.

Bundled Services.  Although all compensation to be paid in connection with bundled services must be disclosed, the regulations clarify that the disclosure obligations generally apply only to the service provider that is a party to the contract or arrangement with a plan.  The regulations do not apply to affiliates or subcontractors of covered service providers solely by virtue of such affiliation or subcontractor relationship.

403(b) Plans.  The regulations do not apply to 403(b) annuity contracts or custodial accounts issued before January 1, 2009, with respect to which (i) the plan sponsor ceased to have any obligation to make contributions, (ii) the plan sponsor actually ceased making contributions for periods before January 1, 2009, and (iii) participants are fully vested and have legally enforceable rights against the insurer or custodian without any involvement by the employer.  Annuity providers that require employer approval for distributions will cause otherwise “frozen” contracts to become subject to the regulations, and, as such, plan sponsors should review such arrangements to ensure that they do not exercise any authority over them.

Third-Party Administrators.  Third-party administrators will likely not need to disclose any information beyond the information that is customarily disclosed in a client service agreement.  Additionally, compensation to service providers that is not paid from plan assets is not subject to disclosure; therefore, third-party administrators that are compensated directly from the plan sponsor or an affiliate need not provide disclosure.

Registered Investment Advisers.  Because the regulations cover services provided by entities registered under the Investment Advisers Act of 1940, registered investment advisers  are likely to be considered covered service providers subject to the regulations even if they provide services other than fiduciary investment advice.  Registered investment advisers will need to consider whether to disclose indirect compensation they receive pursuant to consulting and other advisory arrangements.

Approach To Disclosure

The regulations do not impose a specific format in which compensation disclosure must be presented.  In the preamble to the final regulation, however, the Department of Labor stated that it intends to publish in a separate proposal a guide or similar tool with respect to the initial disclosure of compensation that service providers would be required to furnish to plans. Until then, the information provided in existing contracts, fee schedules, offering materials (such as a private placement memorandum), and, with respect to investment advisers, a Form ADV, may provide some or all of the disclosure required of reasonable arrangements under the Necessary Services Exemption.

Disclosure Changes Or Errors

Any changes to prior disclosure must be provided to the plan as soon as practicable, but no later than 60 days, after the covered service provider is informed of such change, unless disclosure is precluded due to extraordinary circumstances beyond the covered service provider’s control, in which case the information must be disclosed as soon as practicable.  If a change is made with respect to previous investment disclosures, the covered service provider must disclose such change at least annually.  Inadvertent errors and omissions made in good faith will not, by themselves, cause the Necessary Services Exemption to be unavailable; however, the covered service provider must disclose the correct information to the responsible plan fiduciary as soon as practicable, but no later than 30 days, after learning of such error or omission.


Ian L. Levin and Michael A. Katz are Partners in the Executive Compensation and Employee Benefits Department in the New York office of Willkie Farr & Gallagher LLP. Jason R. Ertel and Jennifer E. Long are Associates in the Executive Compensation & Employee Benefits Department in the New York office.

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