Feb 2012 Fiduciary Considerations For Insured Retirement Income[1]
DBR May 2012 The Final408(B)(2)Regulation[1]
1. Investment Management Bulletin
May 2012
The Final 408(b)(2) Regulation:
Impact on Investment Managers
By Fred Reish, Joan Neri, Bruce Ashton, Gary Ammon and Brad Campbell
This bulletin discusses the impact of the U.S. Department of Labor’s (DOL) final 408(b)(2)
disclosure regulation on discretionary investment managers – that is, investment advisers
with the authority to manage the assets of ERISA-governed retirement plans. The final
regulation requires various disclosures to be made by an investment adviser to its
ERISA plan clients prior to July 1, 2012. Failure to comply with these new disclosures
could result in substantial penalties, excise taxes and forfeiture of investment
advisory fees. We would be happy to assist you in drafting or reviewing these new
disclosures.
The new disclosure rules apply to any discretionary asset manager for an ERISA-covered
retirement plan who reasonably expects to receive $1,000 or more of direct or indirect
compensation in connection with its services to a plan. Covered plans include both
defined benefit and defined contribution plans, including ERISA-covered 403(b) plans—
covered plans do not include IRAs or retirement plans that allow employers to contribute
to IRAs set up for employees (referred to as SEPs or SIMPLEs). Discretionary managers
include those hired directly by the plan to manage all or some of its assets, and also the
fiduciary managers of “plan asset vehicles”—investments that are themselves subject to
ERISA, and in which a plan invests. Such investments include collective investment funds
or trusts offered by banks, the separate accounts of insurance companies or certain other
investment vehicles (e.g., hedge funds) if more than 25% of the funds being managed
come from ERISA plans and other “benefit plan investors.” The disclosure rule does not
apply to investment advisers for mutual funds because the investments in mutual funds
are not considered ERISA plan assets.
More information is available from earlier Drinker Biddle alerts addressing DOL Reg.
§408(b)(2):
>> The DOL’s 408(b)(2) Regulation: Impact on Investment Managers (June 6, 2011) –
see www.drinkerbiddle.com/files/ftpupload/pdf/DOLs408b2Regulation.pdf
>> Finally the Final … 408(b)(2) Regulation (February 2012) – see
www.drinkerbiddle.com/files/ftpupload/pdf/FinallytheFinal.pdf
Investment Management Group www.drinkerbiddle.com
2. Investment Management Bulletin May 2012
Key Considerations for Investment Managers
>> The disclosures need to be provided in writing to the “responsible plan fiduciary,” defined as the
fiduciary of an ERISA-covered retirement plan with the authority to cause the plan to enter into a
service arrangement with the investment manager.
>> The compliance date is fast approaching – For existing service arrangements, the disclosures
must be provided no later than July 1, 2012.
>> For new, post-June 30 service arrangements, the disclosures need to be provided reasonably in
advance of entering into the arrangements.
>> These disclosures are new requirements for the prohibited transaction exemption that permits
reasonable arrangements with ERISA retirement plans—failure to provide the disclosures
results in a prohibited transaction.
>> Investment managers who are subject to these rules and who fail to comply will be subject to
excise taxes, may need to refund the compensation, plus interest, they receive under the covered
service arrangement, and could be subject to an additional 20 percent penalty imposed by the
Department of Labor.
>> The rules apply to any discretionary investment manager that provides services as an ERISA
fiduciary directly to an ERISA-covered retirement plan or that manages a Plan Asset Vehicle, such
as a common or collective trust fund of a bank, a separate account of an insurance company, or
certain other investment vehicles if more than 25 percent of the funds being managed come from
ERISA plans and other “benefit plan investors.”
>> If an investment manager provides ERISA fiduciary services to a Plan Asset Vehicle that is also a
“designated investment alternative” (DIA) in an ERISA-covered retirement plan, then the investment
manager must also disclose the total operating expenses and certain other information in its
possession relating to the performance and fees or expenses of the Plan Asset Vehicle. A DIA is
any investment alternative designated by the ERISA-covered retirement plan into which participants
can direct the investment of their plan accounts.
>> Arrangements with third-party payers that result in indirect compensation payments (e.g., soft
dollars or other non-monetary compensation) to the investment manager must be described in
sufficient detail that the responsible plan fiduciaries can evaluate their reasonableness.
Overview
The final 408(b)(2) regulation requires detailed disclosures that must be satisfied by
an investment manager that enters into a contract or arrangement to provide “covered
services” to an ERISA-covered retirement plan, such as a 401(k) plan, a defined benefit
pension plan, a non-participant-directed profit sharing plan or an ERISA-covered 403(b)
plan. Covered services include investment management services provided directly to
an ERISA-covered retirement plan as an ERISA fiduciary. Covered services also include
services provided as an ERISA fiduciary to a Plan Asset Vehicle. Finally, covered services
include services provided by a registered investment adviser. For these services, the
disclosure must be provided to the responsible plan fiduciaries of the ERISA-covered
retirement plans.
Investment Management Group www.drinkerbiddle.com 2
3. Investment Management Bulletin May 2012
The disclosures are enforced through the prohibited transaction rules. Because service
providers are “parties in interest” under ERISA, an exemption from the prohibited
transaction rules is necessary in order for a plan to engage a service provider without
committing a prohibited transaction. ERISA section 408(b)(2) is the prohibited
transaction exemption that permits a plan to engage a service provider that is a party
in interest if the contract or arrangement is “reasonable.” The final 408(b)(2) regulation
adds disclosure requirements as new elements of “reasonableness.” As a result, a
failure by a covered service provider to provide the disclosures will result in a prohibited
transaction under ERISA and the Internal Revenue Code. This means that the investment
manager will be subject to excise taxes and must correct the violation, which may mean
refunding the investment manager’s compensation plus interest on that amount. In
addition, if the DOL recovers the compensation for the plan through either a settlement
agreement or a court order, an additional 20 percent penalty may be imposed.
The disclosures must provide detailed information about the investment manager’s
services, direct and indirect compensation, ERISA fiduciary status, and whether the
manager is an investment adviser registered under the Investment Advisers Act of 1940
or state law. Also, they must be written in a manner that facilitates the responsible plan
fiduciary’s evaluation of the information. The disclosures must be made reasonably in
advance of the date the service contract is entered into, but no later than July 1 in the
case of existing arrangements.
This bulletin focuses on those changes made by the final regulation that impact
investment managers.
1. Effective Date. The compliance effective date of the final regulation was extended
from April 1 to July 1, 2012. The delay benefits investment managers who may not
recognize that they are covered service providers and who therefore may not have
taken steps to comply, such as:
a. Investment managers that provide ERISA fiduciary services to Plan Asset
Vehicles; and
b. Investment managers who manage all or part of the assets of an ERISA-covered
retirement plan such as a profit sharing or pension plan, but who are not
otherwise involved in the retirement plan community.
2. Additional Investment Disclosure for Designated Investment Alternatives. As stated
above, a DIA is generally “any investment alternative designated by the covered plan
into which participants and beneficiaries may direct the investment of assets held
in, or contributed to, their individual accounts,” but does not include brokerage
windows, self-directed brokerage accounts, or similar plan arrangements that allow
participants to select investments not otherwise offered under the plan menu. The
final regulation requires additional disclosures from investment managers that
provide ERISA fiduciary services to a Plan Asset Vehicle that is offered as a DIA in
a participant-directed, individual account plan—such as a 401(k) plan allowing
participant direction of contributions into a collective investment fund. (These
additional disclosure requirements of DIA fiduciary managers, therefore, only
apply in the context of participant-directed, individual account plans, and not to
investments made by traditional pension plans or defined contribution plans in which
there is no participant direction.)
Investment Management Group www.drinkerbiddle.com 3
4. Investment Management Bulletin May 2012
Under the final regulation, the investment manager of a DIA is required to disclose
the total annual operating expenses of the Plan Asset Vehicle and, if within the
control of or reasonably available to the investment manager, performance data and
fee and expense information required in order for the responsible plan fiduciary to
satisfy the participant-disclosure rules (DOL Reg. §2550.404a-5(d)(1)). This means
that the investment manager will need to provide (i) information on the DIA’s
average annual total return for the one-, five- and 10-calendar year periods ending
in the most recently completed calendar year, (ii) an appropriate benchmark, (iii) fee
and expense information, (iv) the DIA’s principal strategies and principal risks, and
(v) the DIA’s portfolio turnover rate. If the investment manager does not provide this
information, the responsible plan fiduciary is required to terminate the relationship
so as to avoid engaging in a prohibited transaction.
3. Disclosure of Indirect Compensation Arrangements and Compensation Paid to
Affiliates. The final regulation includes disclosure requirements for indirect
compensation. Indirect compensation means compensation received by the
investment manager from any source other than the plan, the plan sponsor, or an
affiliate of the manager, and includes non-monetary compensation. Under these
definitions, indirect compensation includes soft dollars provided by a broker-dealer
to an investment manager in exchange for the investment manager’s executing
of securities transactions through the broker-dealer. Indirect compensation could
also include non-monetary compensation, such as gifts, awards and trips. The
compensation must be quantified in the disclosure (e.g., a dollar amount, a formula
based upon plan assets, or a per-participant charge) so that the responsible plan
fiduciary can evaluate the total amount of compensation, both direct and indirect,
that the investment manager will receive.
In addition to describing the indirect compensation the investment manager
expects to receive, the investment manager must describe the services for which
the indirect compensation will be received, the payer of the indirect compensation,
and the “arrangement” with the payer. Thus, in the example above, the investment
manager would need to describe the arrangement with the broker-dealer under
which the broker-dealer provides soft dollars to the investment manager in exchange
for executing transactions. An investment manager also must disclose payments
among itself and its subcontractors or affiliates, such as an affiliated broker-dealer
and subcontractors, that are either set on a transaction basis (e.g., soft dollars,
commissions, finder’s fees) or that are charged directly against the covered plan’s
investment and reflected in the net value (e.g., Rule 12b-1 fees).
The DOL has stated in the preamble to the final regulation that it “intends the
concept of compensation to be received by a covered service provider, or its
affiliates or subcontractors, ‘in connection with’ a particular contract or arrangement
for services [to] be construed broadly.” The preamble provides the example of a
conference offered by a covered service provider to its plan clients in which the
clients pay a small fee for attendance and another institution pays a larger “subsidy
fee” to defray a portion of the cost of the conference. The preamble indicates that
in some instances the subsidy fee could be considered compensation received
by the covered service provider in connection with the covered service provider’s
arrangement with the plan client.
Investment Management Group www.drinkerbiddle.com 4
5. Investment Management Bulletin May 2012
4. Responsible Plan Fiduciary’s Obligation to Terminate the Service Contract Upon
Failure to Disclose. Under ERISA’s prohibited transaction rules, the responsible
plan fiduciary is prohibited from permitting a plan to enter into an arrangement
with a service provider unless the arrangement is “reasonable” – which means the
disclosure requirements of the final regulation are satisfied. This means that in
order to avoid engaging in a prohibited transaction, the responsible plan fiduciary
must make sure that each covered service provider furnishes it with the disclosures
and that the disclosures contain the requisite information regarding services,
compensation, fiduciary status and registration status under the Investment Advisers
Act or state law.
Accordingly, the final regulation provides an exemption process for responsible
plan fiduciaries where a service provider fails to provide the required information.
By satisfying the conditions of this exemption, the plan fiduciary will not be liable
for the prohibited transaction. Among the conditions is a requirement that the
responsible plan fiduciary request the information in writing as soon as it learns
of the failure to disclose, and that it identify the service provider to the DOL if
the service provider fails to provide the information within 90 days of the written
request.
The interim final regulation also required that the responsible plan fiduciary evaluate
whether it should terminate or continue the arrangement if the service provider
failed or refused to provide the requested information. In other words, termination
was permissive and in the discretion of the responsible plan fiduciary. The rule
now states that, “If the requested information relates to future services (i.e., services
that will be performed after the end of the 90-day period…) and is not disclosed
promptly after the end of the 90-day period, then the responsible plan fiduciary shall
terminate the contract or arrangement as expeditiously as possible, consistent
with such duty of prudence.” (Emphasis added.)
5. Disclosure of Changes. The final regulation continues to require that the investment
manager disclose changes in information related to its services, status as a fiduciary
and a registered investment adviser, and compensation within 60 days after
the investment manager is informed of the change. Changes to the investment
information, however, may be provided annually.
6. Disclosures for Reporting and Disclosure Purposes. The interim final regulation
required that information needed by the plan administrator of a covered plan to
enable it to comply with its reporting and disclosure obligations under ERISA had
to be provided within 60 days after a written request. The final rule modifies this
to specify that the information must be provided “reasonably in advance” of the
date the plan administrator states in its written request that it must comply with its
reporting and disclosure requirement. For example, the plan administrator must
state when it expects to file its Form 5500, and the investment manager must
provide the information “reasonably in advance” of that date. This presupposes
that the plan administrator has made its written request in time for the investment
manager to do so.
Investment Management Group www.drinkerbiddle.com 5
6. Investment Management Bulletin May 2012
Conclusion
The final regulation should have limited impact on those investment managers that
already recognize they are covered service providers. However, we are concerned
that many investment managers do not realize that they are subject to these new
requirements. Also, investment managers that provide ERISA fiduciary services to a Plan
Asset Vehicle may not have recognized that they are covered service providers and will
need to act swiftly to comply with these disclosure obligations by July 1 for their existing
service contracts. Such investment managers should also take care to understand and
comply with the expanded requirement in the final regulation to disclose investment
information in their possession regarding designated investment alternatives (DIAs)
associated with participant-directed, individual account plans. An investment manager’s
failure to comply with these rules could result in serious consequences, including
imposition of an excise tax, refunding the investment manager’s compensation plus
interest on that amount, and imposition of a 20 percent penalty.
Investment Management Group www.drinkerbiddle.com 6