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ERISA For Retirement Service Providers[1]
1. ERISA Newsletter
for Retirement
Service Providers
July 2012
Dear Reader: about participant disclosures. Josh Waldbeser’s
article covers the litigation front by discussing
This is a newsletter for service providers to ERISA- how some service providers earn income, that is,
governed retirement plans. While this newsletter “float,” on plan money -- and the consequences.
focuses on legal issues faced by service providers—
such as investment advisers, broker-dealers, third party If you know others who would like to receive
administrators, recordkeepers, and banks and trust these newsletters, they can subscribe at www.
companies, it also contains valuable information for drinkerbiddle.com and use the Publications
plan sponsors and fiduciaries. That is because the issues Subscribe option on the homepage.
faced by service providers ultimately impact plans.
Fred Reish
Upcoming Event For service providers, these Chair, Financial Services ERISA Team
are particularly challenging (310) 203-4047
times, with mandated Fred.Reish@dbr.com
On August 16, 2012, Fred Reish and
Bradford Campbell will discuss the latest disclosures to plan fiduciaries
developments in Washington, D.C., in the and participants and with In This Issue
first of a series of “Inside the Beltway” numerous lawsuits about
presentations. Click here to register:
www.drinkerbiddle.com/beltway.
indirect payments (such
as revenue sharing) and Page
See page 6 for details. unreasonable compensation. 2
Participant Disclosure of Asset Allocations Models
The articles in the newsletter
3 Do Service Providers Have An Obligation To Offset Indirect
touch on those issues. Compensation?
For example, Joe Faucher’s article discusses whether
4 Participant Disclosures for Brokerage Accounts
service providers need to offset indirect compensation
against their direct compensation—which is an issue 5 Handling “Float” Income
raised because of the new plan-level disclosure rules 7 Around the Firm
under 408(b)(2). Bruce Ashton’s and Joan Neri’s articles
discuss specific issues in the DOL’s recent guidance
Financial Services ERISA Team www.drinkerbiddle.com 1
2. Financial Services ERISA | July 2012
Participant the allocations to change, the accounts are periodically
restored to the original allocations. The question
Disclosure of Asset addressed by the DOL is whether an AAM is considered
an investment subject to the disclosure rules governing
Allocations Models
DIAs, rather than merely an allocation service.
The DOL guidance on AAMs is addressed in a
question which uses, as its example, a plan that offers
10 investment choices and three risk-based model
By Joan M. Neri
portfolios comprised of different combinations of the
(973) 549-7393 plan’s investment options. The DOL states that an AAM
Joan.Neri@dbr.com “ordinarily” is not required to be treated as a DIA if it
is clearly presented to participants as a way of allocating
among the plan’s investment options and a description
of how it functions and how it differs from the plan’s
Many broker-dealers, RIAs and recordkeepers have investment options is provided to participants. This is
been struggling with whether the participant disclosure good news for advisors that offer an AAM using only
rules apply to asset allocation models (AAMs). The the core line-up. We refer to an AAM of this type as
Department of Labor has now issued guidance on a “qualifying asset allocation service” because it is not
this issue in Field Assistance Bulletin 2012-02. viewed as an investment. It is important to note, though,
that several conditions must be satisfied for the asset
In that guidance, the DOL addressed whether an AAM allocation service to “qualify,” that is, to avoid DIA status.
that is presented to plan participants as an asset allocation
strategy among investment alternatives is a designated But what about AAMs that allocate among investments
investment alternative or “DIA.” The significance of that are not otherwise available to participants? The
that question is that detailed information about DIAs DOL response is not as clear as we would like; for
must be provided to participants under the participant example, at one point it says: “if a plan offers only model
disclosure rules (404a-5), including the DIA’s expense portfolios made up of investments not separately designated under
ratios and performance history and a website describing the plan, each model would have to be treated as a designated
the DIA’s principal strategies, risks and portfolio investment alternative.” While this statement could be
turnover rates. Even though this obligation is imposed read to mean that, if the AAMs have some investments
on the ERISA plan administrator (typically, the plan from the core line-up and some “outside” investments,
sponsor or the plan committee), in many instances the the AAMs are not DIAs, we believe there is risk in
plan administrator will look to its service providers for that interpretation. For example, the first sentence
this information. To complicate matters, most service in the answer says: “A model portfolio ordinarily is not
providers (e.g., recordkeepers) do not have systems that required to be treated as a designated investment alternative
can capture and report the information about AAMs under the regulation if it is clearly presented to the participants
for those disclosures – and will not be able to do so and beneficiaries as merely a means of allocating account assets
for many months or perhaps even years – which could among specific designated investment alternatives.” Because
cause plan fiduciaries to be out of compliance. of that statement, we believe the safest interpretation
of the DOL’s intent is to require DIA status if
Unlike investment education models (under DOL any outside investments are used in the AAMs.
Interpretive Bulletin 96-1) that educate participants
on ways of managing their own accounts, an AAM is In conclusion, service providers, such as broker-dealers,
presented to plan participants as an investment tool RIAs, and recordkeepers who offer AAMs should
that allows them to allocate their accounts among the restructure them as qualifying asset allocation services
plan’s investment line-up by simply electing to use the in order to avoid DIA status. For those advisers
AAM’s allocations. On occasion, AAMs may also include who want to use outside investments in participant
investment alternatives not available for participant accounts, one option is to offer such services as a
selection under the plan. Most AAMs also have a 3(38) investment manager. If structured properly, the
rebalancing feature so that, after market fluctuations cause asset allocations of a 3(38) investment manager will
Financial Services ERISA Team www.drinkerbiddle.com 2
3. Financial Services ERISA | July 2012
avoid DIA status. The restructuring process should Whether direct compensation should be reduced or
include reviewing all written and website material offset by indirect compensation turns largely on whether
descriptions of the managed account services to make the service provider is a fiduciary – such as a registered
sure they are consistent with the DOL guidance. investment adviser (RIA) that renders investment
advice for a fee – or a nonfiduciary. Unlike fiduciary
Joan Neri is in the firm’s Financial Services ERISA Team. service providers, nonfiduciaries provide services
With more than 24 years of experience, Joan counsels clients that do not involve discretion over the plan’s assets
on all aspects of ERISA compliance including fiduciary or administration, or investment advisory services.
responsibility and plan operational issues. A part of Joan’s
practice includes representing registered investment advisors Fiduciaries and nonfiduciaries are held to very different
in fulfilling their obligations under ERISA. Joan is a standards. ERISA prohibits a fiduciary from dealing with
frequent speaker throughout the country on legislative and the assets of the plan in his own interest or for his own
regulatory developments impacting ERISA fiduciaries. account, and from receiving any consideration for his
own account from any party dealing with the plan in a
Do Service
plan-related transaction. So, it is a prohibited transaction
for a fiduciary to increase his own compensation in a
transaction involving the plan. For example, if an RIA
Providers Have recommends an investment option to the plan client,
and the investment generates indirect compensation
An Obligation To payable to the RIA (such as a commission), a prohibited
transaction occurs. By reducing the direct compensation
Offset Indirect paid by the plan to the extent of the indirect
compensation the RIA will receive, the RIA “levelizes”
Compensation? his compensation and negates the prohibited transaction.
Conversely, nonfiduciaries – such as third party
administrators (TPAs) that do not provide recordkeeping
By Joseph C. Faucher services -- are not bound by ERISA’s prohibitions
(310) 203-4052 against fiduciaries acting for their own account in
connection with plan transactions. As a result, TPAs
Joe.Faucher@dbr.com are not required to (though we are aware that a number
voluntarily do) offset their direct compensation by
any indirect payments they receive. Indeed, many
nonfiduciary service providers set their fees in
The time for service providers to comply with the anticipation of receiving indirect compensation from
disclosures of services, compensation and fiduciary insurance companies and mutual fund companies. Once
status required by the ERISA §408(b)(2) regulation is the 408(b)(2) regulation takes effect, their obligation
upon us. Presumably, most covered service providers will be to disclose to their plan clients all direct and
– such as third party administrators that receive indirect compensation they expect to receive.
indirect compensation, broker-dealers, recordkeepers
and registered investment advisers – have taken steps Nonfiduciaries will, however, still be subject to the
toward complying with their disclosure obligations. requirement that their overall compensation be
reasonable. Consider, for example, the circumstance
As the reality of making the disclosures has set in, in which a TPA charges a reasonable fee to its plan
we have fielded a stream of questions about how, client. When the TPA receives significant additional
exactly, the disclosure requirement might affect service indirect compensation from the insurance company
providers’ arrangements with their clients. One source that provides the plan’s investments, it may cause the
of confusion concerns when and whether service TPA’s overall compensation in connection with its
providers may need to offset or reduce the compensation services to the plan to exceed a reasonable amount.
they would otherwise receive from plans and plan In that case, it may be appropriate for the TPA to
sponsors as a result of indirect compensation they offset or reduce the compensation from the plan
may receive from other service providers. The purpose or the plan sponsor, or to pay a portion of the
of this article is to clear up some of the confusion. indirect compensation to the plan. Otherwise, the
Financial Services ERISA Team www.drinkerbiddle.com 3
4. Financial Services ERISA | July 2012
reasonableness of the compensation may be called performance, benchmarking, expenses, turnover
into question. To the extent the compensation exceeds ratio etc. required for DIAs, don’t apply.
a reasonable amount, it is a prohibited transaction.
So what has to be disclosed? The DOL explains that
Recognize, however, that the issue isn’t always so clear in Q&A 13. First, the DOL acknowledges that the
cut. Consider, for instance, a TPA firm that provides regulation does not specify exactly what information is
nonfiduciary services that is under common ownership required. Instead, it points out that the description must
with – and has clients in common with -- a fiduciary provide “sufficient information” to enable participants
registered investment adviser. In that setting, issues to “understand how the [account] works (e.g., how
may arise when the fiduciary investment adviser and to whom to give investment instructions; account
recommends an insurance company that pays the TPA balance requirements, if any; restrictions or limitations
indirect compensation. In that case, the TPA may need on trading, if any; how the window, account, or
to levelize its compensation and negate the impact arrangement differs from the plan’s designated investment
of the indirect compensation that it will receive as a alternatives) and whom to contact with questions.”
result of its affiliate’s investment recommendation.
Comment: This is helpful, though it is isn’t clear
In addition to handling an active litigation practice, Joe what is needed to explain how the arrangement
Faucher regularly consults with third party administrators, differs from the plan’s DIAs. Presumably, the
registered investment advisers and insurance carriers on disclosure would need to say that the fiduciaries
ERISA and employee benefit matters and fiduciary do not select or monitor the investments in the
liability insurance and ERISA bond issues. brokerage account, that the costs may be greater
than those for the DIAs and the participant is
Participant
on his own for making investment decisions.
Disclosures for
The DOL also makes it clear (in Q&A 14) that
this information must be furnished – both initially
and annually – to all eligible employees, not
Brokerage Accounts just to those who elect to use the account and
not even just those with account balances.
The disclosures must include a description of “any
By Bruce L. Ashton commissions or fees (e.g., per trade fee) charged in
connection with the purchase or sale of a security,
(310) 203-4048
including front or back end sales loads if known; but
Bruce.Ashton@dbr.com would not include any fees or expenses of the investment
selected by the participant or beneficiary (e.g., Rule
12b-1 or similar fees reflected in the investment’s total
annual operating expenses).” In the FAB, the DOL
The first participant fee disclosures under the 404(a)
says that “in some circumstances the specific amount
(5) regulation are due by August 30. Much of the focus
of certain fees associated with the purchase or sale of
is on a plan’s “designated investment alternatives” (or
a security through a window, account, or arrangement,
DIAs), which excludes brokerage windows, self-directed
such as front end sales loads for open-end management
brokerage accounts and the like (which we refer to as
investment companies registered under the Investment
“brokerage accounts”). But the story doesn’t end there.
Company Act of 1940, may vary across investments
available through the window or may not be known
The DOL has issued Field Assistance Bulletin
by the plan administrator or provider of the window,
2012-02 in the form of FAQs. The FAQs provide
account, or arrangement in advance of the purchase or
additional guidance on the required disclosures.
sale of the security by a participant or beneficiary.” In
Several questions bear on brokerage accounts and
recognition of that, the DOL concludes that it would be
appear to create new challenges for broker-dealers.
sufficient to tell the participant that such fees exist and
may be charged against the account and to explain how
Keep in mind that, since brokerage accounts are
to obtain the information from the investment provider,
not DIAs, the disclosure requirements regarding
along with an admonition to ask for the information.
Financial Services ERISA Team www.drinkerbiddle.com 4
5. Financial Services ERISA | July 2012
Now comes the hard part. The regulation requires Bruce Ashton is in the firm’s Financial Services ERISA
quarterly disclosures of individual expenses that were and Retirement Income Teams. Bruce’s practice focuses on all
charged against a participant’s account, expressed in aspects of employee benefits issues, especially representing plan
dollar amounts. For brokerage accounts, the DOL says service providers (including RIAs, independent record-keepers,
that the plan administrator must provide a statement of third party administrators, broker-dealers and insurance
the dollar amount of fees and expenses actually charged companies) in fulfilling their obligations under ERISA and
during the preceding quarter against the individual in assisting service providers and plan sponsors in addressing
account, which must include a description of the the retirement income needs of participants. He is a well-
services to which the charge relates. The description known speaker and author on employee benefits topics.
of services must clearly explain the charges (e.g., $19.99
Handling “Float”
for brokerage trades, a $25.00 minimum balance fee, a
$13.00 wire transfer fee, a $44.00 front end sales load).
Comment: In our experience, there are two
basic structures for brokerage accounts, one in
Income
which the recordkeeper designates a brokerage
firm that participants must use and the other in
which participants may select any broker-dealer. By Joshua J. Waldbeser
(312) 569-1317
In the first situation, it seems likely that the Joshua.Waldbeser@dbr.com
recordkeeper and broker-dealer will work together
to establish systems to capture and disclose the
initial and annual information. Without meaning
to suggest that this will be easy, it appears that since When funds flow in and out of 401(k) and other ERISA
the broker-dealer will have a significant number of plans, they are sometimes held on a short-term basis in
accounts with the same recordkeeper, there will be general accounts established by a service provider. This
a level of uniformity and some economies of scale occurs, for example, when contributions are held pending
that will make the disclosures less problematic. investment, and when checks for benefit distributions
are awaiting deposit. These accounts generate interest
In the second—where participants can select known as “float” or “float income.” Some recordkeepers
any broker-dealer they want – it is not clear what retain float as part of their compensation from plans.
information must be provided to participants.
However, certainly some information must be given. In a recent lawsuit, 401(k) plan participants were awarded
We are advising plan sponsors and broker-dealers $1.7 million from a bundled recordkeeper that the
in these circumstances on a case-by-case basis. court found to have violated ERISA with respect to
its use of float. (The service provider in question has
For the quarterly disclosures of dollar amounts, indicated that it is considering appealing the verdict.)
the reporting requirement may be less daunting In that case, the court ruled that the provider was a
than it appears because it is possible to provide the fiduciary to the plan with respect to its discretion over
information through confirmations that are already the disposition of float income, and that it improperly
required by the securities laws. For other types of exercised that fiduciary authority to use float income
products, however, such as annuities, CIFs, separate for its own benefit and that of other parties.
accounts and privately placed securities, where no
similar confirmation requirement exists, broker- This case illustrates an important lesson: Under ERISA,
dealers will need to develop alternative approaches. any service provider with the power to determine how
plan assets (including float) are used cannot unilaterally
The additional guidance provided by the FAQs is exercise its fiduciary authority over those assets to
welcome and largely helpful, but these examples related pay itself additional compensation without triggering
to brokerage accounts indicate some of the difficulties a prohibited transaction for fiduciary self-dealing.
the financial services industry will face, difficulties that
were not previously anticipated or even contemplated.
Financial Services ERISA Team www.drinkerbiddle.com 5
6. Financial Services ERISA | July 2012
As a consequence, to retain float income, a service the hook.” This is because any service arrangement that
provider must be permitted under the terms of its is not “reasonable” under ERISA Section 408(b)(2), or
contract to retain the float. The Department of that pays a provider more than reasonable compensation,
Labor (“DOL”) has noted that the service provider will likewise result in a prohibited transaction.
should “openly negotiate” with the responsible
plan fiduciary and “provide full and fair disclosure Under the 408(b)(2) disclosure regulations, no service
regarding the use of float” to help ensure that contract with a “covered service provider,” a term
independent fiduciary approval will be deemed to which includes recordkeepers to most 401(k) and other
have been given. More specifically, the DOL has defined contribution plans, will be considered reasonable
stated that the service provider may avoid prohibited unless all the 408(b)(2) disclosures are furnished to
transactions in this context by following these steps: responsible plan fiduciaries no later than July 1, 2012
(and in the future, with respect to new contracts or
• Disclose, to the responsible plan fiduciary, changes, extensions, and renewals). Thus, covered
the circumstances under which float service providers should ensure that they account for
will be earned and retained; compensation they expect to receive from float income as
part of these disclosures. If required disclosures are not
• For float on contributions pending investment,
provided, the service arrangement will automatically be
disclose and stick to established time frames
deemed to have resulted in a prohibited transaction. It is
for when investment will occur;
important to reiterate that all service providers, regardless
• For float on distribution checks, disclose when the of whether they are covered service providers subject to
float period begins (e.g., the date check is written) the 408(b)(2) disclosure regulations, are required to enter
and ends (e.g., when the check is deposited), into reasonable arrangements and to receive no more than
including time frames for mailing and other reasonable compensation to avoid prohibited transactions.
practices that might affect the float period; and
If the DOL finds that a service provider has participated
• Disclose the rate of the float or the in a prohibited transaction, it will likely require the
manner it will be determined. provider to return the compensation it has received,
and the provider may also be liable for civil penalties
Ordinarily, this information would be set forth in the and for excise taxes under Section 4975 of the Internal
service contract. There may be other ways for a provider Revenue Code. Thus, service providers should review
to ensure that it is not unilaterally determining its own their contracts and practices relating to float income to
compensation as a fiduciary with respect to retention ensure they meet the requirements discussed above.
of float – the key is ensuring that the plan’s internal
fiduciary has approved the additional compensation. Joshua has been in the Employee Benefits and Executive
Compensation Practice Group at Drinker Biddle & Reath’s
Where these requirements are satisfied, retaining float Chicago office since 2008. Prior to this he worked for the
will not cause a prohibited transaction for fiduciary self- U.S. Department of Labor, Employee Benefits Security
dealing because the payment of the compensation has Administration. Joshua’s practice focuses on working with plan
received independent fiduciary approval. However, even sponsors and service providers with respect to Title I of ERISA
in this case, the service provider is not automatically “off and the IRS qualification requirements for retirement plans.
Inside the Beltway
Drinker Biddle & Reath’s national Employee Benefits & Executive Compensation Practice is pleased to announce a new, engaging and
highly informative series, Inside the Beltway, which will discuss political considerations and both recent and anticipated administrative
guidance that can impact retirement service providers and plan sponsors.
Join us on Thursday, August 16, 2012 beginning at Noon(ET)/11:00 am (CT)/9:00 am (PT) for a one hour inaugural broadcast of
Inside the Beltway presented by Fred Reish and Bradford Campbell. Topics will include: DOL’s controversial guidance on brokerage
accounts in 401(k) plans; final preparations for participant disclosure; review of DOL’s anticipated 408(b)(2) supplemental guidance;
and the future of DOL’s fiduciary advice regulation.
Please register here or visit www.drinkerbiddle.com/beltway.
Financial Services ERISA Team www.drinkerbiddle.com 6
7. Financial Services ERISA | July 2012
Employee Benefits & Executive Compensation Around the Firm
Fred Reish along with Bruce Ashton and Brad Campbell presented at Insured Retirement Institute (IRI) 2012 Government, Legal
& Regulatory Conference in Washington DC on June 26th. Fred spoke on “SEC and DOL Fiduciary Initiatives”; Bruce presented on
“Product Developments: Legal and Regulatory Challenge”; and Brad provided a “DOL Fiduciary Update.”
Bruce Ashton testified before the ERISA Advisory Council on June13th on retirement income issues.
Fred Reish presented during a live webcast hosted by American Society of Pension Professionals & Actuaries (ASPPA) on May 17th.
Fred discussed the evolution of target date funds and the potential impact of proposed new measures from the SEC and DOL.
Also, Fred was a speaker at the Wells Fargo Advisors National RPAP Meeting held May 22nd in St. Louis, Missouri. His presentation
was titled “408(b)(2) Update--401(k) Plans: The Adviser’s Role Today and Tomorrow.”
Bruce Ashton was a featured speaker at PlanSponsor Magazine Conference in Chicago, where he presented a “Washington
Update.”
A webinar conducted by Fred Reish in association with the SPARK Institute was reported in BenefitsPro. Fred expressed his concern
that the new 408(b)(2) fee disclosure rules did not include a summary or as was first discussed, but instead proposed the issuance
of a guide.
Summer Conley presented at the ISCEBS June meeting on June 6th at the Los Angeles Athletic Club. Her presentation covered
the new disclosure rules for retirement plans which are effective July 1, 2012.
Brad Campbell spoke at the T. Rowe Price 2012 Forum on April 30th held in San Antonio, Texas. The Forum is the primary
annual conference for T. Rowe Price’s retirement plan clients. Brad led a fiduciary training course titled, “Managing Your Fiduciary
Responsibilities.” During the Forum, he also spoke on a panel titled “Understanding and Evaluating Plan Fees.”
Joan Neri was one of three subject matter experts for the Retirement Income Roundtable hosted by ING Retirement Services on
April 19th in Florham Park, New Jersey. Joan also hosted a breakfast seminar titled “408(b)(2): Challenges Facing Employer Plan
Sponsors, But With a Silver Lining” on April 18th. The seminar emphasized challenges and new opportunities for plan sponsors
given the responsibilities the finalized fee disclosure rules impose on plan service providers.
Joe Faucher presented a two-part webcast series co-hosted with Colonial Surety Company which examined the fundamentals of
ERISA bonds and fiduciary liability insurance.
Fred Reish was interviewed for the May 2012 issue of PIMCO DC Dialogue. In the question and answer article, Fred discussed
retirement plan issues on the agenda in Washington, D.C., and how they might be affected by the upcoming election. Fred also
discussed how the need to balance the U.S. federal budget may lead to lower limits on the amount that high-income earners
can contribute to defined contribution plans in the future. He also noted that government officials may back retirement income
solutions and education to improve DC plans. To read the interview, visit www.drinkerbiddle.com/A-Good-Sense-of-Value.
Fred Reish was quoted in RIABiz (April issue) after Merrill Lynch announced plans to allow a select group of its advisors to serve
as fiduciaries on 401(k) plans with assets of $25 million or more. Speaking to RIABiz, Fred explained that there’s no question that
more firms are starting to tiptoe into offering fiduciary advice by letting top advisors offer these services first. Also, a report by
written by Fred entitled, “Re-Enrolling: Doing Well While Doing Good,” was quoted in LifeHealthPro (March 14, 2012). Fred wrote
the piece for John Hancock Mutual Funds.
Fred continues to write his monthly “Out of Reish” column for PlanSponsor Magazine. In January 2012 the column topic was
“Careful Endorsements,” in February 2012 the topic was “A Changing World,” and in March 2012 the topic was “Complexity of
Design.”
Bruce Ashton was quoted in the Pension & Benefits Daily (April 20, 2012) on his April 19th presentation during a webcast entitled
“Don’t Let the New Vendor and Participant Fee Disclosure Requirements Ruin Your Summer!” hosted by ASPPA.
Brad Campbell was quoted in an Economic Times article, “US Labor Dept Ramps Up 401(k) Plan Provider Exams” (April 26, 2012)
on increased efforts by the DOL to more closely examine companies that serve employers’ retirement plans, including brokerage
firms, registered investment advisers and third-party administrators.
Josh Waldbeser was interviewed by the Chicago Daily Law Bulletin (March 15, 2012) on new retirement income products and
services, including the firm’s new retirement income team. Josh described the current crisis in retirement as “the result of a perfect
storm” with four elements: the millions of baby boomers approaching retirement age; people living 20 or 30 years past retirement;
a shift away from lifetime pension plans to plans like 401(k)s; and the stock market investment performance of the last 10-12
years.
Financial Services ERISA Team www.drinkerbiddle.com 7
