New regulations by the U.S. Department of Labor concerning fee disclosures by retirement plan service providers could pose new litigation risks on the murky legal issue of whether service providers act as fiduciaries under the federal Employee Retirement Income Security Act, said an attorney with O'Melveny & Myers.
The life and retirement industries will be required to provide additional disclosures to employers that sponsor retirement plans, such as 401(k) defined-contribution plans, according to a new rule issued by the DOL's Employee Benefits Security Administration. It requires retirement plan service providers provide information that will enable plan fiduciaries to determine the reasonableness of compensation paid to them and any conflicts of interest (Best's News Service, Feb. 21, 2012).
The regulation creates new requirements to qualify for the exemption from ERISA's prohibited transaction rules, Shannon Barrett, a partner in O'Melveny & Myers' ERISA litigation and counseling practice, told Best's News Service. Record-keepers are "one of the major service providers for a plan."
Several life insurance companies act as record-keepers for employer-sponsored defined-contribution plans. Employers also often hire financial advisers and investment consultants to help them choose and monitor the mutual funds in their 401(k) plans (Best's News Service, April 25, 2011)
The regulation will require service providers to disclose "whether they expect to be providing fiduciary services," Barrett said.
There are many service providers in which there's a "real legal question" on whether they are fiduciaries, he said. There's a lot of litigation now involving 401(k) plans, and a "major issue" being litigated is whether entities that are record-keepers have taken on additional responsibilities that were sufficient to make them fiduciaries, he said. The regulation will force record-keepers and similar service providers to "stake a position on something that is a very disputed legal issue."
ERISA also imposes a bar on certain transactions that Congress thought "created a heightened risk of conflicts of interest" but those prohibitions are so broad that, in isolation, "they would basically prevent plans from functioning because they would go so far as to keep a plan from even obtaining services and paying somebody to provide those services," Barrett said. So Congress created exemptions—one of which is an exemption for "necessary plan services," such as record-keeping, he said.
The regulation is creating a "technical set of rules" record-keepers must follow, Barrett said. If they don't, their clients, the fiduciaries, could be subject to civil liability for any consequences of a transaction, even if those fiduciaries are acting in good faith in hiring a record-keeper, he said. Record-keepers also can be subject to the excise taxes that can equal 15% of the amounts involved in a transaction.
Barrett said 401(k) plans need several services to operate. These include administrative services that are often provided through a record-keeper, such as tracking participant accounts, sending out plan communications and maintaining websites and call centers for participants, as well as investment management.
Under ERISA, people who select those services and the service providers for a plan, are considered fiduciaries, which means they must act "in the best interest of the plan," making sure the services and the amounts paid for those services are reasonable, Barrett said. Typically, fiduciaries are the employer that sponsors the plan.
How a plan pays for those services "can vary greatly," Barrett said. In the industry, a common example is that rather than having the plan pay the record- keeper directly for its fees, companies that offer investment funds to a plan will agree to share some of the money they're making from the plans through the investment options to the record-keeper, called "indirect compensation" for the record-keeper.
On top of that, many record-keepers will receive their compensation through a blend of fees — some indirect and some fees paid directly from a plan, Barrett said.
To listen to the interview, where Barrett also discusses which party is actually the "plan," go to http://www.ambest.com/media/MA.asp?lid=latestaudio&vid=barrett312
(By Fran Matso Lysiak, senior associate editor, BestWeek: firstname.lastname@example.org)