4-0-What? (b)What? Just what we needed, more Erisaglyphics!

October 14, 2011 (PLANSPONSOR.com) - Actually, fee disclosure is more logical, straightforward, and beneficial than you may be expecting.  Here’s a plain-English translation and general overview.

Background: Plan fiduciaries (and if you are a frequent reader of this column, you know that all plan-level decision makers are fiduciaries) have always been required to know what fees and expenses are being paid from plan assets and to make sure they are reasonable in light of the services received.  It’s pretty hard to argue against the logic of this.  408(b)(2) will make it easier for fiduciaries to do this part of their job. 

Why the need?  Defined contribution retirement plans, such as 403(b), 401(k), and Profit Sharing can have complicated economic structures under the surface.  Even a knowledgeable, well-intentioned fiduciary can have a heck of a time putting together the puzzle pieces to get a clear picture of: 

  • Who may be receiving direct or indirect payments from the plan? 
  • What are the sources and amounts of all direct and indirect payments? 
  • Who is doing what to earn those payments? 
  • Do any of those arrangements pose a conflict with respect to the interests of the plan’s participants? 

By mandating disclosure of the above, the DoL is facilitating the flow of information from providers to fiduciaries so that they can make better informed decisions.  That’s the Velvet Glove.  The Iron Fist behind it, though, is that “I didn’t know” will be an even less acceptable response during a DoL exam. 

Paid by the plan?  What do we mean when we talk about costs, fees or expenses being “paid by the plan?”  We’re talking about the money that belongs to the plan’s participants – anyone with a balance in the plan, whether they are and active or terminated employee, beneficiary, etc.  Examples: 

  • A flat charge deducted from all participant accounts, such as $40 per year;  
  • A balance-based charge deducted from all participant accounts, such as a 1% wrap fee or asset charge; and 
  • An expense charged against the assets in a particular investment, such as the management and distribution fees of a mutual fund, often expressed as the fund’s “expense ratio.” 
This is money that is being transferred in one way or the other from the plan’s participants to the plan’s service providers.  (Any costs being picked up directly by the employer are not subject to disclosure requirements.)  It is only fair to note that the plan could not exist without service providers and that they are entitled to reasonable compensation, which is a great segue to the rest of the article.

Making sense out of disclosures: So, sometime between now and 4/1/2012, the truck backs up and dumps a load of disclosure data onto your conference table…  What is your committee supposed to do with it?  A sensible approach might be to follow a process similar to the one described below, which we dub “ARC”.   

The committee needs to analyze the disclosures for Amount, Reasonableness, and Conflicts.  It will be less overwhelming if you sort the data by provider or category.  Let’s take some examples: 

If your plan uses a broker or adviser: 

  • Amount – An adviser is usually compensated by way of an explicit, agreed upon fee. (This is “direct compensation”, which is discussed later in this article.) 

        Typically a broker is compensated implicitly, through 12b-1 fees.  (This is “indirect compensation”, which is discussed later in this article.) 

         You’ll need to look at the amount that each investment option on your menu is paying to a broker, in aggregate dollars and in basis points.  You need the aggregate amount for the Reasonableness analysis and you need the basis points for the Conflicts analysis. 

         In case you don’t live-and-breath investments, basis points (abbreviated as “bps” and pronounced as “bips”) are shorthand for 1/100th of 1% of assets.  A 12b-1 fee of 25bps would pay the broker one-quarter of 1% annually of the amount of assets in that particular investment option. 

  • Reasonableness – Is $10 a good price?  For what?  The “for what” part of the analysis requires you to understand exactly what services your plan and its participants are receiving.   

         An investment adviser is required to enter into a written agreement that spells out what they will be doing and how they will be compensated.  Naturally, you would want to feel comfortable that the listed services are actually being delivered. 

         A broker typically has “dealer agreements” with the plan’s investment providers so that they can get paid, but may not have entered into a written agreement with you, with regard to the services they are providing.  If this is the case, you will want an itemized list of services being provided that justify the 12b-1 fees they are receiving. 

         Once you have the “price”, you can begin to determine the “value”, or reasonableness of the compensation.  Some form of benchmarking would be appropriate.  If you wanted to spend the time and money, you could do a full blown RFP.  Alternatively, you could compare notes with other plan sponsors, you could seek out benchmarking data on the internet, or you could ask your broker or adviser to provide some third party benchmarking information which you could validate. 

  • Conflicts – At the risk of wasting ink on the obvious, you want to know who is on which side of the table.  This requires having an understanding of direct and indirect compensation and of the relationships between your service providers. 

         Direct compensation is pretty straightforward.  Examples would include fees charged against participant accounts, such as a $10 quarterly account fee, or fees paid out of a plan’s “ERISA account”.  (An “ERISA account” is an increasingly common arrangement whereby 12b-1 fees and sub-TA credits are paid by investment providers directly into an account in the plan, and then disbursed by the plan’s fiduciaries to cover advisory, recordkeeping, and other allowable expenses.) 

         Indirect compensation is more subtle and the new disclosure mandate is very helpful to plan fiduciaries, who may not have otherwise known about it.  This includes compensation paid to any of your service providers by any of your other service providers.  Examples would include 12b-1 fees paid by one of the plan’s investment providers to the plan’s broker, or “revenue sharing” paid by one of the investment providers to your recordkeeper or other service provider.  Compensation can be in the form of cash or it can consist of other things of value given from one provider to another. 

         Whether compensation is direct or indirect is less important than simply knowing what it is and what is being delivered in return.  Under “Reasonableness” above, we covered the importance of measuring the costs to the plan versus the benefits to the plan.  The conflicts analysis must consider whether any of the compensation arrangements create a condition where interests other than those of the plan and its participants are favored. 

         What sorts of conflicts could exist? Examples: 

    • A broker receiving higher 12b-1 fees from certain investment providers could favor those options when making menu recommendations to the committee and when constructing asset allocations for plan participants.  [Note: best practice would be to “levelize” any asset-based compensation paid to your broker or adviser so that they will earn exactly the same amount on all of the plan’s menu options.] 
    • A tight relationship between a broker/adviser and a service provider can be beneficial to the employer if that leverage is used to benefit the plan.  However, if the broker/adviser is receiving material support (software, hardware, conference fees, Super Bowl tickets, etc.) it is reasonable to explore whether their objectivity is intact.  Registered investment advisers are required to disclose any such potential conflicts in their Form ADV, Part 2A, which is available on-line or by requesting a copy for the adviser.  Brokers do not file Form ADV, so you will have to rely upon disclosures they volunteer, or upon other information you may request.  

What about an ARC analysis for other categories of providers, such as recordkeepers, TPAs (third party administrators), custodians, trust companies, auditors, attorneys, etc.? 

The procedure is similar to the one illustrated above for brokers and advisers.  You should know the amount of compensation they are receiving from your plan and the services being provided.  From that information you can make a reasonableness determination, as described above. 

The potential conflicts may be a bit different.  Examples (could include, but are not limited to): 

  • If you have a “bundled” plan from a recordkeeper that is also an investment provider, such as a mutual fund or insurance company, it would be common for them to recommend their own investment products for a number of your menu slots.    That’s not necessarily bad, but it creates the potential for a conflict between their business interests and the interests of your plan participants. This is nothing new, but fee disclosure may help you to quantify whether the difference in revenue they receive from their own funds is materially different than from “outside” funds that could be used in their place. 
  • Some TPAs receive revenue from service providers.  This can help to keep plan costs down, but you want to satisfy yourself that their allegiance is to your plan and not to the payer of the subsidy as they make recommendations to you. 
  • If the plan’s auditor or attorney does other work for the employer, you will want to make sure that the plan is getting at least as good a deal as it could in an arm’s length arrangement.  It would create a conflict if an employer bartered the plan’s legal or accounting work for more favorable terms on employer work unrelated to the plan.  Likewise, to toss the plan business to a bank as a relationship strengthener would represent a conflict. 

Two more points:  

  1. If you read our last article, The All Important Difference Between Information and Advice, you know that many employers are confused about whether their plan service providers are serving in a fiduciary capacity.  408(b)(2) addresses this knowledge gap by forcing providers to state in writing that they are a fiduciary, if they are.  If they don’t provide this written declaration, they are not on the same side of the table as you or your committee.  They may be treating you very fairly, but they are not legally bound, as you are, to place your participants’ interests first. 
  2. If you haven’t been provided with adequate information to make the determinations discussed in this article, the DoL says it is your obligation to request additional information. 


408(beyond): There are other aspects of 408(b)(2) that go beyond the scope of this plain language overview.  Those Erisaglyphics contain detailed definitions and rules about the timing and types of disclosures that must be made.  A sea of information can be found via internet search, and your ERISA attorney will always be able to give you the best advice regarding your specific circumstances. 


The wrap up: 408(b)(2) better equips plan fiduciaries to do the job that has always been expected of them; to understand who is getting paid from plan assets, whether this represents appropriate compensation for the services the plan is receiving, and whether any of the provider arrangements have embedded conflicts.  An organized approach, such as the ARC analysis suggested above, should help to keep this valuable exercise from becoming overwhelming. 


Jim Phillips, President, and Patrick McGinn CFA, Vice President, Retirement Resources  

Patrick and Jim have over 50 years of combined investment and retirement plans experience.  Retirement Resources in a Registered Investment Advisor that helps employees retire with greater security, while helping employers manage workload, costs and fiduciary liability.  


NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.