This article is one in a series of articles discussing fee and fee disclosure issues with respect to pension and welfare plans subject to ERISA, including the requirements of new Schedule C to Form 5500 applicable to large pension and welfare plans starting with the 2009 plan year.
For large pension and welfare plans, the new Schedule C to Form 5500 will require much more detailed fee disclosure than has been required in the past. The new Schedule C goes into effect for the 2009 plan year.
The enhanced reporting is intended to help plan administrators obtain from service providers information needed to assess the ongoing reasonableness of fees and compensation, and to enhance overall fee transparency. The Department of Labor believes that an annual review of plan fees and expenses as part of the Form 5500 process is part of a plan fiduciary's obligation to monitor its plan service provider arrangements.
Indirect Compensation Is Primary Focus
Much of the focus under the new Schedule C is on "indirect compensation," which is compensation received in connection with services rendered to the plan during the plan year or in connection with the person's position with the plan, but from sources other than directly from the plan or plan sponsor. Indirect compensation picks up amounts where the entitlement to, or the amount of, the payment is based on services that were rendered to the plan, or in connection with a transaction involving the plan. This includes a wide-range of "revenue sharing" payments, investment management fees, finder's fees, float revenue, brokerage commissions and other items where the fee is based on plan services or transactions.
The Department of Labor recognizes that certain types of indirect compensation are subject to disclosure under Department of Labor or other agency regulations, or under common business practices. More relaxed Schedule C reporting is thus allowed for certain types of indirect compensation as long as the plan has received certain disclosures.
Specifically, amounts received by a service provider that qualify as "eligible indirect compensation" need not be separately reported on Schedule C and, if the service provider receives only eligible indirect compensation, the service provider itself need not be identified on Schedule C. This more relaxed reporting is referred to as an "alternative reporting option" for eligible indirect compensation. If the requirements for eligible indirect compensation are not satisfied, the compensation must be reported in the same way as other indirect compensation.
Only Certain Types of Compensation Qualify as "Eligible Indirect Compensation"
The types of indirect compensation that qualify as eligible indirect compensation under Schedule C include:
- Fees or expense payments paid by investment funds in which the plan invests, where the amounts are reflected in the value of the investment or return on investment of the plan or its participants, for investment management, recordkeeping, distribution or shareholder services
- Commissions and finder's fees
- "Soft dollar" revenue
- Float revenue
- Brokerage commissions and other transaction-based fees for transactions or services involving the plan that were not paid directly by the plan or plan sponsor
Not all so-called "revenue sharing" payments qualify as eligible indirect compensation. A servicing fee that is not disclosed in a mutual fund prospectus and reflected in the return of the fund (and does not fit within any of the other delineated categories) is not eligible indirect compensation. If a fee is disclosed in the prospectus and reflected in the return of the fund, it can be eligible indirect compensation even if it passes through the hands of an agent who acts merely as a conduit in the transmission of the payment. However, if an intervening party (e.g., a broker) receives payment from the fund, the mere fact that such payment serves as the source of a payment to be made to another service provider (e.g., recordkeeper) does not make the payment to the ultimate service provider eligible indirect compensation.
For example, the investment manager of a mutual fund may pay a servicing fee to a recordkeeper that is drawn from its investment management fees. While that servicing fee is indirect compensation, it is not "eligible" indirect compensation vis-à-vis the recordkeeper because the investment manager is not serving as a mere conduit of a fee that is disclosed in the mutual fund prospectus and that reduces the fund's rate of return. While the amount paid to the recordkeeper may be drawn from an investment management fee that is disclosed in the prospectus and reduces the fund's return, it is not that fee that is being paid to the recordkeeper. Similarly, a 12b-1 fee paid to a broker may be disclosed in the prospectus and reduce the fund's return. If the broker makes a payment to a recordkeeper that is drawn from that 12b-1 fee, that generally is not eligible indirect compensation to the recordkeeper. It is indirect compensation and the reporting rules for indirect compensation that is not eligible indirect compensation must be followed. If the broker were acting merely as a conduit of a payment that is due to the recordkeeper, then a different result may flow.
Certain Disclosures Also Must Be Received by the Plan Administrator
For compensation to be eligible indirect compensation and thus qualify for the alternative reporting option, the plan administrator must be furnished with written materials (including in electronic form) that disclose:
- Existence of the indirect compensation
- Services provided for the indirect compensation or the purpose for the payment of the indirect compensation
- Amount (or estimate) of the compensation or a description of the formula used to calculate or determine the compensation
- Identity of the party(ies) receiving the compensation
If disclosure of the "formula" is used to calculate compensation, presumably sufficient detail is required regarding the formula to allow the plan administrator to calculate, at least with reasonable accuracy, the actual fee payable to the service provider. It would not be permissible, for example, for a broker to indicate that it receives 12b-1 fees from several funds held in the plan, with the fees from the funds ranging between an identified high and low basis point amount. While fee ranges from multiple funds are not sufficient, the Department of Labor has indicated that, with respect to a given fund, if fees fluctuate over a range that would be difficult to describe with more precision, then the range can be given as the "formula" used to derive the compensation. It appears, however, that the Department expects as much precision as reasonably possible.
The Department of Labor also expects disclosure of the services being provided for the indirect compensation. A broker that receives 12b-1 fees and discloses the dollar amount of such fees or the formula used to derive the fees (i.e., the basis points received) also must provide disclosure to the plan administrator as to the services provided for which the fees are being received.
Disclosures May Come From Multiple Documents and Sources
A service provider need not create a separate disclosure document for the specific purpose of qualifying an amount as eligible indirect compensation. Rather, the disclosure may be drawn from any number of separate documents provided from any number of sources. However, for the disclosure requirement to be met, all required elements of the disclosure must be there in combination among the documents. For example, a recordkeeper may receive a shareholder service fee that is drawn from a mutual fund and reduces its rate of return. The various elements necessary to satisfy the disclosure requirements for eligible indirect compensation may be drawn from the prospectus, the recordkeeper service agreement, or other documents.
The expectation is that the service provider specifically identify the documents that are intended to satisfy the alternative reporting option. This can be done by having specific language in the relevant document that says that it is intended to satisfy the disclosure requirement, or the service provider can provide a separate document that identifies the various other documents that, taken together, satisfy the disclosure requirement. The Department of Labor suggests that this directional document specify the pages or sections in the referenced documents that provide the required information.
Plan Administrators Must Determine Whether Alternative Reporting Option Is Available
The plan administrator is responsible for the Form 5500 and for determining whether the alternative reporting option is available for a given item of compensation. The plan administrator must make sure that disclosures are provided in sufficient time to allow the plan administrator to determine whether the disclosures are acceptable or not. An administrator may wish to include a required delivery date in its service agreements, or otherwise reach agreement with its service providers as to when materials will be provided.
While the plan administrator bears the ultimate responsibility in this regard, the disclosure regime certainly contemplates that the plan administrator will have to look to the service provider to provide the necessary information. Accordingly, it is very important that plan administrators reach out to service providers and make sure there is a meeting of the minds on what is being provided by the service provider and by when. Modification of service-provider agreements to establish expectations and service levels is important.
Plan Administrator Must Maintain Records
ERISA requires that records be retained supporting a given Form 5500 filing for at least six years after the filing. Any document that is relied upon to establish the availability of the alternative reporting option for eligible indirect compensation thus should be retained for this period. The plan administrator must be able to demonstrate on audit that it received the necessary disclosures to qualify an item of compensation for the alternative reporting option.
Under Alternative Reporting Option, Service Provider Revenue Must Still Be Determined
If a service provider provides an estimate of indirect compensation or the formula used to calculate indirect compensation, those amounts may qualify as eligible indirect compensation and need not be reported on Schedule C. However, that does not necessarily relieve the plan administrator of the need to obtain from the service provider the actual amount of eligible indirect compensation received by the service provider. The DOL states that "[i]t may be appropriate for the plan administrator ... to consider obtaining information about a dollar amount as part of monitoring the service arrangement, e.g., to verify the reliability of an estimate or to confirm that a formula was correctly applied."
Accordingly, a plan administrator should not assume that it has done everything it needs to do simply by obtaining sufficient information to avoid disclosure under Schedule C. From a fiduciary standpoint, more detailed information may be necessary from the service provider to allow a full assessment of the reasonableness of fees and whether fees are being determined correctly.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.