Department of Labor Mandates Fee Disclosure From Investment Managers and Certain Other Service Providers to ERISA Plans

March 07, 2012

In February, the Department of Labor promulgated final regulations on the fee information investment managers, some broker-dealers and other selected service providers with respect to ERISA assets must provide to the fiduciaries who engage them. These final regulations amend the interim final regulations the Department issued in July of 2010 on this same topic. They extend the relevant deadline from April 1, 2012 to July 1, 2012 and, like the interim final regulations, affect existing as well as new engagements. The greatest importance of the Department’s action may well be the reminder it provides relevant parties that they need to begin considering now how they will comply with the Department’s regulations, if they have not already done so.

As with the interim final regulations, the final regulations only address fee disclosure by “covered service providers,” defined as:

  • Every ERISA fiduciary directly serving a covered plan
  • Every registered investment adviser directly serving a covered plan
  • Every fiduciary with respect to a contract, product or entity which is deemed to hold an ERISA plan’s assets and in which the ERISA plan has a direct equity investment, e.g., hedge fund managers or “fund of funds” managers
  • Every provider of recordkeeping or brokerage services to an ERISA plan, if that plan permits participants or beneficiaries to direct the investment of their accounts from among one or more designated investment alternatives (not including self-directed brokerage options)
  • Every provider of other services, such as accounting, auditing, recordkeeping, brokerage, insurance, administrative, consulting, legal or appraisal services, to an ERISA plan if either the provider receives any compensation for such services from anyone other than the plan, the plan’s sponsor (e.g., the employer of covered employees), the covered service provider or an affiliate (called “indirect compensation”) or the provider receives compensation that is set on a transaction basis (e.g., commissions) or is charged directly against the plan’s investment (e.g., Rule 12b-1 fees)

Any fiduciary for an ERISA plan who engages others to perform services on behalf of the plan likewise must consider how to deal with these rules. Although not required to provide disclosure, they have a duty to obtain the disclosure and take action (including termination of the provider’s services) when required disclosure is not forthcoming. These persons generally include plan sponsors and their agents (for example, “investment committees”) but may also include others, such as some trustees and investment managers.

An Initial Word of the Meaning of ERISA Plan

As in the interim final regulations, these fee disclosure requirements do not apply to individual retirement accounts, SIMPLE Retirement accounts, SEPs or plans covering only the sole owner (or spouse) of the sponsoring employer (often, “Keogh plans”). The final regulations add yet another category of excluded plans for this purpose: “frozen” 403(b) contracts no longer (since January 1, 2009) receiving employer contributions where the participant is fully vested and all of his or her rights are enforceable against the issuing insurer or custodian without the involvement of the participant’s employer.

The Department’s “Hook” – The Exemption for Necessary Services for Reasonable Compensation

The Department has no explicit authority in ERISA to regulate fee disclosure by service providers. But in many instances service providers must demonstrate that they are only providing necessary services for the operation or administration of an ERISA plan for reasonable compensation pursuant to reasonable arrangements (the “Necessary Services” Exemption). Otherwise, their services to the ERISA plan, and more to the point their receipt of compensation for such services, could result in penalties under the “prohibited transactions” rules of ERISA. The Department’s regulations thus state, quite literally, that no arrangement for the provision of services is reasonable without the fulsome fee disclosure mandated by the Department.

Because the Department relied on the Necessary Services Exemption to promulgate fee disclosure, one may argue that if a different exemption is being relied upon to hire service providers, the fee disclosure mandated under the Necessary Services exemption does not apply. For example, persons engaged to provide services by “in-house asset managers” or “INHAMs,” or by “qualified professional asset managers” or “QPAMs” could argue their engagements are covered by the class exemptions applicable to actions of QPAMs and INHAMs. However, the Department did not explicitly confirm this, despite requests from commenters. In addition, fiduciaries engaging other service providers on the basis of other exemptions should consider whether insisting on the same degree of fee disclosure will not eventually become the standard for what any prudent fiduciary would insist upon before engaging a service provider.

The Scope of the Fee Disclosure

The actual disclosure required is little changed by these final regulations. In general, it includes a description of the services to be provided, a statement of the status of the covered service provider, affiliates and subcontractors, the total amount of direct and indirect compensation expected (including any fees for fiduciary services or for recordkeeping and brokerage services, if applicable), how that compensation is to be paid, and, in a change from the interim final regulations, a description of the arrangement under which any indirect compensation is to be paid. Among the few significant changes or material observations are the following:

  • In discussing the final regulations, the Department notes than when a plan reimburses the plan sponsor for a fee paid to a service provider in respect of the plan, the service provider has been directly compensated by the plan. Such reimbursement would thus subject a fiduciary, or registered investment adviser, to the fee disclosure requirements of the final regulations.
  • Only covered service providers expected to receive $1,000 or more of direct or indirect compensation during the term of their engagement are subject to the fee disclosure regulations, and items of non-monetary compensation (e.g., awards and trips) are ignored unless they aggregate more than $250 during the term of the relevant contract or agreement. But the Department declined to elaborate on or otherwise refine the meaning of “term.” It is thus unclear what early termination provisions, or automatic extension provisions, might have on the “term” of an agreement for this purpose. Without clarity, service providers should be cautious in relying on either de minimis exception to avoid any attempt to comply with the fee disclosure requirements.
  • Contrary to rumors, the Department did not include a specific required form of summary of fees. But it did include a sample summary form, and “strongly encourages” use of that form or something similar, pending future developments.
  • In addition to the fee disclosure required by the final regulations, both the interim final and final regulations require covered service providers to provide any other information the plan fiduciary determines necessary to fulfill its reporting and disclosure responsibilities under ERISA. In the interim final regulations such requests had to be answered shortly after the request was made: in the final regulations, such requests have to be answered reasonably in advance of the relevant reporting or disclosure deadline. As the rule no longer assures covered service providers of any period in which to respond, they may what to negotiate some minimum notice in their contracts.
  • If a contract, product or entity is a designated investment alternative of an individual account plan (that is, an investment alternative for participant selection), the exact form of disclosure changes. In addition, covered service providers must be prepared to respond to any requests the plan administrator may deem necessary to fulfill its disclosure responsibilities to plan participants and beneficiaries with respect to designated investment alternatives. Covered service providers in respect of such contracts, products or entities thus need to clearly understand whether their contracts, products or entities are intended as investment alternatives of an individual account plan.


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This article was originally published by Bingham McCutchen LLP.