The Department of Labor (“DOL”) recently released final regulations on required fee disclosure by service providers to ERISA plans.1 We discussed this release in general terms in our Alert of March 7, 2012.2 This Alert addresses how the new regulations relate specifically to investment managers for ERISA plans.3
Separately Managed AccountsIf you are acting as an ERISA fiduciary, or a registered investment adviser, directly to an ERISA plan4, by July 1, 2012 (for existing relationships), and a reasonable time prior to entering into any new engagements, you must provide the appointing plan fiduciary the following information, without regard to whether such fiduciary requests such information:
Investment ProductsIf instead (or in addition) you manage an investment contract, product, or entity (for convenience, a “hedge fund”), you first need to decide whether the recent fee disclosure regulations apply at all. The regulations only apply to a hedge fund in which an ERISA plan has a direct equity investment. In contrast, if all ERISA plan investors in your fund invest only indirectly, for example, through another unaffiliated fund (a “fund of funds” structure), the regulations will not apply to your fund. They also will not apply to your fund if your fund is not a plan asset vehicle, for example because it is a registered investment company or because less than 25% of every class of equity interests are held by ERISA plans or entities whose assets constitute the assets of an ERISA plan.6
If per above your hedge fund is subject to the regulations, you have the same disclosure obligations as the manager of a separately managed account, with the following modifications and additions:
A description of any compensation that will be charged directly against the hedge fund and that is not included in the fund’s annual operating expenses. Examples include sales loads and surrender charges
A description of the annual operating expenses (e.g., expense ratio) and any ongoing expenses in addition to annual operating expenses. The regulations do not specify how to calculate or express the annual operating expenses. It is anticipated that many hedge funds will use the information provided by the fund’s accountant or alternatively may calculate and express these in the manner required for registered funds on the SEC’s Form N-1A. In the unlikely event your hedge fund is a “designated investment alternative” (“DIA”) for the ERISA plan, however, the fund’s total annual operating expenses must be expressed and calculated in accordance with the DOL’s participant level fee disclosure rules7, which in turn require such expenses to be disclosed and calculated pursuant to the SEC’s Form N-1A. A DIA is any investment alternative designated by the ERISA plan into which plan participants may direct the investment of assets in their individual accounts.
If your hedge fund is a DIA for the ERISA plan, any other information or data required for the plan administrator to comply with its disclosure obligations under the DOL’s participant level fee disclosure rules.8
Other service providers directly to your hedge fund are not subject to the regulations. However, as noted above the direct and indirect compensation of any such providers who are your affiliates or subcontractors form part of your disclosure requirements. In addition, you should consider whether you should obtain and review the same disclosure from any other service providers to your hedge fund as part of fulfilling your fiduciary duty to the ERISA plan investors in your hedge fund.
Changes in Information and a Summary
Any changes in your disclosure must be communicated to the fiduciary who engaged you as soon as practicable, but not later than 60 days from the date on which you become aware of the change. Changes in a hedge fund’s annual operating expenses and other expenses need only be disclosed annually, however.
The regulations include a sample summary of fee information, and we have attached a copy. At this time, you are not required to use this summary, or anything similar (but the DOL does hope to suggest a form of summary which will be required, or possibly only “strongly suggested,” by June of this year). Nevertheless, you should consider whether it may be useful to you, as well as the person who engaged you, to prepare such a summary to satisfy your disclosure obligations, particularly if you intend to incorporate disclosure by reference to other pre-existing documents, such an investment management agreement. For example, such a summary might help you quickly identify which changes in other agreements might require delivery of updated disclosure to your ERISA plan clients.
Be prepared to respond to requests for additional information “that is required for the [ERISA] plan to comply with the reporting and disclosure requirements of Title I of [ERISA] . . ..” As noted in our general Alert, the deadline for responding to such requests is based on when the ERISA plan needs that information, not when you receive a request for it, unless a timely response is precluded by “extraordinary circumstances which are beyond [your] control”. As a result, when convenient you should also consider an amendment to the terms of your engagement requiring reasonable advance notice of any such requests.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Klippert-Barbara
1 In general, “ERISA plan” for this purpose means an employee pension benefit plan subject to ERISA. It does not include, however, an individual retirement account (“IRA”), an individual retirement annuity, a simplified employee plan, a simplified retirement account, or generally a Section 403(b) annuity or custody account that was issued before January 1, 2009 which respect to which neither the employer nor the employee contributes any longer). These regulations (which are set out at 29 C.F.R Section 2550.408b-2) are separate and apart from those governing the fee disclosures requested by ERISA Plans with respect to the filing of a Form 5500, Schedule C, by the ERISA plan.
2 Available here: http://www.bingham.com/Media.aspx?MediaID=13523
3 For purposes of this Alert we assume you are not providing recordkeeping services to the plan, e.g., participant level accounts and monitoring and administering participant enrollment, etc. Additional disclosure is required of providers of such services.
4 If the plan fiduciary which appointed you is a “qualified professional asset manager” (a “QPAM”) or a “in-house asset manager” (an “INHAM”), and your engagement otherwise qualified as an exempt transaction from the ERISA prohibited transactions under the specific exemptions for activities of such QPAMs or INHAMs, the recent regulations do not technically apply at this time. However, we anticipate that such QPAMs and INHAMs will ask for the same disclosure as if the regulations applied as part of fulfilling their fiduciary duties in engaging and retaining you as an investment manager.
5 Hereafter, by “you” we mean you, your affiliates and your subcontractors who reasonably expect to receive more than $1,000 in direct or indirect compensation unless otherwise noted.
6 Here, apply the definition of ERISA plan used to test for “plan assets.” For example, assets of an IRA count in the 25% test, even though IRAs are generally not ERISA plans for purposes of the fee disclosure regulation.
7 Set forth at 29 C.F.R. Section 2550.404a-5(d)(1).
8 In addition to the total annual operating expenses for the fund, the participant level fee disclosure rules would require, for example, a description of any restriction or limitation that may be applicable to a purchase, transfer or withdrawal of the investment; a statement that the amount of fees and expenses are only one of several factors to consider when making investment decisions; and a statement that fees and expenses can on a cumulative basis substantially reduce the growth of an account.
This article was originally published by Bingham McCutchen LLP.