On October 14, 2010, the Department of Labor released final regulations under section 404(a) of ERISA, revising the rules for disclosure of fee and other information to participants in participant-directed individual account plans — plans in which participants choose from a menu of investment funds. In this article we review the final regulation in detail. The new regulation applies to plan years beginning on or after November 1, 2011 — so for calendar year plans it applies beginning in 2012.
The regulation revises ERISA’s fiduciary rules, articulating (in effect, for the first time) a detailed set of rules — subject to ERISA fiduciary sanctions — for what information must be provided to participants in participant-directed individual account plans.
The regulation generally
The regulation requires disclosure of “plan-related” and “investment-related” information to all persons eligible to participate in the plan.
Under the regulation, the plan administrator must provide general plan information, administrative expense information and individual expense information.
General plan information
General plan information includes information about how to give investment instructions; plan-based limitations on instructions; rules for the exercise of voting and similar rights; the designated investment alternatives offered under the plan; any designated investment managers to whom investment directions may be given; and any “brokerage windows,” “self-directed brokerage accounts,” or similar plan arrangements.
Administrative expense information
Administrative expense information includes an explanation of administrative fees charged against participant accounts generally and how those general administrative fees are allocated among participants (e.g., pro rata, per capita). Investment-related fees (e.g., revenue sharing) are excluded from this category.
In addition to general information about administrative expenses, affected participants must be provided, at least quarterly, statements of the dollar amounts actually charged during the preceding quarter to the participants’ accounts for administrative services, and general descriptions of the services to which the charges relate.
Unlike the proposal, the final rule requires an explicit description of any revenue sharing arrangement which pays for administrative expenses. The quarterly statement must include:
An explanation that, in addition to the expenses reported on the statement, some of the plan’s administrative expenses for the preceding quarter were paid from the annual operating expenses of one or more of the plan’s designated investment alternatives (e.g., through revenue sharing arrangements, Rule 12b-1 fees, sub-transfer agent fees).
We note that this is a very general disclosure. There is no requirement that those funds paying revenue sharing be specified.
Individual expense information
Individual expense information includes information about administrative expenses that are assessed on an individual-by-individual, rather than plan-wide, basis. Examples include: charges for qualified domestic relations orders; fees for loans; fees for investment advice; front or back-end loads or sales charges; redemption fees; and investment management fees attendant to a participant’s investment that are charged directly against the individual account, rather than included in the annual operating expenses of the investment.
As with administrative expense information, in addition to general information about individual expenses, affected participants must be provided, at least quarterly, statements of the dollar amounts actually charged. Note that this information has to be provided “at least” quarterly; it may be provided in a quarterly statement; alternatively it could be provided in a timely confirmation statement or similar notice.
Under the regulation the plan administrator must provide identifying information, performance data, benchmark data, fee information and certain additional disclosures about the plan’s designated investment alternatives. This information must be provided in chart form. A website providing certain additional information must also be provided.
Designated investment alternatives generally include everything in a fund menu — mutual funds, separate accounts, collective trusts, GICs. The only exclusion is brokerage windows, which generally get a pass under this regulation. With respect to these arrangements, however, the plan administrator must identify them (where they exist) and disclose any fees and expenses applicable to their utilization.
Identifying information that must be provided with respect to an investment alternative includes:
Performance data includes the average annual total return of the investment for: 1-year, 5-year, and 10-year periods (or for the life of the designated investment alternative, if shorter), together with a statement that an investment’s past performance is not necessarily an indication of how the investment will perform in the future.
Here (and elsewhere) there’s a special rule for “fixed return” investment alternatives (e.g., certificates of deposit and GICs). For these investment alternatives, performance data equals the fixed rate of return; the term of the investment; and (if applicable) a statement that the issuer may adjust the rate of return prospectively and how to obtain (e.g., telephone or website) the most recent rate of return information available.
Following the proposal, under the final rule, for designated investment alternatives with respect to which the return is not fixed, benchmark data must be provided. Specifically the plan administrator must provide: the name and returns of an appropriate broad-based securities market index over the 1-, 5-, and 10- calendar year periods (or for the life of the alternative, if shorter) comparable to the performance data periods provided for plan funds. The benchmark may not be administered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter, unless the benchmark/index is widely recognized and used.
DOL received comments concerning, e.g., funds that are not benchmarked and funds that are a blend of asset classes (e.g., balanced funds). In the preamble DOL states that:
[A] plan administrator may blend the returns of more than one appropriate broad-based index and present the blended returns along with the returns of the required benchmark, provided that the blended returns proportionally reflect the actual equity and fixed-income holdings of the designated investment alternative.
Information as to investment-related fees that a plan administrator must provide generally include:
The amount and a description of each shareholder-type fee (e.g., sales loads and redemption fees). Generally, a shareholder-type fee is a fee that is “not included in the total annual operating expenses of any designated investment alternative.” Note: Some fees, e.g., sales loads, will be disclosed both as a “shareholder-type fee” and as an “individual expense” (discussed above). The preamble states: “The consequence of this overlap is that participants … will not only receive general information regarding the sales load before investing, but … will also receive a statement after investing showing the dollar amount actually charged against their individual accounts.”
A description of any restriction or limitation that may be applicable to a purchase, transfer, or withdrawal of the investment in whole or in part (such as round trip, equity wash, or other restrictions).
The total annual operating expenses of the investment expressed as a percentage (e.g., the expense ratio). The final regulation includes a new requirement that a “dollar-based” example of the expense ratio must be provided: the total annual operating expenses of the investment for a one-year period expressed as a dollar amount for a $1,000 investment (assuming no returns and based on the total annual operating expenses percentage). This requirement was added because DOL found that some participants understood expenses in terms of “dollars” better than in terms of “percentages.”
A statement that fees are only one of several factors that participants should consider when making investment decisions.
The final regulation adds a new required statement that “the cumulative effect of fees and expenses can substantially reduce the growth of a participant’s … retirement account and that participants … can visit the Internet Web site of the Employee Benefits Security Administration for information and an example demonstrating the long-term effect of fees and expenses.”
Again, there’s a special rule for fixed return investment alternatives. With respect to these, the plan administrator must provide the amount and a description of any shareholder type fees that may be applicable to a purchase, transfer or withdrawal of the investment.
One of the more controversial provisions of the proposal was the requirement of a website “that is sufficiently specific to lead participants and beneficiaries to supplemental information regarding the designated investment alternative, including the name of the investment’s issuer or provider, the investment’s principal strategies and attendant risks, the assets comprising the investment’s portfolio, the investment’s portfolio turnover, the investment’s performance and related fees and expenses[.]”
Concerns raised with respect to this requirement included how funds that do not currently maintain such a web site (e.g., many bank collective investment funds, insurance products, and employer stock funds) were to comply with it.
Notwithstanding these concerns, the final regulation retains the website requirement. In the preamble DOL states:
While the Department recognizes, based on the comments, that the required Web sites may not currently be available for all investment vehicles offered by individual account plans in today’s marketplace, the Department is not persuaded that the costs and burdens attendant to establishing and maintaining a Web site that will satisfy the disclosure requirements of this final rule will outweigh the benefits of improved disclosure and ready access to more detailed and current information by participants and beneficiaries.
While the website may (as is typical, e.g., with mutual funds) be maintained by the fund provider:
[T]he responsibility for ensuring the availability of a Web site address falls upon the plan administrator. However, whether, and to what extent, the plan administrator is responsible for establishing and maintaining the Web site itself will depend on the responsibilities assumed by either the issuer of the designated investment alternative(s) or a service provider to the plan. That is, … a plan administrator will not be liable for the completeness and accuracy of information used to satisfy the disclosure requirements of this regulation when the plan administrator reasonably and in good faith relies on information received from or provided by a plan service provider or the issuer of a designated investment alternative.
Under the final regulation, the following information must be included on the website:
The name of the investment alternative’s issuer.
The alternative’s objectives or goals in a manner consistent with Securities and Exchange Commission Form N-1A or N-3, as appropriate.
The alternative’s principal strategies (including a general description of the types of assets held by the investment) and principal risks in a manner consistent with Securities and Exchange Commission Form N-1A or N-3, as appropriate.
The alternative’s portfolio turnover rate in a manner consistent with Securities and Exchange Commission Form N-1A or N-3, as appropriate. (Certain funds, e.g., fixed-return and employer stock funds, are exempted from this requirement.)
The alternative’s performance data (as described above) updated on at least a quarterly basis, or more frequently if required by other applicable law.
The alternative’s fee and expense information (as described above).
The preamble states: “it is the expectation that the information made available via the Web site will be accurate and updated by the plan administrator, service provider or the issuer of a designated investment alternative as soon as reasonably possible following a change, or notification thereof.”
Print disclosure of web information : “Recognizing that some participants may not have ready access to the information required to be made available on an Internet Web site, the final rule requires that participants … be furnished, as part of the required comparative format disclosure document, information about how to request, and obtain free of charge, a paper copy of the information required to be maintained on a Web site ….”
Under this new rule, plans that use non-mutual fund investment options will have a significant challenge: meeting this new requirement while maintaining the cost efficiency of their fund model (collective trust, separate account, etc.).
The final regulation adds a requirement that the plan administrator provide a glossary of investment and financial terms. At this point, there will be no DOL provided/approved glossary — each plan administrator must come up with its own. The DOL is, however, interested in further exploring whether it should develop or identify general investment glossaries that could be utilized by plan administrators. The glossary requirement can be satisfied in different ways — either by including it in the comparative disclosure document (see below) or on the website or as a link to a website.
The regulation requires the plan administrator to provide the foregoing investment-related information in chart form, permitting a straightforward comparison of alternatives. The Appendix to the regulation contains a model chart. The regulation provides that a plan administrator that uses and accurately completes the model chart, taking into account each plan’s specific provisions and each designated investment alternative offered under the plan, will be deemed to have satisfied the regulation’s model comparative chart requirements.
Other investment-related information
Under the regulation, fiduciaries must also provide certain pass-through voting information.
Timing and method of disclosures
Generally, both plan-related and investment-related information must be provided to an individual on or before the date he or she can first direct investments and at least annually thereafter. Information about charges actually applied to a participant’s account must be disclosed quarterly. Except with respect to the latter information, about actual charges, “fees and expenses may be expressed in terms of a monetary amount, formula, percentage of assets, or per capita charge.”
Participants must be furnished a description of any change to a disclosure at least 30 days, but not more than 90 days, in advance of the effective date of the change. The proposal had limited change notices to “material” changes. DOL dropped the materiality qualification in the final rule. The preamble states that “virtually any change in the information would be a ‘material’ change because of its importance to participants and beneficiaries.”
Plan-related information generally may be provided in a summary plan description. Quarterly information may generally be provided in quarterly statements.
DOL reserved the issue of the extent to which electronic communications may be used to satisfy the regulation’s requirements, stating in the preamble that it anticipates “that resolution of this issue will occur in advance of the compliance date for this regulation, so as to ensure for appropriate notice for plans.”
The final regulation provides:
A plan administrator will not be liable for the completeness and accuracy of information used to satisfy these disclosure requirements when the plan administrator reasonably and in good faith relies on information received from or provided by a plan service provider or the issuer of a designated investment alternative.
DOL has extended the effective dates of sponsor-participant fee disclosure rules. For a calendar year plan, disclosures are due 60 days later, i.e., May 31, 2012, and the first quarterly statement disclosures are due 45 days after that, i.e., August 14, 2012.
Probably the key takeaway is, sponsors will have a lot of work to do to bring their plan disclosures into compliance with this new rule. Establishment of websites for non-public funds, developing and formatting participant communications, making sure that necessary information is captured, and the redesign of systems to accomplish all of this, will for many sponsors involve significant expenditure of management time and expense.
The compliance burden aside, the information actually provided to participants may or may not be helpful. DOL has done a lot of work — including focus group testing — to come up with a disclosure scheme that will improve participant choices. Whether, in practice, the new rules have their intended effect only time and experience will disclose.