New DOL Rules Cast Cloud of Confusion Among Plan Service Providers

This year, new DOL rules designed to increase transparency around how ERISA plans compensate their service providers take effect. Ironically, most service providers find the rules to be anything but clear, prompting confusion and concern among providers and plans alike struggling to sort them out.

In 2007, the U.S. Department of Labor (DOL) issued guidance aimed to impose a greater degree of transparency around how ERISA plans compensate their service providers. Effective this year, the new rules affect annual ERISA reporting requirements for Form 5500, as well as the statutory prohibited transaction exemption (ERISA §408(b)(2)), which permits parties-in-interest to provide services to ERISA plans. Employee benefit plans must file Form 5500 annually with information about their financial condition, investments and operations. The underlying goal for both revisions was to significantly expand the degree of information disclosed to and reported by ERISA plans around direct and indirect compensation to their service providers, and ultimately, to increase overall transparency.

Ironically, these new "transparency rules" have seemed anything but clear to service providers, the majority of whom are unsure how to comply with new disclosure requirements in a form they regularly file for plans.1 In a recent industry survey gauging providers' comfort with the now mandatory rules, nearly 75% of service providers surveyed indicated that they would benefit from additional time and guidance in order to properly comply with the new requirements.2 According to The SPARK Institute, a national retirement policy and legislative reform organization and sponsor of the aforementioned study, this confusion may well result in providers interpreting the rules differently, rendering reporting results anything but uniform. Further, providers may be forced to expend significant resources on technology and infrastructure changes that will ultimately prove to be of little or no value to plan sponsors.3

Source of Confusion: Defining Expenses
What is the source of the confusion? The distinction between rules for reporting direct compensation and those for reporting indirect compensation is a key starting point. In fact, one of the biggest challenges that the new rules present to providers is in understanding how plan expenses are defined. The 2009 Schedule C defines fees and compensation as either "direct" or "indirect," which are further broken down between "monetary" or "nonmonetary" fees. Some fees may be difficult to identify, especially if they are lumped into a bundling arrangement and need to be broken out. Direct compensation, generally, is the compensation a plan service provider receives directly from a plan or plan sponsor; or put another way, fees paid to a provider out of the plan's pocket. For example, if a plan pays separately for outside recordkeeping to a third-party provider, that would be considered direct compensation. Indirect compensation is that which is received by a provider from sources other than directly from the plan or plan sponsor, and includes fees paid to the service provider from mutual funds, bank commingled trusts in which the plan invests, and other "soft-dollar" compensation, such as research, for example.

Reporting of direct compensation is fairly straightforward under the new rules—the amount of compensation is fixed and who receives it is clear. The confusion seems to be rooted in how indirect compensation—the primary policy focus underlying the new rules—must now be reported.

Compensation on Schedule C
Under the new rules, unless indirect compensation is "eligible indirect compensation," the amount of such compensation must be reported on Schedule C. The provider (the entity receiving the compensation) does not have to report the actual amount of indirect compensation, but rather may supply a formula pursuant to which such compensation is determined. The plan itself, however, must report an actual amount, usually an estimate of fees based on that same formula.

On the other hand, eligible indirect compensation does not have to be reported, by either the plan or provider. All that the new rules require is a statement from the service provider that it did receive such eligible indirect compensation.

So what is eligible indirect compensation? Generally, it includes fees or expense reimbursement payments charged to investment funds and reflected in the value of the investment or return on investment of the participating plan. It may also come in the form of plan participants' finders' fees "soft dollar" revenue, float revenue, and/or brokerage commissions or other transaction-based fees for transactions or services involving the plan, but that were not paid directly by the plan or plan sponsor (whether or not they are capitalized as investment costs).

This alternative disclosure option is available as long as a few criteria are met. However, a primary source of confusion regarding the eligible indirect compensation option concerns the written disclosure requirements that trigger the classification overall. For example, a provider does not officially get eligible indirect compensation treatment unless certain written disclosure requirements are met. The plan must have received written materials that disclosed and described the existence of the indirect compensation, the services provided in exchange for the payment of indirect compensation, the amount (or estimate) of the compensation or a description of the formula used to calculate the fees owed, and the identity of the parties paying and receiving the compensation. Written disclosures for a bundled arrangement must separately disclose and describe each component of indirect compensation that would be required to be separately reported if the provider were not relying on this alternative reporting option.

The bottom line is if the plan receives adequate disclosure that meets the rule's written disclosure requirements, it does not have to report the amount of the eligible indirect compensation paid to a service provider on Schedule C, just that such fees were in fact paid out. Additionally, this alternative reporting option for eligible indirect compensation can be used to report compensation paid or received in separately managed investment accounts of a single plan. By its very instructions, Schedule C states that eligible indirect compensation includes fees or expense reimbursement payments charged to investment funds and reflected in the value of the plan's investment or return on investments. The instructions do not further define the term "investment fund" for this purpose, however, and the DOL has stated that this term would include separately managed accounts that contain assets of an individual plan, as long as the other conditions for this exemption are met.

What Plan Sponsors Should Do
Because plan sponsors take the ultimate responsibility for the information reported on Form 5500, they should make sure that service providers are aware of the increased disclosure requirements and are prepared to disclose both direct and indirect expenses, beginning with the 2009 plan year. Additionally, all methodologies should be discussed in advance with audit firms for support-and, potentially, ERISA attorneys for guidance when necessary. As with any first-year regulatory changes, additional planning and discussions with their service providers, ideally with all parties collectively represented, is the path to success.

For more information, please contact Peter Donatio, Executive Director, Fund Accounting and Administration at 617-223-9147 or peter.a.donatio@jpmchase.com

1. Source: The SPARK Institute.
2. Ibid.
3. The Spark Institute: Analysis of Form 5500 Schedule C Reporting Survey Results, by Larry   H. Goldbrum, March 24, 2009.