[Federal Register: December 13, 2007 (Volume 72, Number 239)]
[Proposed Rules]
[Page 70987-71005]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13de07-23]
[[Page 70987]]
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Part III
Department of Labor
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Employee Benefits Security Administration
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29 CFR Part 2550
Reasonable Contract or Arrangement Under Section 408(b)(2)--Fee
Disclosure; Proposed Rule
[[Page 70988]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB08
Reasonable Contract or Arrangement Under Section 408(b)(2)--Fee
Disclosure
AGENCY: Employee Benefits Security Administration, DOL.
ACTION: Proposed regulation.
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SUMMARY: This document contains a proposed regulation under the
Employee Retirement Income Security Act of 1974 (ERISA) that, upon
adoption, would require that contracts and arrangements between
employee benefit plans and certain providers of services to such plans
include provisions that will ensure the disclosure of information to
assist plan fiduciaries in assessing the reasonableness of the
compensation or fees paid for services that are rendered to the plan
and the potential for conflicts of interest that may affect a service
provider's performance of services. The proposed regulation will
redefine what constitutes a ``reasonable contract or arrangement'' for
purposes of the statutory exemption from certain prohibited transaction
provisions of ERISA. The regulation, upon adoption, will affect
employee benefit plan sponsors and fiduciaries and the service
providers to such plans.
DATES: Written comments on the proposed regulation should be received
by the Department of Labor on or before February 11, 2008.
ADDRESSES: To facilitate the receipt and processing of comment letters,
the Employee Benefits Security Administration (EBSA) encourages
http://www.regulations.gov. Persons submitting comments electronically are
encouraged not to submit paper copies. Persons interested in submitting
paper copies should send or deliver their comments (preferably at least
three copies) to the Office of Regulations and Interpretations,
Employee Benefits Security Administration, Attn: 408(b)(2) Amendment,
Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW.,
Washington, DC 20210. All comments will be available to the public,
without charge, online at http://www.regulations.gov and http://www.dol.gov/ebsa
and at the Public Disclosure Room, N-1513, Employee
Benefits Security Administration, U.S. Department of Labor, 200
Constitution Avenue, NW., Washington, DC 20210.
FOR FURTHER INFORMATION CONTACT: Kristen L. Zarenko, Office of
Regulations and Interpretations, Employee Benefits Security
Administration, (202) 693-8510. This is not a toll-free number.
SUPPLEMENTARY INFORMATION:
A. Background
(1) General
In recent years, there have been a number of changes in the way
services are provided to employee benefit plans and in the way service
providers are compensated. Many of these changes may have improved
efficiency and reduced the costs of administrative services and
benefits for plans and their participants. However, the complexity of
these changes also has made it more difficult for plan sponsors and
fiduciaries to understand what the plan actually pays for the specific
services rendered and the extent to which compensation arrangements
among service providers present potential conflicts of interest that
may affect not only administrative costs, but the quality of services
provided.
Despite these complexities, section 404(a)(1) of ERISA requires
plan fiduciaries, when selecting or monitoring service providers, to
act prudently and solely in the interest of the plan's participants and
beneficiaries and for the exclusive purposes of providing benefits and
defraying reasonable expenses of administering the plan. Fundamental to
a fiduciary's ability to discharge these obligations is the
availability of information sufficient to enable the fiduciary to make
informed decisions about the services, the costs, and the service
provider. In this regard, the Department of Labor (Department) has
published interpretive guidance concerning the disclosure and other
obligations of plan fiduciaries and service providers under ERISA.\1\
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\1\ See, e.g., Field Assistance Bulletin 2002-3 (November 5,
2002) and Advisory Opinions 97-16A (May 22, 1997) and 97-15A (May
22, 1997).
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In addition to technical guidance, the Department makes available
on its Web site various materials intended to assist plan fiduciaries
and others in understanding their obligations, the importance of fees,
and the assessment of service provider relationships.\2\ The
Department's Web site also provides a Model Plan Fee Disclosure Form to
assist fiduciaries of individual account pension plans when analyzing
and comparing the costs associated with selecting service providers and
investment products.\3\
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\2\ See http://www.dol.gov/ebsa/publications/undrstndgrtrmnt.html and http://www.dol.gov/ebsa/newsroom/
>
\3\ http://www.dol.gov/ebsa/pdf/401kfefm.pdf. This model form
was developed jointly by the American Bankers Association, the
Investment Company Institute, and the American Council of Life
Insurers.
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Although the Department has issued technical guidance and
compliance assistance materials relating to the selection and
monitoring of service providers, the Department nevertheless believes
that, given plan fiduciaries' need for complete and accurate
information about compensation and revenue sharing, both plan
fiduciaries and service providers would benefit from regulatory
guidance in this area. For this reason, the Department proposes the
amendment described below relating to the conditions for a ``reasonable
contract or arrangement'' under section 408(b)(2) of ERISA, as set
forth in 29 CFR Sec. 2550.408b-2.\4\
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\4\ The Department also implemented changes to the information
required to be reported concerning service provider compensation and
compensation arrangements as part of the Form 5500 Annual Report.
These changes to Schedule C of the Form 5500 complement the
amendment proposed in this Notice in assuring that plan fiduciaries
have the information they need to monitor their service providers
consistent with their duties under section 404(a)(1) of ERISA. See
72 FR 64731.
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(2) The Statutory Exemption for Services
Section 406(a)(1)(C) of ERISA generally prohibits the furnishing of
goods, services, or facilities between a plan and a party in interest
to the plan. As a result, absent relief, a service relationship between
a plan and a service provider would constitute a prohibited
transaction, because any person providing services to the plan is
defined by ERISA to be a ``party in interest'' to the plan.\5\ However,
section 408(b)(2) of ERISA exempts certain arrangements between plans
and service providers that otherwise would be prohibited transactions
under section 406 of ERISA. Specifically, section 408(b)(2) provides
relief from ERISA's prohibited transaction rules for service contracts
or arrangements between a plan and a party in interest if the contract
or arrangement is reasonable, the services are necessary for the
establishment or operation of the plan, and no more than reasonable
compensation is paid for the services.\6\ Regulations issued by the
Department clarify each of these conditions to the exemption.\7\
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\5\ See ERISA Sec. 3(14)(B).
\6\ See ERISA Sec. 408(b)(2).
\7\ See 29 CFR Sec. 2550.408b-2.
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[[Page 70989]]
In this Notice, the Department proposes to amend the regulations
under ERISA section 408(b)(2) to clarify the meaning of a
``reasonable'' contract or arrangement. Currently, the regulation at 29
CFR Sec. 2550.408b-2(c) states only that a contract or arrangement is
not reasonable unless it permits the plan to terminate without penalty
on reasonably short notice.\8\ In the amendment described below, the
Department proposes to add that, in order for a contract or arrangement
for services to be reasonable, it must require that certain information
be disclosed by the service provider to the responsible plan fiduciary.
The Department believes that in order to satisfy their ERISA
obligations, plan fiduciaries need information concerning all
compensation to be received by the service provider and any conflicts
of interest that may adversely affect the service provider's
performance under the contract or arrangement. Accordingly, under the
proposal, an arrangement would not be reasonable unless the service
provider agrees to furnish, and in fact does furnish, the required
information to the responsible plan fiduciary. The ``responsible plan
fiduciary'' is the fiduciary with authority to cause the plan to enter
into, or extend or renew, a contract or arrangement for the provision
of services to the plan.
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\8\ See 29 CFR Sec. 2550.408b-2(c).
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B. Proposed Amendment to Regulations Under ERISA Section 408(b)(2)
(1) Overview of Proposed Regulation
In general, the proposal amends paragraph (c) of Sec. 2550.408b-2
by moving, without change, the current provisions of paragraph (c) to a
newly designated paragraph (c)(2) and adding a new paragraph (c)(1) to
address the disclosure requirements applicable to a ``reasonable
contract or arrangement.'' The new paragraph (c)(1) of Sec. 2550.408b-
2 generally requires that, in order to be reasonable, any contract or
arrangement between an employee benefit plan and certain service
providers must require the service provider to disclose the
compensation it will receive, directly or indirectly, and any conflicts
of interest that may arise in connection with its services to the plan.
(a) Scope of the Proposal
Paragraph (c)(1)(i) of the proposal describes the scope of the
regulation's disclosure requirements. The Department recognizes that
responsible plan fiduciaries may not always need all of the required
disclosures from every type of service provider in order to evaluate
the reasonableness of the service provider's compensation. Thus, this
paragraph limits the proposal's application to contracts or
arrangements to provide services by service providers that fall within
one or more of three categories. The first category, described in
paragraph (c)(1)(i)(A), includes within the scope of the regulation
service providers who provide services as a fiduciary under ERISA or
under the Investment Advisers Act of 1940. Paragraph (c)(1)(i)(B)
includes service providers who provide banking, consulting, custodial,
insurance, investment advisory (plan or participants), investment
management, recordkeeping, securities or other investment brokerage, or
third party administration services, regardless of the type of
compensation or fees that they receive. Finally, paragraph (c)(1)(i)(C)
includes service providers who receive any indirect compensation in
connection with accounting, actuarial, appraisal, auditing, legal, or
valuation services.
The Department believes that the compensation arrangements for
services provided by the service providers enumerated in paragraphs
(c)(1)(i)(A) and (B) are most likely to give rise to conflicts of
interest. As to the service providers enumerated in paragraph
(c)(1)(i)(C), the Department believes that requiring every service
contract or arrangement with these providers to satisfy the
requirements of the proposed regulation may not be appropriate or yield
helpful information to plan fiduciaries. However, the Department
believes that these providers perform some of the most important and
potentially influential services to plans and, to the extent these
service providers receive indirect compensation in connection with
their services, similar conflict of interest concerns would be raised,
as with other enumerated service providers.
If a contract or arrangement meets the threshold scope requirement
in paragraph (c)(1)(i), then the terms of such contract or arrangement
must satisfy the proposal's disclosure requirements in order to be
reasonable for purposes of paragraph (c)(1), regardless of the nature
of any other services provided or whether the plan is a pension plan,
group health plan, or other type of welfare benefit plan. Nevertheless,
the proposal's application to contracts or arrangements between plans
and the listed categories of service providers should not be construed
to imply that responsible plan fiduciaries do not need to obtain and
consider appropriate disclosures before contracting with service
providers who do not fall within these categories. Responsible plan
fiduciaries must continue to satisfy their general fiduciary
obligations under ERISA with respect to the selection and monitoring of
all service providers. Further, contracts or arrangements with these
service providers must be ``reasonable'' and otherwise satisfy the
requirements of section 408(b)(2) of ERISA.
The proposal also applies only to contracts or arrangements for
services to employee benefit plans. The proposed regulation, if
adopted, would not apply to contracts or arrangements with entities
that are merely providing plan benefits to participants and
beneficiaries, rather than providing services to the plan itself. For
example, a pharmacy benefit manager that contracts with an employee
benefit plan to manage the plan's prescription drug program would be
covered as a service provider to the plan providing third party
administration or recordkeeping, and possibly consulting, services.
However, if a fiduciary contracts on behalf of a welfare plan with a
medical provider network, for example an HMO, a doctor that is part of
the network and that has no separate agreement or arrangement with the
plan would not be a service provider to the plan; the doctor merely
provides medical benefits to the plan's participants and beneficiaries.
(b) Disclosure Concerning Compensation and Services
If a contract or arrangement for services falls within the scope of
the proposed regulation, the contract or arrangement must comply with
paragraphs (c)(1)(ii) through (vi) of the proposal. Paragraph
(c)(1)(ii) requires that the contract or arrangement be in writing. The
proposal requires specific disclosures and representations from the
service provider, and the Department believes they must be made in
writing to ensure a meeting of the minds between the service provider
and the responsible plan fiduciary.
The proposed regulation next provides in paragraph (c)(1)(iii) that
the terms of the contract or arrangement must specifically require the
service provider to disclose in writing, to the best of its knowledge,
the information set forth in the proposal. The Department believes it
is important for the responsible plan fiduciary to obtain assurance
from the service provider that it has disclosed complete and accurate
information. To ensure that the responsible plan fiduciary has the
opportunity to consider all required disclosures before entering into a
[[Page 70990]]
contract or arrangement with a service provider to the plan, the
proposal requires that the contract or arrangement include a
representation by the service provider that, before the contract or
arrangement was entered into, all required information was provided to
the responsible plan fiduciary.
The proposal does not prescribe the manner in which such
disclosures should be presented to the plan fiduciary, other than
requiring a statement by the service provider that the disclosures have
been made. All of the required disclosures need not be contained in the
same document, as long as all of the required information is presented
to the responsible plan fiduciary in writing before such fiduciary
enters into the contract or arrangement. Written disclosures may be
provided in separate documents from separate sources and may be
provided in electronic format, as long as these documents,
collectively, contain all of the elements of disclosure required by the
regulation. For example, a prospectus required by Federal securities
laws, or a Form ADV required to be filed by a registered investment
adviser, may include some of the indirect fee or conflict of interest
information that a service provider would be required to disclose under
this proposal. In these circumstances, the contracting parties are free
to incorporate such materials by reference. The Department expects that
the service provider will clearly describe these additional materials
and explain to the responsible plan fiduciary the information they
contain. The Department invites comments on whether, and the extent to
which, duplicate disclosures can be avoided, while at the same time
ensuring that responsible plan fiduciaries receive comprehensive,
straightforward, and helpful information concerning the service
provider's compensation and possible conflicts of interest.
The proposal also does not designate any specific time period prior
to entering into the contract or arrangement for receipt of the
required disclosures, other than requiring a representation by the
service provider that all information was provided in writing before
the parties entered into the contract. The Department believes it would
be incumbent on the service provider to furnish current and accurate
information to the plan fiduciary. Further, the responsible plan
fiduciary, consistent with its general fiduciary obligations under
ERISA, must ensure in its negotiations with a service provider that he
or she obtains current and accurate information from the service
provider sufficiently in advance of entering into the contract or
arrangement to allow the fiduciary to prudently consider the
information.
To facilitate the responsible plan fiduciary's determination that
the service provider will receive no more than reasonable compensation,
paragraph (c)(1)(iii)(A) of the proposal provides that the contract or
arrangement must require the service provider to disclose the services
to be provided to the plan and all compensation it will receive in
connection with the services. A service provider must describe all
services that it will provide, regardless of whether such services are
described in the proposal's applicable scope provision. For example, if
a plan consultant will provide appraisal, legal, and administrative
services to the employee benefit plan in addition to its consulting
services, then all of these services must be described. The subsections
that follow in paragraph (c)(1)(iii)(A)(1) through (4) of the proposal
clarify the requirement that the service provider disclose all
compensation or fees that it will receive for its services.
Paragraph (c)(1)(iii)(A)(1) broadly defines compensation or fees to
include money and any other thing of monetary value received by the
service provider or its affiliate in connection with the services
provided to the plan or the financial products in which plan assets are
invested. Examples of compensation or fees that are covered by this
definition include, but are not limited to: gifts, awards, and trips
for employees, research, finder's fees, placement fees, commissions or
other fees related to investment products, sub-transfer agency fees,
shareholder servicing fees, Rule 12b-1 fees, soft dollar payments,
float income, fees deducted from investment returns, fees based on a
share of gains or appreciation of plan assets, and fees based upon a
percentage of the plan's assets. The Department believes that an
investment of plan assets or the purchase of insurance is not, in and
of itself, compensation to a service provider for purposes of this
regulation. However, persons or entities that provide investment
management, recordkeeping, participant communication and other services
to the plan as a result of an investment of plan assets will be treated
as providing services to the plan.
Consistent with recommendations of the ERISA Advisory Council
Working Group, the Department concludes that plan fiduciaries must
receive more comprehensive information about the compensation or fees
involved in plan administration and investments, including indirect
compensation.\9\ Indirect compensation includes fees that service
providers receive from parties other than the plan, the plan sponsor,
or the service provider.
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\9\ See ERISA Advisory Council Working Group report at http://www.dol.gov/ebsa/publications
.
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Service providers also must disclose compensation or fees received
by their affiliates from third parties. For purposes of the proposal,
an ``affiliate'' of a service provider is defined in paragraph
(c)(1)(iii)(A)(1) to be any person directly or indirectly (through one
or more intermediaries), controlling, controlled by, or under common
control with the service provider, or any officer, director, agent, or
employee of, or partner in, the service provider. The Department does
not intend this requirement to result in any ``double counting'' of
compensation. For instance, an employee's salary or a bonus that is
paid to an employee from the general assets of his or her employer
(i.e., the service provider) would not need to be separately disclosed,
even if the employee is paid in connection with services to an employee
benefit plan. The proposal merely clarifies that disclosure of any
direct or indirect compensation that otherwise is required under the
proposal cannot be avoided merely because such compensation is paid to
an employee or agent of the service provider or an affiliate, rather
than directly to such service provider or affiliate.
The proposal next provides in paragraph (c)(1)(iii)(A)(2) that if a
service provider cannot disclose compensation or fees in terms of a
specific monetary amount, then the service provider may disclose
compensation or fees by using a formula, a percentage of the plan's
assets, or a per capita charge for each participant or beneficiary. The
Department understands that it is not always possible at the time the
parties enter into a service contract or arrangement to know the exact
amount of compensation, whether direct or indirect, that the service
provider will receive for its services. However, the service provider
must describe its compensation or fees in such a way that the
responsible plan fiduciary can evaluate its reasonableness. For
instance, the service provider must clearly explain any assumptions
that would be used in determining the compensation or fees according to
any such formula or other charge.
Paragraph (c)(1)(iii)(A)(3) of the proposed regulation clarifies
the nature of disclosures that must be provided
[[Page 70991]]
concerning bundled arrangements. In many cases, administrative and
investment services are provided to employee benefit plans in
``bundled'' arrangements, whereby a package or ``bundle'' of services
is provided, either directly or through affiliates or subcontractors of
a service provider. These bundles are priced to the plan by a single
service provider as a package, rather than on a service-by-service
basis. For example, rather than hiring separate service providers for
investment management, recordkeeping, Form 5500 annual report
preparation, participant communications and statement preparation,
payroll processing, and other functions, a plan fiduciary may arrange
for one service provider to have all of these services performed as a
bundle. The provider of the bundle may in turn use other affiliated
service providers, or unaffiliated subcontractors, to provide some of
the services in the bundle. However, the responsible plan fiduciary
obtains a ``package deal'' and will negotiate only with the provider of
the bundle.
Under paragraph (c)(1)(iii)(A)(3) of the proposed regulation, if a
service provider offers a bundle of services, then a contract or
arrangement must require only that the provider of the bundle make the
prescribed disclosures. This bundled service provider must disclose
information concerning all services to be provided in the bundle,
regardless of who provides them. Further, the bundled service provider
must disclose the aggregate direct compensation or fees that will be
paid for the bundle, as well as all indirect compensation that will be
received by the service provider, or its affiliates or subcontractors
within the bundle, from third parties. Generally, the bundled provider
is not required to break down this aggregate compensation or fees among
the individual services comprising the bundle. For instance, the
service provider would not have to break down the aggregate fee into
the amount that will be charged for preparing the Form 5500 annual
report and the amount that will be charged for preparing participant
statements. Also, the bundled provider generally is not required to
disclose the allocation of revenue sharing or other payments among
affiliates or subcontractors within the bundle.
There are, however, exceptions to these rules. Specifically,
paragraph (c)(1)(iii)(A)(3) requires the bundled provider to disclose
separately the compensation or fees of any party providing services
under the bundle that receives a separate fee charged directly against
the plan's investment reflected in the net value of the investment,
such as management fees paid by mutual funds to their investment
advisers, float revenue, and other asset-based fees such as 12b-1
distribution fees, wrap fees, and shareholder servicing fees if charged
in addition to the investment management fee. Also, paragraph
(c)(1)(iii)(A)(3) requires the separate disclosure of compensation or
fees of any service provider under the bundle that are set on a
transaction basis, such as finder's fees, brokerage commissions, or
soft dollars. Soft dollars include research or other products or
services, other than execution, received from a broker-dealer or other
third party in connection with securities transactions. Compensation or
fees that are charged on a transaction basis must be separately
disclosed even if paid from mutual fund management fees or other
similar fees. The Department does not believe that disclosure of these
fees would require bundled providers to disclose any revenue sharing
arrangements or bookkeeping practices among affiliates that could
legitimately be classified as proprietary or confidential. Further, the
Department believes that investment-based charges, commissions, and
other transaction-based fees paid to affiliates are just as likely to
be relevant to the responsible plan fiduciary's evaluation of potential
conflicts of interest, whether or not they are part of a bundled
service arrangement.
Paragraph (c)(1)(iii)(A)(4) requires that the service provider also
explain the manner of receipt of compensation, for example whether the
service provider will bill the plan, deduct fees directly from plan
accounts, or reflect a charge against the plan investment. The
description also must explain how any pre-paid fees will be calculated
and refunded when the contract or arrangement terminates.
(c) Disclosure Concerning Conflicts of Interest
The subsections that follow in (B) through (F) of paragraph
(c)(1)(iii) are intended to inform the responsible plan fiduciary of
the service provider's relationships or interests that may raise
conflicts of interest for the service provider in its performance of
services for the plan. As service arrangements have become more
complex, so have the ways that service providers are compensated, as
well as the relationships among different players in the plan service
provider industry. Plan fiduciaries must know of these relationships
and indirect sources of compensation because they may impact the manner
in which the provider performs services for the plan. There may be
other, oftentimes subtle, influences on the service provider or its
affiliates that may be relevant to a plan fiduciary's assessment of the
objectivity of a service provider's decisions or recommendations.
The Department's attention to service providers' potential
conflicts of interest is not new. For example, in 2005 the Department
issued guidance with the Securities and Exchange Commission concerning
potential conflicts of interest involved in pension consultant
relationships.\10\ This guidance provides a list of tips and related
explanations to help plan fiduciaries obtain the information necessary
to ensure that engagement of the pension consultant serves the best
interest of the plan's participants and beneficiaries. The Department
believes that the engagement of many plan service providers presents
similar issues for the plan fiduciary. Accordingly, under the proposal,
a contract or arrangement must require that the service provider
disclose specific information that will help the responsible plan
fiduciary assess any real or potential conflicts of interest.
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\10\ See ``Selecting and Monitoring Pension Consultants--Tips
for Plan Fiduciaries'' at http://www.dol.gov/ebsa/newsroom/fs053105.html
.
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Subsection (B) of paragraph (c)(1)(iii) requires that the service
provider identify whether it will provide services to the plan as a
fiduciary, either as an ERISA fiduciary under section 3(21) of ERISA or
as a fiduciary under the Investment Advisers Act of 1940. The
Department believes it is important for the responsible plan fiduciary
and the service provider to understand at the outset of their
relationship whether or not the service provider considers itself a
fiduciary and how this status affects the nature of the services to be
provided.\11\
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\11\ The Department notes that persons who perform one or more
of the functions described in section 3(21)(A) of ERISA with respect
to a plan are fiduciaries. See 29 CFR Sec. 2509.75-8. Thus,
fiduciary status depends on a factual analysis of a person's
activities with respect to a plan. Formal agreements stating whether
a person is a fiduciary are not dispositive of whether the person
actually is a fiduciary under ERISA by virtue of the functions
performed.
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Subsection (C) requires that the service provider disclose any
financial or other interest in transactions in which the plan will
partake in connection with the contract or arrangement. For example, if
a service provider will be buying (or advising on the purchase of) a
parcel of real estate for the plan, and an affiliate of the service
provider owns an interest in the real estate, the service provider will
[[Page 70992]]
have to state that it has an interest in the transaction and describe
its affiliate's ownership of the real estate. The responsible plan
fiduciary can then weigh the nature and extent of the conflict in
analyzing the objectivity of the service provider when making the
recommendations.
The proposal also provides that a reasonable contract or
arrangement must require the service provider to disclose its
relationships with other parties that may give rise to conflicts of
interest. Specifically, subsection (D) obligates the service provider
to describe any material financial, referral, or other relationship it
has with various parties (such as investment professionals, other
service providers, or clients) that creates or may create a conflict of
interest for the service provider in performing services pursuant to
the contract or arrangement. If the relationship between the service
provider and this third party is one that a reasonable plan fiduciary
would consider to be significant in its evaluation of whether an actual
or potential conflict of interest exists, then the service provider
must disclose the relationship.
Conflicts also may arise when a service provider can affect its own
compensation in connection with its services. Under subsection (E) of
the proposal, a contract or arrangement must require the service
provider to identify whether it can affect its own compensation without
the prior approval of an independent plan fiduciary and to describe the
nature of this compensation. A common example of this potential
conflict of interest is the receipt of ``float'' compensation.\12\ If
the amount a service provider receives in float compensation will not
be approved by an independent plan fiduciary, then the service provider
must state that it will receive float compensation and explain the
nature of this compensation.\13\
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\12\ Many financial service providers, such as banks and trust
companies, maintain omnibus accounts to facilitate the transactions
of employee benefit plan clients. The service provider may retain
earnings (``float'') that result from the anticipated short-term
investment of funds held in these accounts. These accounts generally
hold contributions and other assets pending investment. Plan
fiduciaries also may transfer funds to an omnibus account in
connection with issuance of a check to make a plan distribution or
other disbursement.
\13\ For more information concerning ``float'' compensation and
the information concerning such compensation that plan fiduciaries
should obtain from service providers, see the Department's Field
Assistance Bulletin 2002-3 (Nov. 5, 2002) at http://www.dol.gov/ebsa/regs/fab_2002-3.html
.
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Finally, the Department recognizes that service providers may have
policies or procedures to manage these real or potential conflicts of
interest. For example, a fiduciary service provider may have procedures
for offsetting fees received from third parties (through revenue
sharing or other indirect payment arrangements) against the amount that
it otherwise would charge a plan client. Accordingly, subsection (F) of
paragraph (c)(1)(iii) of the proposal provides that a reasonable
contract or arrangement must require service providers to state whether
or not any such policies or procedures exist and, if so, to provide an
explanation of these policies or procedures and how they address
conflicts of interest. The Department views this requirement as an
opportunity for service providers to educate plan fiduciaries about how
they address potential conflicts of interest.
(d) Material Changes to Disclosed Information
Paragraph (c)(1)(iv) of the proposal provides that a reasonable
contract or arrangement must require that, during the term of the
contract or arrangement, service providers must disclose to responsible
plan fiduciaries any material changes to the information that is
required by paragraph (c)(1)(iii), subsections (A) through (F). Changes
on the part of a service provider or its employee benefit plan business
may occasionally occur and may alter the information previously
disclosed by the service provider. If any resulting change to the
information previously disclosed to a plan fiduciary would be viewed by
a reasonable plan fiduciary as significantly altering the ``total mix''
of information made available to the fiduciary, or as significantly
affecting a reasonable plan fiduciary's decision to hire or retain the
service provider, then the change is material. To ensure that plan
fiduciaries continue to be well-informed concerning the compensation
and conflict of interest issues affecting their service provider
relationships, a contract or arrangement must require service providers
to notify fiduciaries of material changes within 30 days of the service
provider's knowledge of the change.
(e) Reporting and Disclosure Requirements
The proposed regulation under paragraph (c)(1)(v) requires that a
reasonable contract or arrangement obligate the service provider to
furnish all information related to the contract or arrangement and the
service provider's receipt of compensation or fees thereunder that is
requested by the responsible plan fiduciary or plan administrator in
order to comply with the reporting and disclosure requirements of Title
I of ERISA and the regulations, forms, and schedules issued thereunder.
For example, this provision would obligate the service provider to
furnish information that is necessary for the plan administrator to
complete the annual report on Form 5500, and information that is
necessary for the responsible plan fiduciary to comply with disclosure
obligations to plan participants and beneficiaries.
Of course, detailed reporting concerning some service providers may
not be required for annual reporting purposes, for example because the
amount or nature of the compensation paid to the service provider does
not fall within the threshold or other requirements of the annual
report on Form 5500. Further, not all employee benefit plans are
subject to the same annual reporting requirements, for example small
plans and certain self-funded welfare plans. This does not mean that
service providers to these plans would not be required to fully satisfy
the disclosure requirements of this proposed regulation, assuming they
otherwise fall within the scope of the proposal. The Department
anticipates that this proposal would apply more broadly to
relationships between service providers and employee benefit plans that
are not necessarily covered by ERISA's reporting requirements. The
primary goal of this proposal--to provide comprehensive and useful
information to responsible plan fiduciaries when entering service
contracts or arrangements--is different than that of ERISA's annual
reporting and disclosure requirements, which provide more limited
retrospective financial information on direct and indirect service
provider compensation to facilitate and reinforce the broader fiduciary
obligations imposed by this proposal.
(f) Compliance by Service Providers
The proposal's final requirement is contained in paragraph
(c)(1)(vi). This condition provides explicitly that a service provider
must comply with its obligations under the contract or arrangement as
described in the proposed regulation. Not only must a contract or
arrangement require disclosure from the service provider, but the
service provider must actually provide all of the required disclosures
in order for the contract or arrangement to be reasonable. Similarly,
it is not enough for a service provider to commit in the written
contract to later notify the responsible plan fiduciary of material
changes to the disclosures contained in the contract; subsection (vi)
requires that the service provider in fact provide such notification.
[[Page 70993]]
Subsection (vi) also refers to relief that may be available to a
responsible plan fiduciary when a service provider fails to comply with
this requirement. In addition to this proposed regulation, the
Department is publishing a proposed Class Exemption in today's Federal
Register. Subject to certain conditions, this Class Exemption will
provide relief from ERISA's prohibited transaction rules for a
responsible plan fiduciary when a contract or arrangement fails to be
``reasonable,'' through no fault of the responsible plan fiduciary, but
due to a service provider's failure to satisfy its disclosure
obligations under this regulation. The proposed Class Exemption is
discussed below in paragraph (2), ``Consequences of Failure to Satisfy
the Proposed Regulation.''
(g) Relationship Between Disclosures and the Plan Fiduciary's ERISA
Section 404(a) Duties
The parties to a service contract or arrangement that falls within
the scope of paragraph (c)(1)(i) of the proposal must, at a minimum,
satisfy the requirements contained in this proposal and the other
conditions to ERISA section 408(b)(2) in order for the provision of
services under the contract or arrangement to be exempt from ERISA's
prohibited transaction rules. However, the engagement of any particular
service provider will not necessarily satisfy the fiduciary's
obligations under section 404(a) of ERISA to act prudently and solely
in the best interest of the plan's participants and beneficiaries
merely because the service provider furnishes the information described
in the proposed regulation.
Section 404(a) of ERISA requires that the responsible plan
fiduciary engage in an objective process designed to elicit information
necessary to assess not only the reasonableness of the compensation or
fees to be paid for services, but also the qualifications of the
service provider and the quality of the services that will be
provided.\14\ Although the steps taken by a responsible plan fiduciary
may vary depending on the facts and circumstances, solicitation of bids
among service providers is a means by which the responsible plan
fiduciary can obtain information relevant to the decision-making
process. A responsible plan fiduciary should not consider any one
factor, including the fees or compensation to be paid to the service
provider, to the exclusion of other factors. Further, a fiduciary need
not necessarily select the lowest-cost service provider, so long as the
compensation or fees paid to the service provider are determined to be
reasonable in light of the particular facts and circumstances.
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\14\ See, e.g., Information Letters to D. Ceresi (Feb. 19, 1998)
and to T. Konshak (Dec. 1, 1997).
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Further, plan fiduciaries are not limited by the disclosures
required in this proposal. Plan fiduciaries may ask service providers
for any additional information that they feel is necessary to their
decision. For example, a responsible plan fiduciary may have questions
for a service provider concerning the specific personnel that will be
assigned to manage or perform services under the contract or
arrangement.
Finally, although this proposal looks to disclosures made at the
time a service contract or arrangement is entered into or renewed,
responsible plan fiduciaries must continue to monitor service
arrangements and the performance of service providers. Receipt of the
disclosures described in this proposed regulation at the onset of a
service relationship will not relieve plan fiduciaries of this ongoing
obligation.
(h) Existing Requirement Concerning Termination of Contract or
Arrangement
Paragraph (c)(2) of the regulation continues to require that
service contracts or arrangements permit termination by the plan
without penalty and on reasonably short notice. This requirement has
not been changed, though the Department invites comments from the
public as to any practical issues relating to the current regulation's
requirements concerning contract termination. Specifically, the
Department would like to know whether the current regulatory framework
presents practical problems and whether further regulatory or
interpretive guidance could address these problems.
(i) Other Statutory Exemptions Concerning Service Providers
The Department understands that, in certain circumstances, plans
and service providers to such plans must rely on statutory exemptions
other than section 408(b)(2) of ERISA in order to conduct business
without violating ERISA's prohibited transaction provisions. Therefore,
the Department invites comment on the extent to which the application
of the disclosure requirements contained in this proposed regulation
will affect, or may be affected by, other ERISA statutory exemptions
that may relate to plan service arrangements.
(2) Consequences of Failure To Satisfy the Proposed Regulation
If the contract or arrangement fails to require disclosure of the
information described in the proposed regulation, or if the service
provider fails to disclose such information, then the contract or
arrangement will not be ``reasonable.'' Therefore, the service
arrangement will not qualify for the relief from ERISA's prohibited
transaction rules provided by section 408(b)(2). The resulting
prohibited transaction would have consequences for both the responsible
plan fiduciary and the service provider. The responsible plan
fiduciary, by participating in the prohibited transaction, will have
violated section 406(a)(1)(C) of ERISA's prohibited transaction
rules.\15\ The service provider, as a ``disqualified person'' under the
Internal Revenue Code's (Code) prohibited transaction rules, will be
subject to the excise taxes that result from the service provider's
participation in a prohibited transaction under Code section 4975.\16\
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\15\ See ERISA Sec. 406(a)(1)(C).
\16\ The Internal Revenue Code (Code) also provides statutory
relief for transactions between a plan and a service provider that
otherwise would be prohibited. Any excise taxes imposed by Code
section 4975(a) and (b) for failure to satisfy the statutory
exemption are paid by the disqualified person who participates in
the prohibited transaction, in this case the service provider, not
the plan fiduciary. See Code Sec. 4975(a), (b), (c)(1)(C), (d)(2),
and (e)(2)(B).
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The Department believes that this significant result will provide
incentives for all parties to service contracts or arrangements to
cooperate in exchanging the disclosures required by the proposed
regulation. However, the Department also believes that, in certain
circumstances, a responsible plan fiduciary should not be held liable
for a prohibited transaction that results when a service provider,
unbeknownst to the plan fiduciary, fails to satisfy its disclosure
obligations as required by the proposed regulation. Accordingly, the
Department also published a proposed Class Exemption in today's Federal
Register. The scope of the relief provided by the Class Exemption and
the conditions that must be satisfied by a responsible plan fiduciary
in order to obtain such relief are discussed in the preamble to the
proposed Class Exemption. The Department notes that, in general, the
parties seeking to avail themselves of either the statutory exemption
provided by ERISA section 408(b)(2), or the administrative exemption
provided in the Department's proposed Class Exemption, will bear the
burden of establishing compliance with the conditions of these
exemptions.
[[Page 70994]]
C. Effective Date
The Department proposes that its amendments to regulation section
2550.408b-2(c) be effective 90 days after publication of the final
regulation in the Federal Register. The Department invites comments on
whether the final regulation should be made effective on a different
date.
D. Request for Comments
The Department invites comments from interested persons on the
proposed regulation and other issues discussed in this Notice. Comments
should be submitted electronically by e-mail to e-ORI@dol.gov, or by
using the Federal eRulemaking portal at http://www.regulations.gov.
Persons wishing to submit paper copies should address them to the
Office of Regulations and Interpretations, Employee Benefits Security
Administration, Room N-5655, U.S. Department of Labor, 200 Constitution
Avenue, NW., Washington, DC 20210, Attn: 408(b)(2) Amendment. All
comments received will be available for public inspection, without
charge, at http://www.regulations.gov or at http://www.dol.gov/ebsa and
in the Public Disclosure Room, N-1513, Employee Benefits Security
Administration, 200 Constitution Avenue, NW., Washington, DC 20210.
The comment period for this proposed regulation will end 60 days
after publication of the proposed rule in the Federal Register. The
Department believes that this period of time will afford interested
persons an adequate amount of time to analyze the proposal and submit
comments.
E. Regulatory Impact Analysis
(1) Overview of the Proposal
Under section 406(a)(1)(C) of ERISA's prohibited transaction rules,
the furnishing of goods, services, or facilities between a plan and a
party in interest to the plan is generally prohibited.\17\ A service
relationship between a plan and a service provider would thus
constitute a prohibited transaction in the absence of regulatory
relief, because ERISA defines any person providing services to the plan
as a ``party in interest'' to the plan.\18\ Section 408(b)(2) of ERISA,
however, exempts certain arrangements between plans and service
providers that otherwise would be prohibited transactions. To obtain
relief under that section, the arrangement must be reasonable, the
services must be necessary for the establishment or operation of the
plan, and no more than reasonable compensation must be paid for the
services.\19\ Regulations issued by the Department clarify each of
these conditions to the exemption.\20\
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\17\ See ERISA Sec. 406(a)(1)(C).
\18\ See ERISA Sec. 3(14)(B).
\19\ See ERISA Sec. 408(b)(2).
\20\ See 29 CFR 2550.408b-2.
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To further clarify the meaning of a ``reasonable'' contract or
arrangement under section 408(b)(2), the Department proposes to amend
the regulation at 29 CFR Sec. 2550.408b-2(c). Under the proposal, a
contract or arrangement to provide covered services to a plan would not
be reasonable unless it requires the service provider to disclose, in
writing, certain information before the contract or arrangement is
entered into, extended, or renewed. The Department believes that, in
order to satisfy their ERISA obligations, plan fiduciaries need
information concerning all compensation to be received by the service
provider and any conflicts of interest that may adversely affect the
service provider's performance of the contract or arrangement.
The proposal requires that, in order to be considered a reasonable
contract or arrangement, the contract must require the service provider
to furnish the specified information to the responsible plan fiduciary.
The rule also would require that the service provider comply with its
contractual obligation and actually furnish the specified information.
These disclosures are intended to enable the responsible plan fiduciary
to ensure that no more than reasonable compensation is paid to the
service provider for the services and to illustrate any actual or
potential conflicts of interest that may affect the service provider's
judgment.
Once adopted, these requirements will apply to all contracts or
arrangements between plans (including pension plans, group health
plans, and other types of welfare benefit plans) and service providers
who are fiduciaries; who provide banking, consulting, custodial,
insurance, investment advisory, investment management, recordkeeping,
securities or other investment brokerage, or third party administration
services; or who receive indirect compensation for accounting,
actuarial, appraisal, auditing, legal, or valuation services to the
plan (collectively ``covered services'' or ``covered providers'').
The Department's interest in this proposal stems from concerns
about the fees paid for by employee benefit plans, and the ability of
plan sponsors and fiduciaries to understand these fees which may be
paid directly or indirectly by plans. The Department believes that
greater understanding of these fees by the affected parties will
increase efficiency and competition in the service provider market and
generate benefits to plans and thus to plan participants. Although the
Department believes this rule will have the greatest effect on service
providers to pension plans, the Department identified other employee
benefit plans, such as health and welfare plans, that would be affected
by this regulation and could realize benefits from the proposal similar
to the benefits realized by pension plans.
In a separate regulatory effort, the Department has revised
Schedule C of the annual Form 5500, which is filed by most large plans.
Schedule C collects information about plan service providers that were
compensated in excess of $5,000. These revisions are intended to
improve the reported information on compensation and revenue sharing
arrangements of service providers to employee benefit plans. Similar to
the proposed revisions under section 408(b)(2) of ERISA, the revisions
to Schedule C are intended to help plan sponsors and fiduciaries in
determining the reasonableness of the fees they pay to service
providers and to help assess any potential conflicts of interest. While
the proposed regulation under section 408(b)(2) of ERISA concerns the
disclosure of information during the decision-making process, the
changes to Schedule C concern the provision of retrospective
information as part of a plan's annual reporting obligations.
The Department is also publishing, simultaneously with this
regulatory initiative, a proposed class exemption for plan fiduciaries
in certain circumstances when plan service arrangements fail to comply
with ERISA section 408(b)(2). The exemption is published elsewhere in
this issue of the Federal Register. In the preamble to the exemption,
the Department describes how it has taken into account the availability
of conditional relief under the exemption in assessing the economic
costs and benefits of the regulation. The Department believes that the
exemption is essential to achieve the purposes underlying the
regulation.
(2) Executive Order 12866 Statement
Under Executive Order 12866, the Department must determine whether
a regulatory action is ``significant'' and therefore subject to the
requirements of the Executive Order and subject to review by the Office
of Management and Budget (OMB). Under section 3(f) of the Executive
Order, a ``significant regulatory action'' is an action that is
[[Page 70995]]
likely to result in a rule (1) having an annual effect on the economy
of $100 million or more, or adversely and materially affecting a sector
of the economy, productivity, competition, jobs, the environment,
public health or safety, or State, local or tribal governments or
communities (also referred to as ``economically significant''); (2)
creating serious inconsistency or otherwise interfering with an action
taken or planned by another agency; (3) materially altering the
budgetary impacts of entitlement grants, user fees, or loan programs or
the rights and obligations of recipients thereof; or (4) raising novel
legal or policy issues arising out of legal mandates, the President's
priorities, or the principles set forth in the Executive Order. OMB has
determined that this action is significant under section 3(f)(1)
because it is likely to materially affect a sector of the economy.
Accordingly, the Department has undertaken, as described below, an
analysis of the costs and benefits of the proposed regulation in
satisfaction of the requirements of the Executive Order. The Department
believes that the proposed regulation's benefits justify its costs.
(3) Need for Regulatory Action
Employee benefit plans have evolved over the past several years,
resulting in changes to both the services provided to the plans and the
compensation received by service providers. Fee structures for service
providers have, in some cases, become more complex and less transparent
for plan sponsors or fiduciaries determining what is actually paid for
services. This increased complexity also makes it more difficult to
discern the service provider's potential conflicts of interest. It has
also become more difficult to determine the impacts of these potential
conflicts of interest on the fees paid by, or the quality of the
services provided to, the plan.
Despite these complexities, when selecting or monitoring service
providers, plan fiduciaries must act prudently and solely in the
interest of the plan's participants and beneficiaries and for the
exclusive purpose of providing benefits and defraying reasonable
expenses of administering the plan. To meet these obligations, it is
vital that fiduciaries have enough information to make informed
assessments and decisions about the services, the costs and the
providers. In this regard, the Department has published interpretive
guidance concerning the disclosure and other obligations of plan
fiduciaries and service providers under sections 404, 406(b) and 408(b)
of ERISA.\21\
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\21\ See, e.g. Field Assistance Bulletin 2002-3 (Nov. 5, 2002)
and Advisory Opinions 97-16A (May 22, 1997) and 97-15A (May 22,
1997).
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To the extent that plan fiduciaries are unable to obtain this
information, or unable to use it to choose among service providers in a
manner that upholds their fiduciary duty, a failure exists in the
market for services for employee benefit plans. This market failure
results from information asymmetry between the providers of plan
services who possess information about their fee structures and
potential conflicts of interest and plan fiduciaries that lack this
information but need it to act in the best interest of their plans. The
Department believes that both responsible plan fiduciaries and service
providers will benefit from this proposed regulation, which will
promote the efficiency of plan fiduciaries finding and using the
information they need to search for service providers. This action
furthers important public policy goals of increased transparency and
increased competition in the service provider market.
(4) Regulatory Alternatives
Executive Order 12866 directs Federal Agencies promulgating
regulations to evaluate regulatory alternatives. The Department
considered the following alternatives: Remaining with the status quo, a
general regulatory framework, broad applicability, and a specific
framework with limited application. These alternatives are described
further below:
Remain with status quo
The Department weighed the option of remaining with the status quo
and relying on the current regulatory framework. ERISA's existing
fiduciary duties imposed by sections 404 and 408(b)(2) already require
plan fiduciaries to ensure that fees paid to service providers are
reasonable. As part of this duty, fiduciaries must obtain information
about fees and conflicts of interest. Absent a regulation, the status
quo framework relies upon these more general fiduciary requirements to
ensure that plans pay reasonable service fees.
The status quo alternative was rejected. Although the Department
has issued technical guidance concerning plan fiduciaries' obligations
to assess all compensation received by service providers, issues remain
concerning the adequacy of current disclosures made to plans. The
Department believes that plan fiduciaries would benefit from a clear
and uniform regulatory standard for disclosure. Additionally, under the
``status quo'' alternative, it is unclear whether non-fiduciary service
providers are obligated by law to provide the information the
Department believes fiduciaries need in order to evaluate whether a
provider's fees are reasonable.
General regulatory framework
Second, the Department considered establishing a general regulatory
framework requiring service providers to furnish, and plan fiduciaries
to obtain, information on fee structures and conflicts of interest.
This alternative would not have specified in detail the exact
information that must be exchanged, but would have left this up to the
parties to the contract or arrangement. The Department rejected this
alternative because it believes both responsible plan fiduciaries and
service providers would benefit from additional guidance concerning the
information that must be exchanged. The Department felt that, although
this alternative would create an obligation on the part of the parties
to exchange information that relates to the reasonableness of fees,
parties may be left with ongoing ambiguity about exactly what
information is necessary to fully evaluate a service provider contract
or arrangement. The Department therefore believes that this alternative
would fail to generate significant benefits in the form of greater
efficiency with higher costs than the status quo.
Broad applicability
Third, the Department considered applying the proposed regulation
broadly to all service arrangements that rely on the section 408(b)(2)
service provider exemption for relief from ERISA's prohibited
transaction rules. Upon further consideration, this alternative was
rejected because the Department believed that the proposal's written
disclosure requirements should be targeted to a more specifically
defined group of service providers. The Department believes that
certain service arrangements generally do not involve complex
compensation arrangements or conflicts of interest, and therefore need
not be separately regulated in order to ensure that compensation
information is disclosed. Benefits from this alternative and the
proposed rule would be similar and benefits would be accruing primarily
to those plans with complex service provider arrangements. This
alternative would be more costly than the proposed framework as more
service providers would be affected.
Specific framework with limited application
Lastly, the Department considered, and ultimately has adopted as
its
[[Page 70996]]
proposal, a rule requiring that, in order to be reasonable, a contract
or arrangement for services must mandate that certain sets of service
providers disclose specified information about their compensation and
conflicts of interest. The proposal covers typical plan service
providers that are most likely to have complex compensation
arrangements or conflicts of interest. They include: fiduciary service
providers; providers furnishing banking, consulting, custodial,
insurance, investment advisory or management, recordkeeping, securities
or other investment brokerage, or third party administration services;
or providers who receive indirect compensation for accounting,
actuarial, appraisal, auditing, legal or valuation services. The
Department believes this framework will yield the information that plan
fiduciaries need in order to assess the reasonableness of compensation
paid for services from these service providers. Absent the regulation,
such information may be difficult to obtain. The Department believes
that the proposed rule provides the largest benefit among the four
alternatives, while also limiting the costs.
(5) Characterization of Affected Entities
(a) Interaction of Affected Entities
The Department considered the costs and benefits of the proposed
regulation over a 10-year time frame beginning in 2008. The proposed
regulation will apply to all contracts or arrangements between plan
fiduciaries and service providers that fall within its scope. The
Department believes that other entities also may be affected either
directly or indirectly by the proposal, including plan participants and
plan sponsors. Using data from plan year 2003 submissions of Form 5500
and Schedule C, the Department developed a detailed industry profile to
obtain information on these entities and their growth over the analysis
period. The industry profile also describes the interactions among
these entities and the influence of the proposed regulation on these
interactions.\22\
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\22\ See Technical Appendix A to the 408(b)(2) Regulatory Impact
Analysis, which is available as part of the public docket associated
with this regulation, for details.
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(b) Growth of Affected Entities Over Time
To estimate the costs of the rule in future years, it is necessary
to project the growth of the affected entities. To estimate this
growth, the Department calculated a growth rate from past data on
pension plans and participants. This growth rate was used to project
the numbers of potentially affected entities in future years out to
2020. In the absence of more specific information, the Department
assumed a growth in pension plans and participants equal to that of the
labor force and the economy. The estimated growth rate was thus based
on industry-wide trends in pension plans and participants.
The Department used data from 1985 to 2005 on numbers of defined
benefit (DB) and defined contribution (DC) plans.\23\ Since 1985, there
has been a dramatic increase in the number of 401(k) plans, while other
DC and DB plans show a marked decrease. Overall, there are slight
increases in the total number of plans and participants. These
increases are driven by the growth of 401(k) plans.
---------------------------------------------------------------------------
\23\ Investment Company Institute, 401(k) Plans: A 25-Year
Retrospective (Dec. 2006) at 3.
---------------------------------------------------------------------------
The Department estimated a growth rate model based on fitting an
exponential curve function through the data points. This growth rate
model was then used to predict future numbers of plans and
participants. The results showed steady increases in the total number
of plans (from about 800,000 in 2010 to 850,000 in 2020) and
participants (from around 81,800,000 in 2010 to 90,800,000 in 2020) for
the years 2010 through 2020.
(c) Quantitative Characterization of Affected Entities
The Department undertook a quantitative characterization of the
benefit plan industry to gain additional information on the entities
the Department believes would be affected by the rule. This subset of
employer-sponsored plans was used for this characterization due to the
availability of data on these types of plans. Data from plan year 2003
submissions of Form 5500, a yearly filing required for many benefit
plans, were used for this analysis. The general approach of this
characterization was to look at the two major plan types, pension
(defined benefit and defined contribution) and welfare, and, where
appropriate, subcategories within each plan type.
For plan year 2003, there were around 762,000 benefit plans for
which a Form 5500 was filed, 676,000 of which were pension plans and
roughly 86,000 of which were welfare plans. This population of benefit
plans can be divided into large plans ([gteqt]100 participants) and
small plans (< 100 participants), according to the filing instructions
for Form 5500. For plan year 2003, there were nearly 153,000 large
plans and nearly 610,000 small plans. Thus, most employee benefit plans
have fewer than 100 participants.
The Department made a rough characterization of the plan sponsor
population using data collected via Form 5500. For all plans filed that
year, there were over 622,000 plan sponsors, with about 86 percent of
sponsors having only one benefit plan. Among plans filed for 2003,
there were nearly 79,000 sponsors of large plans and over 555,000
sponsors of small plans. The Department believes, however, that these
numbers might be slightly overestimated due to some plan sponsors
filing under more than one employer identification number.
The Department characterized data for service providers to benefit
plans from Schedule C submissions for plan year 2003. Compared to plan
sponsor data, the data on service providers was very limited, as only a
subset of plans must file Schedule C. For example, data for services
and service providers to small plans, which account for over 80 percent
of all plans, are not represented in the Schedule C filings. In terms
of the number of service providers per plan, almost three quarters (72
percent) of the plans listed using one or two service providers, and 95
percent of the plans used 10 or less service providers. Only 14 plans
used 40 or more unique service providers.
The Department also characterized the number of affected services
provided by plan type and size (based on the number of participants)
for all plans that filed Schedule C for plan year 2003, or the number
of plan-provider arrangements. There were nearly 55,000 affected plan-
provider arrangements for pension plans, and nearly 31,000 affected
plan-provider arrangements for welfare plans. This analysis resulted in
an estimate of the number of affected service providers to pension
plans as nearly 9,878, and to welfare plans as 7,519, for a total
number of about 15,600 affected service providers (providers that
service both markets are counted only once). Although this analysis
only covered a subset of the service provider market, the Department
believes that this analysis included most of the affected service
providers. Additional characterizations of service providers in terms
of the services provided and compensation received are presented in
Technical Appendix A to the 408(b)(2) Regulatory Impact Analysis.
The Department characterized benefit plan participants from Form
5500 submissions for plan year 2003. This analysis showed roughly 151.8
million pension plan participants and 162.7 million welfare plan
participants. The totals for pension plans and welfare
[[Page 70997]]
plans may overlap, as individuals may participate in more than one type
of plan.
(6) Benefits
As an example of the kind of benefits that could arise from this
rule, the Department considered the possible benefits to defined
contribution pension plans. The Department considered these benefits of
the proposal from a qualitative perspective due to the ambiguous nature
of the benefits arising from the proposal and the difficulty of
quantifying them. Primary benefits of the proposal were thought to
result from the potential for reduced unit costs incurred by plans for
fiduciaries to search for service providers. This potential reduced
unit cost of searching would encourage plan fiduciaries to obtain
information from a larger set of service providers when they were
making decisions about which provider to engage. Additionally,
fiduciaries would have fewer barriers to changing service providers if
they were not happy with their current fees or the returns they were
receiving.
The social benefits arising from the proposal would be the sum of
three different possible categories of primary benefits: possible lower
fees paid by plans, possible increased efficiency due to reduced
conflicts of interest, and possible higher returns due to reduced unit
search costs incurred by plans. The magnitude of these benefits would
depend in part on the degree to which the proposal actually resulted in
lower search costs, and the degree to which different kinds of
inefficiency currently exist in the market for service providers. A
graphical analysis of these primary benefits is provided in Technical
Appendix A to the 408(b)(2) Regulatory Impact Analysis which shows how
the proposal lowers the marginal search costs for plans and how this
cost reduction results in a greater amount of searching effort
performed at a lower cost. The graphical analysis also shows the total
net benefits to plans from the increased search effort by fiduciaries
and the total societal net benefits of the reduction in unit search
costs for service providers.
In addition to the potential primary benefits of the proposal, the
Department identified potential secondary benefits due to possible
higher rates of investment by participants in defined contribution
pension plans. These secondary benefits could potentially arise from
increased plan efficiencies and better investment choices by plan
fiduciaries, and possibly from increases in plan participants'
confidence in their plans as well. With greater transparency of fee
structures, plan participants may have increased levels of confidence
in their plans and may feel that their investment opportunities are
more attractive. This increased confidence and attractiveness of
investments could in turn result in a higher rate of investment in
plans by plan participants. The existence and magnitude of these
secondary benefits would depend on the preferences of employees in
trading current for future consumption. Possible increases in rates of
investment would be a benefit to society if the rate of return on
capital investment were greater than the social rate of time preference
between current and future consumption. Both of these issues are
covered in Technical Appendix B to the 408(b)(2) Regulatory Impact
Analysis.
(7) Costs
The Department estimated costs for the proposal over the 10-year
time frame for the analysis. The primary costs of the rule are seen to
accrue to service providers. \24\ The Department used information from
the quantitative characterization of the service provider market
presented above as a basis for these cost estimates. This
characterization did not account for all service providers, but did
provide information on the segments of the service provider industry
that are likely to be most affected by the proposal (i.e., those who
service pension plans). In addition to the costs to service providers,
the Department also considered other potential costs and savings from
the proposal, including savings to plan participants and costs to the
plan due to its fiduciaries' review of any additional material they
receive as part of the required disclosures.
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\24\ Costs to service providers might be ultimately borne by
plans and their participants.
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(a) Costs to Service Providers
(i) Initial costs. When the Department publishes the proposal,
affected service providers will need to evaluate whether their current
disclosure practices comply with the proposal and, if not, how their
practices must be changed to be compliant. The Department projected
this as a cost incurred in the year in which the rule takes effect.
The Department assumed that all affected service providers will
incur a cost for rule familiarization, and estimated this cost to be
one hour per service provider. The Department assumed that the rule
familiarization would be performed by an in-house professional-level
employee at a cost of $56 per hour. \25\ Using the number of unique
service providers identified in the quantitative analysis presented
earlier (15,600), this cost was estimated to be about $870,000 (15,600
x 1 x $56).
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\25\ The hourly wage estimates used in this analysis are
estimates for 2007 and are based on data from the Bureau of Labor
Statistics National Occupational Employment Survey (May 2005) and
the Bureau of Labor Statistics Employment Cost Index (Sept. 2006).
---------------------------------------------------------------------------
Although all affected service providers are assumed to incur these
initial costs, it is more likely that only service providers with
complex fee arrangements and conflicts of interest would find a formal
review process to be necessary. The Department assumed that the number
of service providers undertaking this kind of formal review is similar
to the number of unique service providers who are reported on the
Schedule C as having received $1 million or more in compensation
(2,100). Assuming that 24 working hours would be required to read the
proposal, review a service provider's current disclosure practices, and
describe needed changes, if any, the initial cost of legal review is
around $5.4 million (2,100 service providers x 24 hours x $106 in-house
lawyer rate).
Affected service providers must also develop or update their
current disclosure statements. This activity includes developing
formulae and algorithms to estimate direct and indirect compensation
that will be applied in a pro forma projection for each plan with which
the provider will contract. The Department again assumed that the
majority of this cost would be incurred by service providers in the
first year of the analysis period. The existing amount of disclosure
supplied by many service providers is likely to be adequate for
compliance with the new rule. For example, a service provider offering
unbundled trustee services or unbundled participant communications
services is likely to stipulate a single direct payment that is already
being adequately disclosed in the absence of the new rule. For this
calculation, the Department assumed that the number of unique service
providers reported on the Schedule C as having received $1 million or
more in compensation (2,100) is a reasonable proxy for the number of
service providers that will need to update their current disclosure
statements. The Department assumed that 80 working hours would be
required to implement changes to disclosure statements, producing a
cost of about $9.4 million (2,100 service providers x 80 hours x $56
in-house professional rate).
[[Page 70998]]
(ii) Recurring costs.
In addition to the initial costs identified above, the Department
estimated the burden for two recurring costs that would accrue during
each subsequent year of the analysis period. The first recurring cost
was for service providers entering the market (either for the first
time or by re-entry) to provide service to plans after the first year
of applicability. These firms incur the initial cost of rule
familiarization. The Department has assumed that one-twelfth (1,300 =
15,600 x \1/12\) of all service providers are new in each year
subsequent to the first.\26\ Familiarization costs then equal around
$73,000 (1,300 service providers x 1 hour x $56 in-house professional
rate).
---------------------------------------------------------------------------
\26\ Industry growth, and therefore the growth in the number of
service providers over time, has been addressed in Exhibit 7-4. For
example, in 2009 the Department has assumed that there are 12% more
service providers than in 2003.
---------------------------------------------------------------------------
The second recurring cost arises from affected service providers
needing to develop the written disclosure statement each time the
``contracts and arrangements entered into,'' are ``extended, or
renewed.'' Many contracts between plans and service providers have
multi-year terms, automatic annual renewals, or no specific term
(having instead a provision for either party to terminate at will).\27\
Despite these longer contract terms, though, even these contract types
are likely to include, at least annually, material changes to elements
such as unit costs. The Department thus estimated one disclosure per
year per contract between a plan and service provider.\28\ Service
providers may provide similar written disclosures as plan
administrators ask for multiple bids for a single service or as plan
administrators ask for costs for multiple investment or service options
from a single provider. These additional written disclosures are not
strictly subject to the proposal because they are not directly related
to a transaction. For this reason, these additional disclosures were
not included in the estimated costs of the rule.
---------------------------------------------------------------------------
\27\ Please note that 29 CFR 2550.408b-2(c) provides, in part,
that a contract or arrangement for services must be terminable, on
reasonably short notice, by a plan.
\28\ These recurring costs are assumed to accrue every year,
starting with the first year.
---------------------------------------------------------------------------
Exhibit 7-1 presents an estimate of the number of contracts using
Form 5500 data from plan year 2003. The projection assumes that those
who are not Schedule C filers have as many providers on average as
Schedule C filers. Firms such as insurance companies that may be
service providers for purposes of the proposal may have been reported
on Schedule A. These firms are not included in this estimate.
Exhibit 7-1.--Number of Disclosures Per Year
--------------------------------------------------------------------------------------------------------------------------------------------------------
Affected service
Schedule C Affected Affected Affected provider
Type and number of participants Number of plans filers schedule C provider-plan providers per arrangements
filers arrangements plan (projected)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Pension (DB, DC) < 100 participants.......... 596,641 526 444 613 1.38 823,741
Pension (DB, DC) 100-499 participants....... 57,961 16,680 15,289 18,846 1.23 71,446
Pension (DB, DC) 500-1,000 participants..... 8,958 4,774 4,488 7,470 1.66 14,910
Pension (DB, DC) >1,000 participants........ 12,427 8,478 8,077 28,255 3.50 43,472
All Pension (DB, DC)........................ 675,987 30,458 28,298 55,227 ................ 953,569
Welfare < 100 participants................... 13,095 801 738 913 1.24 16,200
Welfare 100-499 participants................ 46,224 7,366 6,736 8,811 1.31 60,463
Welfare 500-1,000 participants.............. 10,475 2,558 2,377 4,286 1.80 18,888
Welfare >1,000 participants................. 16,670 5,075 4,780 16,946 3.55 59,098
All Welfare................................. 86,464 15,800 14,631 31,025 ................ 154,649
All Plans................................... 762,451 46,258 42,929 86,692 ................ 1,108,218
--------------------------------------------------------------------------------------------------------------------------------------------------------
The Department assumed that many written disclosure statements
under the proposal could be made routine and automatic. In the absence
of good data on the number of easily automated versus not easily
automated disclosure statements, the Department estimated that 70
percent are easy and would not require any significant time to produce,
and 30 percent are complex, requiring 1 hour and 40 minutes to produce.
The weighted average for the time needed is therefore 0.5 hours per
written disclosure, yielding a recurring contracting disclosure cost of
around $31 million (1,108,000 disclosures x 0.5 hours x $56 in-house
professional rate). The Department invites the public to comment on
these assumptions.
A summary of the initial and recurring labor costs is shown below
in Exhibit 7-2.
Exhibit 7-2.--Summary of Initial and Recurring Labor Costs
----------------------------------------------------------------------------------------------------------------
Affected
quantity (2003 Hours Labor rate Total (2007$s)
data) (2007$s)
----------------------------------------------------------------------------------------------------------------
Initial Cost 1 (First Year)............. 15,609 1 $56 $874,104
Initial Cost 2 (First Year)............. 2,101 24 106 5,344,944
Initial Cost 3 (First Year)............. 2,101 80 56 9,412,480
[[Page 70999]]
Subtotal Initial Cost................... ................ ................ ................ 15,631,528
�����������������������������������������
Recurring Cost 1 (Subsequent Years)..... 1, 300 1 56 72,800
-----------------------------------------------------------------------
Recurring Cost 2 (All Years)............ 1,108,218 0.5 56 31,030,104
----------------------------------------------------------------------------------------------------------------
Lastly, the Department estimated annual materials costs
attributable to the disclosures required under the proposal. The
Department's proposal does not provide detailed guidance on the format
of the disclosure. However, the Department previously made available on
its Web site (http://www.dol.gov/ebsa) a Model Fee Disclosure Form
developed in cooperation with industry representatives that reflects
similar types of information and runs to 11 pages. The disclosures are
thus assumed to add 11 pages to existing written materials in each
year. Paper and printing costs are estimated at $0.05 per page. The
Department assumed that there would be no significant additional
postage costs because the disclosures, in most cases, could be included
with other written materials given to the plan before the contract is
entered into. [Total material costs are therefore roughly $609,500
($0.05 per page x 11 additional pages x 1,108,000 disclosures).]
This materials cost was then added to the initial and recurring
costs to estimate the total costs of the rule. These calculations are
summarized below in Exhibit 7-3.
Exhibit 7-3.--Summary of Total Initial and Recurring Costs by Year
----------------------------------------------------------------------------------------------------------------
Labor costs Materials costs Total costs
----------------------------------------------------------------------------------------------------------------
First Year: Initial Costs................................. $15,631,528 ................ ................
First Year: Recurring Costs 2............................. 31,030,104 $609,520 ................
-----------------------------------------------------
First Year: Cost Total................................ 46,661,632 609,520 47,271,152
Subsequent Years: Recurring Costs 1....................... 72,800 ................ ................
Subsequent Years: Recurring Costs 2....................... 31,030,104 609,520 ................
-----------------------------------------------------
Subsequent Years: Cost Total.......................... 31,102,904 609,520 31,712,424
----------------------------------------------------------------------------------------------------------------
Exhibit 7-4 below shows the projection of costs over the 10-year
time horizon for the proposal. The number of service providers is
expected to grow above the number projected from plan year 2003 Form
5500 data. In order to quantify the increase in affected service
providers over time, the Department has used 1997 and 2002 Economic
Census data from the U.S. Census Bureau. The growth in ``Portfolio
Managers'' (NAICS 523920) between the 1997 and 2002 Economic Census
represents a compound annual growth rate of 3.8 percent and was
utilized for this analysis as an approximation of the growth rate for
all affected service providers. The Department applied a conservative
growth rate of half that historical value, 1.9 percent, to the plan
year 2003 Form 5500 data. A real discount rate of 7 percent, as
recommended in OMB Circulars A-94 and A-4, was applied to the ten-year
stream of costs to obtain an estimate of the net present value of the
costs. The 7 percent rate is an estimate of the average before-tax rate
of return to private capital in the U.S. economy. The analysis is
relatively insensitive to the value of the discount rate. Since the
benefits of the proposal are not quantified, this net present value of
the costs is also equal to the Department's estimate of the quantified
net costs of the rule.
Exhibit 7-4.--Calculation of Net Present Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Growth in
Real 2007 service Real 2007 Discounted 2007
Year dollars providers from constant dollars Discount factor dollars
2003 with growth
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008.......................................................... $47,271,152 1.099 $51,950,996 0.935 $48,574,181
2009.......................................................... 31,712,424 1.120 35,517,915 0.873 31,007,140
2010.......................................................... 31,712,424 1.141 36,183,876 0.816 29,526,043
2011.......................................................... 31,712,424 1.163 36,881,549 0.763 28,140,622
2012.......................................................... 31,712,424 1.185 37,579,222 0.713 26,793,986
2013.......................................................... 31,712,424 1.207 38,276,896 0.666 25,492,413
2014.......................................................... 31,712,424 1.230 39,006,282 0.623 24,300,913
2015.......................................................... 31,712,424 1.253 39,735,667 0.582 23,126,158
2016.......................................................... 31,712,424 1.277 40,496,765 0.544 22,030,240
2017.......................................................... 31,712,424 1.301 41,257,864 0.508 20, 958,995
-----------------------------------------------------------------------------------------
Total..................................................... ................ ................ ................ ................ 279,950,691
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 71000]]
(b) Cost Savings for Plan Participants
The proposal may allow fiduciaries to make even better choices
among offers from competing service providers and among options offered
by any service provider. Since the fiduciary makes these choices in the
best interest of the participants and beneficiaries, cost savings
generally accrue to the plan and thus plan participants. The Department
cannot directly quantify the amount of savings. The Department can,
however, calculate a threshold value for the point at which the cost
savings equal the costs identified above.
Because the largest costs to plans generally are investment
management costs, it is useful to express the threshold in terms of a
percent against assets. Total assets held in private defined benefit
and defined contribution plans in 2005 were $4.9 trillion.\29\ If more
than 8 percent of plans realize expense reductions of 1 basis point
(one one-hundredth of a percent), then cost savings will exceed costs.
The Department assumes that at least 8 percent of plans will experience
a reduction of at least 1 basis point. Therefore, cost savings are
expected to exceed costs. These results are summarized below in Exhibit
7-5. The Department invites the public to comment on these assumptions.
---------------------------------------------------------------------------
\29\ Investment Company Institute, 401(k) Plans: A 25-Year
Retrospective (Dec. 2006) at 3.
Exhibit 7-5.--Calculation of Threshold Value at Which Cost Savings Equal
Costs
------------------------------------------------------------------------
------------------------------------------------------------------------
A.................... Annuity Equivalent to $39,858,680
$280.0 M.
B.................... Total Assets............ $4,861,000,000,000
C.................... Assets x 1 basis point.. $486,100,000
D = A/C.............. Threshold Percent of 8%
Firms.
------------------------------------------------------------------------
(c) Costs to Plans
Plan fiduciaries already have a fiduciary duty to evaluate the
reasonableness of offers from service providers, and they already have
access to tools like the Model Plan Fee Disclosure Form to assist them
in asking service providers questions in order to encourage disclosure.
The proposed changes to the Department's regulation under section
408(b)(2) of the Act attempt to facilitate this duty by providing a
framework as to what must be disclosed concerning service arrangements
and by requiring service providers to provide such disclosures in order
to benefit from the section 408(b)(2) statutory exemption.
On the other hand, some plans may incur costs under the proposal.
First, the new written disclosures are likely to become longer and more
detailed than what fiduciaries are currently receiving. The prudent
fiduciary may spend additional hours reviewing the longer written
disclosure document, resulting in costs to their plan. In addition,
some fiduciaries may be concerned that the availability of the detailed
written disclosures exposes them to potential fiduciary liability.
Fiduciaries could go so far as to hire outside consultants to review
and evaluate the new written disclosures, which would again result in
costs to their plans.
On the whole, the Department projects that the amount of time saved
by fiduciaries in gathering data is offset by the additional time spent
by them in reviewing additional data. These potential costs to plans
were thus not included in the estimates. The amount of time spent by
fiduciaries is likely to be similar with or without the proposal,
though: As was previously discussed in the benefits section, the time
spent under the proposal evaluating and documenting fees as reasonable
is likely to be more efficient than in the baseline.
(8) Initial Regulatory Flexibility Analysis
The Regulatory Flexibility Act (5 U.S.C. 601, et seq.) (RFA)
imposes certain requirements with respect to Federal rules that are
subject to the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551, et seq.) and which are
likely to have a significant economic impact on a substantial number of
small entities. Unless an agency determines that a proposal is not
likely to have a significant economic impact on a substantial number of
small entities, section 603 of the RFA requires that the agency present
an initial regulatory flexibility analysis (IRFA) at the time of the
publication of the notice of proposed rulemaking describing the impact
of the rule on small entities and seeking public comment on such
impact. Small entities include small businesses, organizations and
governmental jurisdictions.
In response to this request, the Department prepared an IRFA of the
proposal because, although the Department considers it unlikely that
the rule will have a significant effect on a substantial number of
small entities, the Department does not have enough information to
certify to that effect.
(a) Reasons for and Objectives of the Proposal
Employee benefit plans have evolved over the past several years,
resulting in service providers having more complex compensation
arrangements and conflicts of interest. Thus, plan fiduciaries face
greater difficulty in assessing whether the compensation paid to their
service providers is reasonable. This proposal is intended to help plan
fiduciaries get the information they need to negotiate with and select
service providers who offer high quality services at reasonable rates.
The reasons for and objectives of this proposed regulation are
discussed in detail in Section A of this preamble, ``Background,'' and
in section 3 of the Regulatory Impact Analysis (RIA), ``Need for
Regulatory Action.'' The legal basis for the proposal is set forth in
the ``Authority'' section of this preamble, below.
(b) Estimating Compliance Requirements for Small Entities
The Department estimated the number of small entities that would be
required to make disclosures under the proposal by examining 2002
Economic Census data for industries in North American Industry
Classification System (NAICS) codes for activities affected by the
proposal. Next, the Department used information on firms in the
affected NAICS codes to estimate the population of affected firms. From
this analysis, the Department estimated that about 14,600 small firms
would incur costs under the proposal. Further detail on this estimation
procedure is provided in Technical Appendix C to the 408(b)(2)
Regulatory Impact Analysis.
To determine the impact of the rule on small entities, the
Department examined the initial and recurring costs that would be borne
by small firms in further detail. As discussed in Section 7, the
initial costs are estimated to amount to $56 for every small entity for
rule
[[Page 71001]]
familiarization, and roughly $7,000 for more in-depth review and
changes to disclosure practices for small entities at the larger end of
the range, or those with over $1,000,000 in annual revenues. These
costs, which are at most less than one percent of a single year's
revenues, should be easily affordable for all small entities.
The impact of recurring costs will depend on the number of plans
served by each firm, and the fraction of plans requiring complex
disclosures. In an attempt to determine the numbers of plans served by
small service providers relative to large ones, the Department examined
data from Form 5500 filings for plan year 2003. These data showed a
strong tendency for smaller service providers (measured in terms of the
total number of participants served) to serve plans of smaller average
size. The Department found that, if all plans with 5 or fewer
participants are served by the smallest of the service providers, it is
possible that up around 5,150 small entities could face costs equal to
one percent of revenues. Comparing this maximum to the total number of
small entities bearing costs under this rule (about 14,600), or roughly
one third of affected small entities could possibly bear ongoing costs
equal to one percent of revenues as a result of the proposal. Because
these magnitudes are above the thresholds commonly used to measure
impacts on small entities, the Department considered it inappropriate
to certify that the rule would not cause a ``significant impact on a
substantial number of small entities.''
In conclusion, the Department believes that the rule is very likely
to result in costs that are insignificant in comparison to revenues for
all but the smallest affected entities. This conclusion, however, is
subject to considerable uncertainty, due largely to a lack of data on
both small plans and small service providers. The Department believes
that it is at least possible for a substantial number of small entities
to bear costs that could be considered significant, and therefore, the
Department examined the issue in detail. Additional detail on the
Department's analysis of this issue can be found in Technical Appendix
C to the 408(b)(2) Regulatory Impact Analysis.
(c) Considered Alternatives
In accordance with the RFA, the Department considered whether
several alternatives to the proposed regulation would minimize the
economic impact on affected small entities. The Department also
considered the anticipated benefits of the proposal for these entities.
These alternatives are described further below, followed by a
discussion of the Department's chosen alternative.
(i) Exemption for Small Entities.
The Department considered exempting from the requirements of the
proposed regulation small service providers with a threshold of $6.5
million in annual revenue. The threshold of $6.5 million follows from
the Small Business Administration's definition of small firms.\30\ An
exemption may lessen the burden on small service providers, to the
extent such small service providers are not already providing written
disclosures that would comply with the requirements of the proposed
regulation. The Department believes, however, that such an exemption
would not comport with the rule's objectives of providing plan
fiduciaries with the information they need to assess the reasonableness
of service fees. There is no indication that small service providers
are any less likely to have complex fee arrangements or conflicts of
interest. Instead, the Department has determined that the likely
existence of complex fee structures and conflicts of interest depends
more on the nature of the service provided than upon the size of the
service provider. Accordingly, the Department has narrowed the
proposal's scope to providers of a limited set of services, such as
investment advice and management.
---------------------------------------------------------------------------
\30\ U.S. Small Business Administration, ``Table of Small
Business Size Standards Matched to North American Industry
Classification System Codes.'' Available online at: http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf.
For further discussion please see the Technical
Appendix Section C which can be accessed at the Department's Web
site at http://www.dol.gov/ebsa.
---------------------------------------------------------------------------
The Department believes that small providers and the plans they
serve will benefit from the proposal, because it will clarify the
information that must be disclosed to responsible plan fiduciaries.
(ii) Delaying Implementation for Small Service Providers.
The Department also considered delaying implementation of the
proposal for small service providers and small plans. This delay would
provide these parties with more time to become familiar with the
disclosure requirements, over a period of up to two years beyond the
rule's generally applicable effective date. However, similar to the
Department's rationale for deciding not to provide an exemption for
small entities, the Department believes that plans, large and small,
contracting with small service providers need the information required
by the proposal in order to determine the reasonableness of service
provider fees. Further, the Department does not believe there is any
benefit to delaying application of this proposal, because doing so
would delay the benefits to all plans of the proposal's required
disclosures. Failure to obtain such information could cause plans to
pay too much for services.
(iii) Benefits of the Proposal to Small Plans.
The Department believes that small plans will benefit significantly
from the proposal. Fiduciaries to small plans may sometimes have
trouble obtaining complete disclosures from potential service
providers. Because the proposal is conditioned on compliance by both
responsible plan fiduciaries and service providers, the Department
believes that it will assist small plan fiduciaries in obtaining the
information they need to make informed decisions when selecting service
providers. Additionally, responsible plan fiduciaries for plans, both
large and small, will benefit from the clarity that the proposal
provides concerning the specific information that the Department
believes is relevant to these decisions.
(d) The Selected Alternative
The Department considered and selected a disclosure framework that
outlines what disclosures must be included in a ``reasonable'' contract
or arrangement. As indicated above, small plans will benefit from this
increased information at least as much as large plans will. Because
there is no standard form for the disclosure, small service providers
with relatively simple compensation arrangements and few, if any,
conflicts of interest can provide a relatively simple, short written
disclosure. The Department also limited the application of the rule to
certain classes of services providers, as discussed above in the
``Scope'' section of the preamble. By limiting the scope of the
regulation to contracts or arrangements with service providers that are
more likely to have complicated fee structures and conflicts of
interest, the Department believes that the proposal will avoid
unnecessary burdens on small service providers that will not be subject
to its written disclosure requirements.
(e) Duplicative, Overlapping, and Conflicting Rules
The Department identified two rules that potentially overlap or
duplicate the proposal: Changes to the Form 5500,
[[Page 71002]]
Schedule C, and The Investment Advisers Act of 1940.
(i) Changes to the Form 5500, Schedule C.
Recent changes to the Form 5500, Schedule C, clarify the
requirements for the reporting of direct and indirect compensation
received by service providers. Also, Schedule C requires that the
source and nature of compensation in excess of $1,000 received from
parties other than the plan or the plan sponsor be disclosed for
certain key service providers.
Both the revised Schedule C requirements and the proposal aim to
make indirect compensation received by service providers more
transparent. The proposal, however, requires disclosure of compensation
and fees in advance of contract performance so that the fiduciary can
assess their reasonableness before they are paid. The Form 5500
revisions, on the other hand, require disclosure of actual compensation
and fees after contract performance.
Small plans need not file the Schedule C, so the rule does not
overlap for over 90 percent of plans. In addition, because small plans
may tend to use small service providers, the existing relief for small
plans from filing the Schedule C also minimizes the burden on small
service providers.
(ii) The Investment Advisers Act of 1940.
The Investment Adviser's Act of 1940 authorizes the U.S. Securities
Exchange Commission (SEC) to regulate investment advisors. The SEC
requires SEC-registered investment advisers to disclose compensation
and conflicts of interest to clients using the SEC Form ADV.
Some of the information disclosed on Form ADV may be similar to
disclosures required by this proposal, which also will elicit
information about indirect compensation and conflicts of interest.
However, the Department clarifies above in the preamble that parties
may satisfy the proposal's disclosure requirements by incorporating
other written materials. This flexibility is afforded to parties in
order to avoid unnecessary duplication. Thus, the Form ADV may serve as
part of the disclosure made by service providers to comply with the
proposal. Further, many of the service providers covered by the
proposal are not subject to the Investment Advisers Act.
(f) Congressional Review Act Statement
This notice of proposed rulemaking is subject to the Congressional
Review Act provisions of the Small Business Regulatory Enforcement
Fairness Act of 1996 (5 U.S.C. 801 et seq.) and, if finalized, will be
transmitted to the Congress and the Comptroller General for review.
(g) Unfunded Mandates Reform Act Statement
For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L.
104-4), as well as Executive Order 12875, the notice of proposed
rulemaking does not include any federal mandate that will result in
expenditures by state, local, or tribal governments in the aggregate of
more than $100 million, adjusted for inflation, or increased
expenditures by the private sector of more than $100 million, adjusted
for inflation.
(9) Paperwork Reduction Act
As part of its continuing effort to reduce paperwork and respondent
burden, the Department of Labor conducts a preclearance consultation
program to provide the general public and Federal agencies with an
opportunity to comment on proposed and continuing collections of
information in accordance with the Paperwork Reduction Act of 1995 (PRA
95) (44 U.S.C. 3506(c)(2)(A)). This helps to ensure that the public
understands the Department's collection instructions; respondents can
provide the requested data in the desired format, the reporting burden
(time and financial resources) is minimized, and the Department can
properly assess the impact of collection requirements on respondents.
Currently, the Department is soliciting comments concerning the
information collection request (ICR) included in the Proposed Rule on
Reasonable Contract or Arrangement Under Section 408(b)(2). A copy of
the ICR may be obtained by contacting the person listed in the PRA
Addressee section below. The Department has submitted a copy of the
proposal to OMB in accordance with 44 U.S.C. 3507(d) for review of its
information collections. The Department and OMB are particularly
interested in comments that:
Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility;
Evaluate the accuracy of the agency's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
Enhance the quality, utility, and clarity of the
information to be collected; and
Minimize the burden of the collection of information on
those who are to respond, including through the use of automated,
electronic, mechanical, or other technological collection techniques,
e.g., by permitting electronic submission of responses.
Comments should be sent to the Office of Information and Regulatory
Affairs, Office of Management and Budget, Room 10235, New Executive
Office Building, Washington, DC 20503; Attention: Desk Officer for the
Employee Benefits Security Administration. Although comments may be
submitted through February 11, 2008, OMB requests that comments be
received within 30 days of publication of the Notice of Proposed
Rulemaking to ensure their consideration. Please note that comments
submitted to OMB are a matter of the public record.
PRA Addressee: Address requests for copies of the ICR to Gerald B.
Lindrew, Office of Policy and Research, U.S. Department of Labor,
Employee Benefits Security Administration, 200 Constitution Avenue,
NW., Room N-5718, Washington, DC 20210. Telephone: (202) 693-8410; Fax:
(202) 219-4745. These are not toll-free numbers. ICRs submitted to OMB
are also available at reginfo.gov (http://www.reginfo.gov/public/do/PRAMain
).
(a) The Proposal
The ICRs are contained in paragraph (c)(1)(iii) of the proposal and
pertain to the written disclosure requirements that the service
provider must make whenever a contract or arrangement is entered into,
extended, or renewed as a condition to the relief provided by the
proposal. The written disclosure must include a description of the
specific services to be provided, the direct and indirect compensation
or fees to be received by the service provider, and the manner of
receipt of such compensation or fees. It must also include a statement
concerning whether the service provider will provide any services to
the plan as a fiduciary and statements about the potential for
conflicts of interest.
The Department estimates that about 15,600 affected service
providers would need to review the rule and their current disclosure
practices in the first year. The Department assumed that the rule
familiarization would require one hour and be performed by an in-house
professional-level employee at a cost of $56 per hour.
In years subsequent to the first year of applicability, the
Department estimates that providers newly entering the market for plan
services will need to become familiar with the rule. One-twelfth
(around 1,300) of all service
[[Page 71003]]
providers are assumed to be new to the market for plan services in each
year subsequent to the first.\31\ The Department again assumed that the
rule familiarization would take one hour and would be performed by an
in-house professional-level employee at a cost of $56 per hour.
---------------------------------------------------------------------------
\31\ Industry growth, and therefore the growth in the number of
service providers over time, has been addressed in Exhibit 7-4. For
example, in 2009 the Department has assumed that there are 12% more
service providers than in 2003.
---------------------------------------------------------------------------
The Department assumed that 2,100 affected service providers would
have more complex fee arrangements and would therefore need to
undertake a more formal review of their disclosure practices in the
first year. The Department assumed that this formal review would
require 24 working hours and be performed by an in-house lawyer at an
estimated cost of $106 per hour. The Department assumed that the same
affected providers (2,100) would also need to update templates and
processes for disclosure in the first year. This update is assumed to
require 80 working hours and be performed by a in-house profession-
level employee at a cost of $56 per hour, as described above.
The Department estimates that 1,108,000 contracts or arrangements
exist between service providers and plans and that each contract or
arrangement will require a written disclosure. It is assumed that
contracts or arrangements are either entered into or renewed once in
each of the first three years after the regulation would become
effective. Preparation and delivery of the required disclosure is
assumed to add, on average, one half hour to the process of entering
into a contract or arrangement. Preparation and delivery are assumed to
be performed by an in-house professional-level employee at a cost of
$56 per hour. The average annual burden hours across the first three
years is therefore estimated as 633,000 hours. The equivalent cost for
this burden hour estimate is about $36,290,000 per year.
In addition to burden hours, the Department has estimated annual
materials costs attributable to the disclosure. The Department's
proposal does not provide detailed guidance on the content or format of
the disclosure. However, the Department makes available a model 401(k)
plan fee disclosure form that represents similar types of information
and runs to 11 pages. The disclosures are assumed to add 11 pages to
existing written contracts in each year. Paper and printing costs were
estimated at $0.05 per page. It is assumed that there are no postage
costs because, in most cases, the disclosures simply add content to
what would generally be a written contract even absent the proposal.
For each of the first three years, materials costs are therefore
estimated to be roughly $609,500 (1,108,000 disclosures x 11 pages x
$0.05 per page cost).
(b) The Proposed Class Exemption
Not only does the proposal provide that the terms of the service
contract must require the service provider to disclose its compensation
and conflicts of interest, the service provider must also comply with
the contract on an on-going basis and actually disclose this
information in writing to the responsible plan fiduciary. If the
service provider fails to disclose the data, then the provision of
services will constitute a prohibited transaction under ERISA section
406(a)(1)(C) because it will not be considered a ``reasonable contract
or arrangement'' exempted by ERISA section 408(b)(2). Therefore, in
such instances, the responsible plan fiduciary will have violated
section 406(a)(1)(C) even if it made every effort to comply with the
proposed regulation by entering into, or extending or renewing, a
written contract that required such disclosures. The failure to make
the required disclosures also would result in a prohibited transaction
by the service provider under section 4975(c)(1)(C) of the Internal
Revenue Code.
Therefore, as an accompaniment to the proposed regulation, the
Department also proposes a Class Exemption that will relieve such
fiduciaries from liability for a prohibited transaction under ERISA
section 406(a)(1)(C) in cases where the contract or arrangement
requires the specified disclosures but the service provider fails to
make them. This proposed Class Exemption is published in today's
Federal Register.
The ICR contained in the proposed exemption requires that the
responsible plan fiduciary, upon discovering a service provider's
failure to make the required disclosures, must submit a written request
to the provider for all information that the provider should have
disclosed. It also requires the responsible plan fiduciary to report a
service provider's refusal or failure to comply with the request in
certain situations. As discussed below, the Department has determined
that this ICR imposes a small paperwork burden on responsible plan
fiduciaries in addition to the ICR imposed by the proposal.
To estimate this burden, the Department started with the number of
disclosures made in the first year of the analysis (1,108,000) and
assumed that 10 percent (111,000) of these disclosures would result in
a concern by the responsible plan fiduciary after the contract or
arrangement was solidified. According to the requirements of the
exemption, the responsible plan fiduciary must, upon discovering a
failure to disclose, submit a written request to the service provider
for all information that it should have disclosed. The Department thus
assumed that 111,000 written requests to service providers would be
made for additional disclosure in the first year of the analysis. The
Department assumed that the number of written requests would decrease
in future years as service providers became more accustomed to the new
disclosure requirements. Thus, in years two and three of the analysis,
it was assumed that only five percent (about 55,500) of the total
number of disclosures would be questioned. The Department averaged the
number of exemption related requests over three years to obtain an
average annual total of roughly 74,000 written disclosures.
Upon receipt of the written request by the responsible plan
fiduciary, the service provider then has 90 days to comply with the
request. If the service provider fails or refuses to comply with the
responsible plan fiduciary's request in this timeframe, the exemption
requires the responsible fiduciary to notify the Department of the
service provider's failure or refusal. The Department estimates the
number of notifications they would expect to receive as ten percent of
the total number of written requests received by service providers, or
nearly 11,000 the first year and 5,500 in the two succeeding years.
Averaging this number of notifications over the three years resulted in
an annual number of notifications of around 7,400.
The Department next estimated the total annual hour burden for the
additional tasks required of plan fiduciaries under the exemption. The
Department assumed that the written request to service providers would
take a half hour of a fiduciary's time, resulting in a total annual
hour burden of about 37,000 hours (74,000 requests x 0.5 hours). The
Department next assumed that a notification to the Department of a
service provider's failure or refusal to comply with a written request
by the responsible fiduciary would take one hour of the responsible
fiduciary's time, resulting in a total annual hour burden of 7,400
(7,400 x 1 hour). Summing the burden of these two tasks resulted in a
total annual hour burden estimate for plan fiduciaries of roughly
44,000 hours. The
[[Page 71004]]
equivalent costs of these annual burden hours are about $2,070,000 ($56
in-house professional labor rate x 37,000 hours) and $783,000 ($106 in-
house lawyer rate x 7,400 hours) for a total equivalent cost of around
$2,850,000.
In addition to burden hours, the Department has estimated annual
materials costs for plan fiduciaries to comply with the requirements of
the exemption. Paper and printing costs are estimated at $0.05 per
page. The Department assumed that both requests to service providers
and notifications to the Department would be two pages. Since 81,300 of
these requests and notifications are expected annually, the annual
material cost is about $8,100 (81,300 x $0.05 x 2), plus an annual
postage cost of $33,300 (83,100 x $0.41), totaling around $41,400.
These paperwork burden estimates are summarized as follows:
Type of Review: New collection (Request for new OMB control
number).
Agency: Employee Benefits Security Administration, Department of
Labor.
Title: Reasonable Contract or Arrangement Under Section 408(b)(2)--
Fee Disclosure.
OMB Control Number: 1210-New.
Affected Public: Business or other for-profit; not-for-profit
institutions.
Estimated Number of Respondents: 79,500.
Estimated Number of Responses: 1,189,000.
Frequency of Response: Annually; occasionally.
Estimated Average Annual Burden Hours: 677,000.
Estimated Average Annual Burden Cost: $651,000.
F. Federalism Statement
Executive Order 13132 (August 4, 1999) outlines fundamental
principles of federalism and requires the adherence to specific
criteria by Federal agencies in the process of their formulation and
implementation of policies that have substantial direct effects on the
States, the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government. The proposed regulation would not have
federalism implications because it has no substantial direct effect on
the States, on the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government. Section 514 of ERISA provides, with
certain exceptions specifically enumerated that are not pertinent here,
that the provisions of Titles I and IV of ERISA supersede State laws
that relate to any employee benefit plan covered by ERISA. The
requirements implemented in the proposed regulation do not alter the
fundamental provisions of the statute with respect to employee benefit
plans, and as such would have no implications for the States or the
relationship or distribution of power between the national government
and the States.
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Exemptions, Fiduciaries, Investments,
Pensions, Prohibited transactions, Reporting and recordkeeping
requirements, and Securities.
For the reasons set forth in the preamble, the Department proposes
to amend Chapter XXV, subchapter F, part 2550 of Title 29 of the Code
of Federal Regulations as follows:
SUBCHAPTER F--FIDUCIARY RESPONSIBILITY UNDER THE EMPLOYEE RETIREMENT
INCOME SECURITY ACT OF 1974
PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY
1. The authority citation for part 2550 continues to read as
follows:
Authority: 29 U.S.C. 1135; and Secretary of Labor's Order No. 1-
2003, 68 FR 5374 (Feb. 3, 2003). Sec. 2550.401b-1 also issued under
sec. 102, Reorganization Plan No. 4 of 1978, 43 FR 47713 (Oct. 17,
1978), 3 CFR, 1978 Comp. 332, effective Dec. 31, 1978, 44 FR 1065
(Jan. 3, 1978), 3 CFR, 1978 Comp. 332. Sec. 2550.401c-1 also issued
under 29 U.S.C. 1101. Sec. 2550.404c-1 also issued under 29 U.S.C.
1104. Sec. 2550.407c-3 also issued under 29 U.S.C. 1107. Sec.
2550.404a-2 also issued under 26 U.S.C. 401 note (sec. 657, Pub. L.
107-16, 115 Stat. 38). Sec. 2550.408b-1 also issued under 29 U.S.C.
1108(b)(1) and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR,
1978 Comp. p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3,
1978), and 3 CFR, 1978 Comp. 332. Sec. 2550.412-1 also issued under
29 U.S.C. 1112.
2. Section 2550.408b-2(c) is revised to read as follows:
Sec. 2550.408b-2 General statutory exemption for services or office
space.
* * * * *
(c) Reasonable contract or arrangement--(1) Disclosure concerning
contract or arrangement. (i) No contract or arrangement to provide
services to an employee benefit plan, nor any extension or renewal of
such contract or arrangement, by:
(A) A service provider who provides or may provide any services to
the plan pursuant to the contract or arrangement as a fiduciary either
within the meaning of section 3(21) of the Act or under the Investment
Advisers Act of 1940;
(B) A service provider who provides or may provide any one or more
of the following services to the plan pursuant to the contract or
arrangement: banking, consulting, custodial, insurance, investment
advisory (plan or participants), investment management, recordkeeping,
securities or other investment brokerage, or third party
administration; or
(C) A service provider who receives or may receive indirect
compensation or fees, as described in paragraph (c)(1)(iii)(A)(1) of
this section, in connection with providing any one or more of the
following services to the plan pursuant to the contract or arrangement:
accounting, actuarial, appraisal, auditing, legal, or valuation; is
reasonable within the meaning of section 408(b)(2) of the Act and Sec.
2550.408b-2(a)(2) unless the requirements of paragraphs (c)(1)(ii)
through (vi) of this section are satisfied.
(ii) The terms of the contract or arrangement shall be in writing.
(iii) The terms of the contract or arrangement (including any
extension or renewal of such contract or arrangement) shall require the
service provider to disclose in writing, to the best of the service
provider's knowledge, the information set forth in this paragraph
(c)(1)(iii) and shall include a representation by the service provider
that, before the contract or arrangement was entered into (or extended
or renewed), all such information was provided to the fiduciary with
authority to cause the employee benefit plan to enter into (or extend
or renew) the contract or arrangement (the ``responsible plan
fiduciary''):
(A) All services to be provided to the plan pursuant to the
contract or arrangement and, with respect to each such service, the
compensation or fees to be received by the service provider, and the
manner of receipt of such compensation or fees. For purposes of this
paragraph (c)(1)(iii):
(1) ``Compensation or fees'' include money or any other thing of
monetary value (for example, gifts, awards, and trips) received, or to
be received, directly from the plan or plan sponsor or indirectly
(i.e., from any source other than the plan, the plan sponsor, or the
service provider) by the service provider or its affiliate in
connection with the services to be provided pursuant to the contract or
arrangement or because of the service provider's or affiliate's
position with the plan. An ``affiliate'' of a service provider is any
person directly or indirectly (through one or more intermediaries)
controlling, controlled by, or under common control with the
[[Page 71005]]
service provider, or any officer, director, agent, or employee of, or
partner with, the service provider.
(2) Compensation or fees may be expressed in terms of a monetary
amount, formula, percentage of the plan's assets, or per capita charge
for each participant or beneficiary of the plan. The manner in which
compensation or fees are expressed shall contain sufficient information
to enable the responsible plan fiduciary to evaluate the reasonableness
of such compensation or fees.
(3) If a service provider offers a bundle of services to the plan
that is priced as a package, rather than on a service-by-service basis,
then only the service provider offering the bundle of services must
provide the disclosures required by this paragraph (c)(1). The service
provider must disclose all services and the aggregate compensation or
fees to be received, directly or indirectly, by the service provider,
any affiliate or subcontractor of such service provider, or any other
party in connection with the bundle of services. The service provider
shall not be required to disclose the allocation of such compensation
or fees among its affiliates, subcontractors, or other parties, except
to the extent such party receives or may receive compensation or fees
that are a separate charge directly against the plan's investment
reflected in the net value of the investment or that are set on a
transaction basis, such as finder's fees, brokerage commissions, and
soft dollars (research or other products or services other than
execution in connection with securities transactions).
(4) A description of the manner of receipt of compensation or fees
shall state whether the service provider will bill the plan, deduct
fees directly from plan accounts, or reflect a charge against the plan
investment and shall describe how any prepaid fees will be calculated
and refunded when a contract or arrangement terminates.
(B) Whether the service provider (or an affiliate) will provide any
services to the plan as a fiduciary either within the meaning of
section 3(21) of the Act or under the Investment Advisers Act of 1940,
(C) Whether the service provider (or an affiliate) expects to
participate in, or otherwise acquire a financial or other interest in,
any transaction to be entered into by the plan in connection with the
contract or arrangement and, if so, a description of the transaction
and the service provider's participation or interest therein,
(D) Whether the service provider (or an affiliate) has any material
financial, referral, or other relationship or arrangement with a money
manager, broker, other client of the service provider, other service
provider to the plan, or any other entity that creates or may create a
conflict of interest for the service provider in performing services
pursuant to the contract or arrangement and, if so, a description of
such relationship or arrangement,
(E) Whether the service provider (or an affiliate) will be able to
affect its own compensation or fees, from whatever source, without the
prior approval of an independent plan fiduciary, in connection with the
provision of services pursuant to the contract or arrangement (for
example, as a result of incentive, performance-based, float, or other
contingent compensation) and, if so, a description of the nature of
such compensation, and
(F) Whether the service provider (or an affiliate) has any policies
or procedures that address actual or potential conflicts of interest or
that are designed to prevent either the compensation or fees described
in paragraph (c)(1)(iii)(A) of this section or the relationships or
arrangements described in paragraph (c)(1)(iii)(C), (D), and (E) of
this section from adversely affecting the provision of services to the
plan pursuant to the contract or arrangement, and, if so, an
explanation of these policies or procedures and how they address such
conflicts of interest or prevent an adverse effect on the provision of
services.
(iv) The terms of the contract or arrangement shall require that
the service provider must disclose to the responsible plan fiduciary
any material change to the information required to be disclosed in
paragraph (c)(1)(iii) of this section not later than 30 days from the
date on which the service provider acquires knowledge of the material
change.
(v) The terms of the contract or arrangement shall require that the
service provider must disclose all information related to the contract
or arrangement and any compensation or fees received thereunder that is
requested by the responsible plan fiduciary or plan administrator in
order to comply with the reporting and disclosure requirements of Title
I of the Act and the regulations, forms, and schedules issued
thereunder.
(vi) The service provider shall comply with its disclosure
obligations under the contract or arrangement as described in this
paragraph (c)(1). Prohibited Transaction Class Exemption 2008-XX will
provide relief for a responsible plan fiduciary from the prohibitions
of section 406(a)(1)(C) of the Act as a result of a service provider's
failure to comply with this paragraph (c)(1)(vi).
(2) Termination of contract or arrangement. No contract or
arrangement is reasonable within the meaning of section 408(b)(2) of
the Act and Sec. 2550.408b-2(a)(2) if it does not permit termination by
the plan without penalty to the plan on reasonably short notice under
the circumstances to prevent the plan from becoming locked into an
arrangement that has become disadvantageous. A long-term lease which
may be terminated prior to its expiration (without penalty to the plan)
on reasonably short notice under the circumstances is not generally an
unreasonable arrangement merely because of its long term. A provision
in a contract or other arrangement which reasonably compensates the
service provider or lessor for loss upon early termination of the
contract, arrangement, or lease is not a penalty. For example, a
minimal fee in a service contract which is charged to allow recoupment
of reasonable start-up costs is not a penalty. Similarly, a provision
in a lease for a termination fee that covers reasonably foreseeable
expenses related to the vacancy and reletting of the office space upon
early termination of the lease is not a penalty. Such a provision does
not reasonably compensate for loss if it provides for payment in excess
of actual loss or if it fails to require mitigation of damages.
* * * * *
Signed at Washington, DC, this 7th day of December, 2007.
Bradford P. Campbell,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. E7-24064 Filed 12-12-07; 8:45 am]
BILLING CODE 4510-29-P