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This report was produced by the 2007 ERISA Advisory
Council’s Working Group on Fiduciary Responsibilities and Revenue
Sharing Practices. The ERISA Advisory Council was created by ERISA to
provide advice to the U.S. Secretary of Labor. The contents of this report
do not represent the position of the Department of Labor (DOL). |
The 2007 ERISA Advisory Council formed the Working
Group on Fiduciary Responsibilities and Revenue Sharing Practices
(hereinafter referred to as the “Working Group”) to study numerous
issues as to fiduciary responsibilities arising from the enactment of the
Pension Protection Act (“PPA”), as well as to address issues relative
to the practice of revenue sharing which has become a common practice used
to offset plan expenses with respect to defined contribution 401(k) plans.
The desired result of the Working Group was to discover and present
matters that would enhance the ability of fiduciaries to fulfill their
responsibilities under ERISA, to develop criteria in the area of
disclosure to participants and otherwise to satisfy the objectives of
ERISA.
Testimony to the Working Group was provided on July 11,
2007 and September 20, 2007, by seventeen (17) speakers representing the
federal government, professionals that represent multiemployer plans,
investment consultants, benefit plan administrators, benefit plan
consultants, the actuarial industry, benefit plan trustees, plan sponsors,
representatives of the investment industry, record keepers, and other
individuals who provide services to benefit plans. After careful debate
and analysis of the issues and transcripts, the Working Group submits the
following recommendations to the Secretary of Labor for consideration:
Recommendation 1: The DOL should propose
regulations that permit the payment from multiemployer plan assets for
professional services rendered to the multiemployer plan trustees that
would generally be deemed settlor functions – e.g., plan design, merger,
amendment and termination, without requiring that such activities be
artificially characterized as fiduciary functions, regardless of whether
there is a perceived incidental benefit to plan settlors or the bargaining
parties. While this recommendation is actuated by concerns arising under
the Pension Protection Act of 2006 (“PPA”), the regulations should not
be limited to actions taken to satisfy the PPA.
Recommendation 2: The DOL should issue guidance
with respect to what procedures should be followed by trustees in the
development of funding improvement or rehabilitation plans to provide some
degree of protection or “safe harbor” from breach of fiduciary duty
challenges, including litigation from groups that may be disadvantaged by
such decisions.
Recommendation 3: The DOL should issue suggested
best practices to assist multiemployer plan trustees and other
multiemployer plan fiduciaries in considering the use and monitoring of
various asset allocation strategies to meet the funding requirements of
the PPA.
Recommendation 4: The DOL should develop
definitions of revenue sharing-related terms designed to assist benefit
plan sponsors, fiduciaries, service providers, and participants. The
Working Group feels such an undertaking should take into account
definitions/terminology followed by other agencies (e.g. Securities and
Exchange Commission) and consider ongoing and anticipated changes in
capital markets.
Recommendation 5: The DOL should issue guidance
clarifying that revenue sharing is not a plan asset under ERISA unless and
until it is credited to the plan in accordance with the documents
governing the revenue sharing.
Recommendation 6: The DOL should issue guidance
regarding the treatment of revenue sharing received by a plan.
Specifically, there should be guidance patterned after Field Assistance
Bulletins 2003-03 and 2006-01 regarding the allocation of revenue sharing
received by a plan. Consistent with the approach taken in those FABs, such
guidance would confirm that there is not a single permissible method of
allocation because cost, efficiency and other factors may enter into the
fiduciary’s allocation decision. Such guidance should be coordinated
with the U.S. Department of Treasury in order to address any possible tax
consequences.
Respectfully submitted,
Robert M. Archer, Chair
Randy DeFrehn, Vice Chair
Richard David Landsberg
Kathryn J. Kennedy
Christopher Rouse
Willow J. Prall
Edward A. Schwartz
Dennis Simmons
Edward S. Mollahan
Trisha Brambley
Elizabeth Dill
Stephen W. McCaffrey
Richard J. Helmreich
James D. McCool, Ex Officio
William L. Scogland, Ex Officio
The Working Group undertook several issues for study.
The balance of this report will address the scope of the Working Group,
the questions for witnesses, the list of witnesses, the consensus
consideration of the Working Group and a Summary of Testimony from the
witnesses.
The Working Group made inquiry of two rather distinct
areas. The first area of inquiry related to a fiduciary responsibilities
update as to implications of the PPA. It was observed that the PPA had
resulted in significant changes to the rules affecting both defined
benefit ("DB") and defined contribution ("DC") plans,
the most significant far reaching changes being made with respect to
funding rules for single employer and multiemployer DB Plans. The Working
Group focused on the area of multiemployer plans and that the fact that
the PPA imposed new and broad obligations on the boards of trustees that
sponsor collectively bargained multiemployer DB plans and on collective
bargaining parties that were responsible for plan funding. It was
recognized that the focus of inquiry must be on what changes, if any,
directly affect the respective legal and fiduciary responsibilities of the
Trustees vis-a-vis the responsibility to more closely engage the
bargaining parties and the extent to which bargaining parties would be
drawn more closely into the process of monitoring DB Plans. It was
recognized that consideration of these issues would require input from
professional advisors such as actuaries, accountants and attorneys, and
that there was a need to more fully define the assembly of plan financial
and actuarial information in the course of collective bargaining as a
matter of plan fiduciary expense.
The Working Group sought to analyze the DOL's current
protocols concerning expenditure for calculation of plan design features
and the assembly of plan information and to revisit whether these expenses
are fiduciary or settlor in nature. A concern in this area, as more fully
set forth below, was that Field Assistance Bulletins and other protocol
issued by the DOL did not provide sufficient guidance and the concern that
judicial consideration of these issues resulted in conflicting precedents,
thereby causing confusion to fiduciaries and their professional advisors.
Furthermore, the Working Group was concerned that for groups that chose to
follow the guidance in FAB 2002-02 in order to pay for the required
calculations, the introduction of the statutorily mandated requirements
for plan trustees to develop funding improvement and rehabilitation plans
pursuant to the PPA would invite additional litigation by groups that are
disadvantaged by the decisions made by plan fiduciaries; decisions that
would otherwise not be subject to challenge because they are normally
undertaken as settlor activities.
The Working Group understood that some guidance to
fiduciaries in this process of disclosure might be forthcoming if, at the
very least, to provide some degree of protection or "safe
harbor" against litigation that might arise as a result of the
selection of one alternative over another.
The Working Group also addressed the requirement of PPA
for substantially more disclosure of a plan's financial situation and to
evaluate whether such disclosure would invariably lead to challenges to
decisions made by the boards of trustees.
The Working Group also noted another provision in PPA
that had not received considerable attention; that is, the methodology
that could be followed to increase a DB plan's investment funding to a
certain level and the pressure on fiduciaries of multiemployer plans to
enhance investment returns by a more aggressive strategy, which would
necessarily lead to consideration of alternative investments such as hedge
funds. It is understood that the 2006 Working Group on Prudent Investment
Process had considered this issue and made appropriate recommendations;
nevertheless, enactment of the PPA has placed even more emphasis on this
issue.
From the standpoint of revenue sharing practices, the
Working Group recognized that revenue sharing was a common and
considerable practice used to offset plan expenses with respect to DC
plans. The Working Group understood that there appears to be nothing in
ERISA that prevents a plan fiduciary from negotiating with a service
provider for the return to the plan of any revenue sharing payments that
the provider may receive. The Working Group recognized the need to define
revenue sharing with some specificity and to consider the potential role
of the DOL and other administrative agencies in defining and assessing
this issue. As the practice of revenue sharing has increased, the need for
greater understanding of the practice and its parameters was to be
considered. The Working Group further understood that with greater
disclosure being provided to participants on costs and revenue sharing,
plan sponsors are questioning how to allocate expense offset payments
received by the plan. Against that backdrop, the Working Group sought to
evaluate the following issues:
-
Whether the DOL should issue guidance with respect to
the acceptable and proper use of plan revenues generated by revenue
sharing arrangements in an appropriate circumstance where there is excess
revenue sharing (i.e., revenue sharing that exceeds record
keeping/administration fees), and how should such excess revenue sharing
be allocated to the participants;
-
Survey current practices to determine the manner in
which plan sponsor/fiduciaries currently ensure understanding of revenue
sharing/fee arrangements;
-
Determining what guidance the DOL should issue with
respect to allocating monies to a participant's account;
-
What a plan sponsor/fiduciary needs to know and plan
provider should be required to provide when they enter into a revenue
sharing or rebate arrangement.
Fiduciary Responsibilities Update
-
Will the PPA complicate bargaining in connection
with multiemployer plans because of the focus on plan funding, tougher
funding standards and the perceived need to often alter plan design?
-
Define those expenses that can be paid with plan
assets to meet PPA obligations, and whether there is need for further
guidance in this area.
-
Will the PPA directly affect the respective legal
responsibility of bargaining parties vis-à-vis trustees by drawing
bargaining parties more closely into the process of monitoring plan
funding/design issues?
-
What guidance can be provided to a plan sponsor with
respect to simplifying disclosure of the plan’s financial situation,
plan design, etc. to individual contributing employers, individual plan
participants, and others?
-
Understanding the considerable pressure being placed
on the trustees of many DB plans to meet PPA-mandated funding standards;
what guidance, if any, would you provide as to appropriate investments to
meet such funding obligations?
Revenue Sharing Practices
-
What are the current practices as to revenue-sharing
arrangements, including the basis upon which the revenue-sharing is
determined and the methods by which employers utilize the amounts shared?
-
What, if any, guidance should the DOL issue with
respect to the obligations of plan sponsors, trustees and other
fiduciaries regarding the allocation of revenue sharing payments received
by plan from a service provider?
-
What guidance could the DOL offer with respect to
what a plan sponsor needs to know and what a service provider should be
required to provide when they consider a revenue-sharing arrangement?
-
Should the DOL develop a model prototype in this
area?
The scope of inquiry for the Working Group and the
intended questions were given to all the witnesses in advance of the
testimony. The witnesses were advised that the questions were not intended
to limit the parameters of testimony, but rather to generate thought and
discussion of the scope of the Working Group. Specific emphasis was placed
on developing through the expertise of these witnesses, potential
recommendations for consideration by the Working Group and ultimately the
DOL.
The Working Group solicited testimony of witnesses from
a broad cross section of the employee-benefit community. Both through
their written presentations and their testimony, the witnesses addressed
the issues raised and provided a considerable source of developmental
information for consideration by the Working Group. The witnesses and the
dates of their testimony were as follows:
July 11, 2007
-
Robert Doyle, Director of Regulations and
Interpretations, Employee Benefits Security Agency, U.S. DOL
-
Louis Campagna, Chief of the Division of Fiduciary
Interpretations, Office of Regulations and Interpretations, Employee
Benefits Security Agency, U.S. DOL
-
Barry Slevin, Esq., Slevin & Hart
-
Marc LeBlanc, Field Administrator and General Counsel,
Sheet Metal Workers National Pension Fund
-
Troy Saharic, Mercer Investment & Consulting, Inc.
-
Judy Mazo, The Segal Company
-
Mark Lotruglio, QuanVest Investment Consultants
September 20, 2007
-
Joyce Mader, Esq., O'Donoghue & O'Donoghue
-
Gene Kalwarski, Cheiron
-
David Blitzstein, United Food & Commercial Workers
Union
-
Michael Malone, MJM-401(k)
-
Laura Gough, Robert W. Baird & Co., Inc., on behalf
of the Securities Industry & Financial Markets Assoc.
-
Francis X. Lilly, Esq., Independent Fiduciary Services,
Inc.
-
Allison Klausner, Honeywell, on behalf of the American
Benefits Council
-
Frederick Reish, Esq., Reish, Luftman, Reicher &
Cohen
-
Sam Brkich, Newport Group, on behalf of the Council of
Independent 401(k) Record Keepers
-
Mary Podesta, Investment Company Institute
Fiduciary Responsibilities Update
The Working Group recognizes and commends the
Department on its sensitivity to the unique nature of multiemployer plans
and the circumstances that distinguish such plans from single employer
plans in the traditional application of rules governing settlor vs.
fiduciary functions, including the questions of how the costs associated
with what are traditionally settlor functions can be paid from plan
assets. It is clear that the approach described in FAB 2002-02 was a
creative attempt to resolve this dilemma within the Department’s then
existing authority in a more expeditious and economical manner than would
be the case if the issue were to be dealt with through the formal
regulatory process. Unfortunately, the testimony provided by a variety of
witnesses demonstrated that it is also clear that this approach was an
imperfect solution to a complicated problem. Although they existed before
the PPA, these imperfections have been amplified by its passage and the
confusion experienced by plan fiduciaries, settlors and their professional
advisors over their responsibilities has only increased and will increase
further as they begin to address the requirements imposed on them as
delineated in the PPA. Consequently, as one witness observed, design
decisions that are required by law should not be recast as fiduciary
simply to enable them to be paid for by plan assets. This reasoning was
expanded on by another witness who cited a ruling by the Supreme Court in
which it very clearly stated that “plan sponsors who alter the terms of
a plan do not fall into the category of fiduciaries.”(1)
In discussing the operational conflicts between the
existing Departmental policy as expressed in FAB 2002-02 and the
requirements to provide settlor type information to the bargaining parties
under the PPA, the Working Group welcomed the Department’s general
proposition that payment for any activity required by the statute would be
an appropriate plan expense. However, for reasons stated by subsequent
witnesses, the Working Group is concerned that such an extension of
informal guidance will only compound the confusion experienced by plan
trustees of inconsistent Departmental and, more broadly, judicial
interpretation of such guidance especially as plans implement the benefit
modification procedures required of Critical Status plans and groups that
are adversely affected by these decisions challenge them in the courts.
It is for these reasons that the Working Group noted
with optimism the Department’s willingness to consider moving beyond
existing guidance to a more formal regulatory process if a compelling case
for such action could be made. Indeed, it appears that such a compelling
case has been made through the testimony received from a variety of expert
practitioners.
First, and in particular, the Working Group notes the
inconsistent treatment of the question of what may be settlor vs.
fiduciary historically as applied by the Courts (not limited to the
implementation of the PPA) as detailed in the testimony of one witness.
Additionally, the specific reference to the Supreme Court’s decision in
Heinz (Central Laborers' Pension Fund v. Heinz, et al., 541 U.S. 739
(2004)) which, while not specific to the settlor v. fiduciary issue, is
particularly troublesome. Referenced by several witnesses, Heinz called
into question the deference to be afforded by the Courts to informal
agency guidance. After the Supreme Court overruled by a 9-0 vote a
longstanding practice endorsed by the IRS for over thirty years and
supported in oral argument by the US Solicitor General, it is difficult to
envision that the courts would endorse an informal interpretation that a
settlor function would be deemed to be a fiduciary function by the simple
act of saying it is so. Additionally, the intent of the FAB appears to
have been circumvented by the imposition of a statutory requirement for
plans to adopt rehabilitation plans that, by definition, will require
certain groups of participants be chosen over others for benefit
reductions. Rather than finding a creative solution to a difficult
problem, the continued application of FAB 2002-02 in the future will
undoubtedly foster additional fiduciary breach litigation against trustees
for doing what they are required to do under the PPA.
Second, administration of informal policy within the
Department has been inconsistent and has been described by some as a “trickle
down” approach to policy dissemination that leaves plans uncertain as to
the rules simply because they may fall within the jurisdiction of one
regional office rather than another.
Third, the Working Group was advised that the question
of payment from plan assets for settlor expenses is not a settled issue
and that the Department’s interpretation is inconsistent with a number
of court decisions and may be inconsistent with its own determination
regarding incidental benefits. Also called into question is the notion
that payment for certain functions that are in the interests of plan
participants and beneficiaries may be appropriate, even if there is an
incidental benefit to employers.(2)
Finally, the additional requirements for the
development of rehabilitation plans under PPA have inexorably altered (and
some have contended, intentionally blurred) the roles of multiemployer
plan trustees with respect to their roles in support of the collective
bargaining process. As plan trustees develop new contribution / benefit
design schedules consistent with their statutory mandates, the Working
Group finds it difficult to conceive of a scenario wherein Congress would
not have intended plan assets to be used by trustees to pay for the very
calculations required to be developed by the trustees in order to meet the
requirements under the PPA. To that end, it appears that informal guidance
of the sort provided under FAB 2002-02 is no longer sufficient.
Therefore, it is the consensus of the Working Group
that the Department should engage in the more formal regulation process
through which input from the entire multiemployer plan universe can be
solicited with respect to updating current informal guidance pertaining to
the use of plan assets for plan design activities. Furthermore, based on
witness testimony that the confusion over this issue preceded the
enactment of the PPA, it is also the consensus of the Working Group that
such a review not be limited to the new requirements of the PPA, but
rather that the Department use this opportunity to develop comprehensive
regulatory guidance, perhaps in the form of a narrowly crafted exemption
from prohibited transactions, under which all multiemployer plans can
distinguish when payment for design related issues may be made from plan
assets.
The Working Group also reviewed the issue of how the
new funding targets contained in the PPA will influence the asset
allocation determinations of plans’ investment programs. Several
witnesses commented on the fact that the new funding targets contained in
the PPA will have an effect on the plans’ overall investment policies
and will undoubtedly result in broader diversification into
non-traditional asset classes. These asset classes contain investment
alternatives which require a much greater depth of knowledge with respect
to the advantages and potential pitfalls that may be encountered than do
the more traditional asset classes. In reviewing their plans’ investment
policies and in evaluating various non-traditional asset classes to
determine whether such investments may meet the plans’ investment
objectives, it will be necessary for trustees to expand their knowledge of
the various proposed instruments in order to meet their due diligence
requirements. As such, it would be quite useful for plans if the
Department would provide additional informative guidance to plans
regarding their obligations to understand the nature of such instruments
and the conditions under which, and to what extent the inclusion of some
alternatives may be appropriate for pension plan investments. Overall, the
DOL should issue suggested best practices to assist multiemployer plan
trustees and fiduciaries in considering the use and monitoring of various
allocation strategies to meet the PPA funding standards.
In reaching this recommendation, it was the consensus
of the Working Group that the Pension Protection Act will require the
strengthening of the funding status of defined pension benefit plans. It
was the general feeling of the Working Group that the guidance in this
area has been inconsistent and that there may be an enormous amount of
uncertainty as to the fiduciary responsibilities in addressing the funding
status and plan design in making investment decisions. The Working Group
understands that it is not the role of the DOL to determine the
appropriateness of specific investment vehicles necessary to address this
PPA issue. Likewise, it is not our role to determine the use of “alternative
investments” generally. Rather, we suggest that there should be
available a level of consistent information which can be relied upon by
multiemployer trustees in understanding their fiduciary responsibilities.
Finally, while the Working Group understands that a prior 2006 Working
Group on prudent investment process evaluated this issue, the
implementation of PPA warrants action on this issue.
Revenue Sharing Practices
The Working Group recognized that there was a
considerable amount of consensus with respect to the concept of revenue
sharing, how it can benefit plan sponsors and their participants. Some of
the consensus thoughts include:
-
Revenue sharing is an acceptable practice;
-
There is a need for transparency in order to
fulfill and execute the fiduciary responsibility of plan sponsors and
their trustees;
-
Bundled providers use “bundled” revenue
sharing, which is not necessarily the practice with “unbundled”
providers; and
-
A plan sponsor needs to investigate and understand
revenue share from vendor to consultant/broker.
The Working Group recognizes that revenue sharing in a
broad sense allows the market "to develop efficiencies and
innovations that have enhanced the quality of services of products
available to DC and 401(k) plans." The witnesses generally testified,
and the Working Group recognizes that revenue sharing supports a wide
variety of distribution and shareholder servicing activities, including
administrative record keeping and sub-transfer agent services that were
traditionally viewed as investment fund responsibilities. As offered by
one witness, as of year-end 2006, 401(k) plans held $2.7 trillion in
assets, not counting assets that were rolled over into IRAs. In this
connection, estimates suggest that one-half of $4.2 trillion in IRAs in
2006 came from 401(k) and other employer plans. The number of 401(k) plans
grew from fewer than 30,000 in 1985 to approximately 450,000 in 2006. The
Working Group therefore recognizes the essential role of such plans and
the need for plan sponsors and fiduciaries to assure that workers can rely
with confidence in these types of plans for retirement savings. Indeed, it
appears that defined contribution plans and particularly participant
directed plans, are the primary retirement vehicle for both employers and
employees in this country.
The Working Group recognizes that in the DOL's view,
revenue sharing does not involve any inherent ERISA violations. To the
contrary, many of these arrangements may serve to reduce overall plan
costs and provide plans with services and benefits not otherwise
affordable to them.
The Working Group recognizes that fiduciaries, such as
plan sponsors and trustees, must discharge their duties solely in the
interest of participants and beneficiaries and for the sole purpose of
providing benefits and defraying "reasonable" expenses of
administering the plan. ERISA Section 404(a)(1)(A). Further, these
fiduciaries must discharge their duties with the care, skill and prudence
and diligence, under the circumstances, a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims.
The Working Group recognizes that in order to discharge
these duties, plan sponsors must understand all the plan fees and expenses
to: 1) fulfill their responsibilities under ERISA; 2) evaluate the
reasonableness of provider compensation; and 3) evaluate whether there
are any prohibited transactions or other conflicts of interest. As
discussed hereinafter, such fees and expenses generally include indirect
payments such as revenue sharing, which may be 12 b-1 fees and sub transfer
agency or sub TA fees.
According to DOL testimony, ERISA's prudence
requirement applies to all fiduciary decisions including, but not limited
to, the selection and monitoring of investments and the selection and
monitoring of service providers such as third-party administrators,
investment managers and advisors, record keepers and providers of
investment information. A DOL witness referred to prior guidance it had
issued concerning how fiduciaries might discharge its duties consistent
with ERISA standards. For example, DOL Field Assistance Bulletin 2007-1
had been issued concerning selection and monitoring of investment
managers. Several witnesses addressed that the DOL is currently working on
two initiatives that are designed to help ensure that plan fiduciaries
have the information they need concerning revenue sharing and similar
agreements so that they can discharge their responsibilities in connection
with the selection and monitoring of service providers in an informed and
prudent manner.(3)
As its first recommendation, the Working Group believes
that the DOL should compile appropriate terminology in connection with
defining revenue sharing. The consensus of the Working Group is that there
should be a definition of revenue sharing crafted in the manner to
maintain flexibility in light of ongoing and anticipated changes in the
market place. In this connection, the Working Group recognized the concern
of several witnesses to define the most frequently used terminology in
this area. As one witness stated, and the Working Group concurs, if the
DOL does not define these terms, it is possible that conflicting Court
decisions would create "a mine field" for plan sponsors,
fiduciaries and fair and honest service providers.
As a general proposition, revenue sharing is a broad
term that means many different things to different constituents. As one
witness noted, there is an inconsistency between the use of the term
"revenue sharing" in the securities industry and the way the
term is used in the employee benefit plan community. This witness stated,
with some concurrence from other witnesses, that in the employee benefit
community, the term "revenue sharing" is used loosely to
describe virtually any payment that a plan service provider receives from
a party other than the plan.
Clearly from the testimony presented, there is a role
for the DOL to "take the lead" in formally defining 401(k)
terms. In the view of several witnesses, this would be a considerable step
in reducing the confusion about the flows of revenues, fees and costs. It
is therefore concluded that the need for the DOL to provide concise
definitions in this area can only benefit the plan sponsors, fiduciaries
and service providers in fulfilling their role to participants. Finally,
any undertaking should be in coordination with other administrative
agencies such as the Securities & Exchange Commission.
As a second recommendation, the Working Group believes
that the DOL should consider issuing guidance with respect to the
obligations of plan sponsors and trustees and other fiduciaries regarding
allocation of revenue sharing payments received by the plan from a service
provider. The Working Group heard considerable testimony on whether
revenue sharing payments are "plan assets." As a result, it
believes that there is a need for guidance on that issue. If, in fact,
revenue sharing amounts were considered "plan assets", these
amounts must be held for the "exclusive purpose of participants and
beneficiaries and are subject to ERISA Section 406(b) prohibited
transaction rules." Additionally, to the extent providers have
control over the management and disposition of these payments, these
providers may be considered fiduciaries.
Concern in this area is amplified in the considerable
recent case law. For instance, a recent decision of the U.S. District
Court for the District of Connecticut in Haddock v. Nationwide Financial
Services, 419 F. Supp. 2d, 156 (D. Conn. 2007) held that fees, such as
revenue sharing payments received from mutual funds and their affiliates
by companies providing services to ERISA covered employee benefit plans,
could be characterized as "plan assets" of those plans for
purposes of the fiduciary responsibility requirements of ERISA. Other
cases have held to the contrary. As one witness opined, the state of
litigation and the "law in this arena remains uncertain at this
time." Other witnesses suggested that the failure by the DOL to issue
regulations or provide clear guidance might well result in conflicting
Court decisions and inconsistent requirements for plan sponsors and
service providers.
The Working Group understands the sense of the
witnesses that this failure to act could have profound consequences in the
401(k) market place. It would appear that ERISA fiduciary status comes
with a price to a benefit plan because "fiduciaries must be
compensated for the cost of compliance and the risk of liability."
After considerable consideration of this issue, it is the feeling of the
Working Group that the DOL should issue guidance that clarifies that
revenue sharing is not a Plan asset under ERISA unless and until it is
credited to the Plan in accordance with the documents governing revenue
sharing. For this reason, many of the concerns raised in the testimony may
be avoided via alternative methods of evaluating and handling revenue
sharing issues.
The Working Group would suggest that the DOL be mindful
in interaction with other agencies having similar regulatory authority in
developing any such guidance.
Third, the Working Group understands that ERISA does
not specifically speak to methods by which revenue sharing proceeds might
be allocated among the plan's participants and beneficiaries. The DOL
suggests that in its testimony that in the absence of statutory guidance,
allocation decisions must be made taking into account the terms of the
plan and the obligations of plan fiduciaries to have prudently acted in
the interests of the plan's participants and beneficiaries. It offers
Field Assistance Bulletin 2003-3 pertaining to the allocation of expenses
in a defined contribution plan and Field Assistance Bulletin 2006-1
pertaining to the distribution of settlement proceeds relating to late
trading and market time as having applicability in the allocation of
revenue sharing proceeds among plan participants.
The Working Group notes testimony that plan sponsors
have considerable discretion to determine how revenue sharing proceeds
will be allocated to and among the plan participants and beneficiaries. It
also understands DOL's suggestion that the documents and instruments
governing a plan therefore might specifically provide that revenue sharing
could be used to reduce plan expenses generally or that such proceeds
would be allocated among all participants on a pro rata or per capita
basis or that such proceeds would be allocated to particular participants
and beneficiaries whose accounts are responsible for generating the
proceeds. The suggestion that prudence would require a process by which
the fiduciary weighs the competing interests of the various classes of the
plan's participants and the effects of various allocations on these
interests supports a position of DOL intervention in this area. On this
point, broad and strong testimony has been presented that suggests the
need for such further guidance as to this issue of allocation of proceeds.
The Working Group therefore recommends that a Field
Assistance Bulletin be issued regarding the treatment of revenue sharing
and this Field Assistance Bulletin be patterned after Field Assistance
Bulletins 2003-03 and 2006-01. Consistent with the approach taking in
those FABs, such guidance would confirm that there is not a single
permissible method of allocation because cost, efficiency, and other
factors may enter into the fiduciary’s allocation decision. Some view
was expressed that this guidance could be coordinated with the Department
of Treasury to confirm that such allocations are treated as miscellaneous
earnings or expense reimbursement to a participant’s account, rather
than an addition for Internal Revenue Code Section 415 purposes. The
Working Group makes this recommendation mindful of the fact that there is
a potential for litigation in this area and it believes that guidance of
this type will be beneficial to plan sponsors in assessing any allocation
decision.
As an observation, the Working Group sees the need for
plan sponsors to obtain all appropriate information necessary for
dissemination to participants and to identify, negotiate and monitor fees
and expenses that are not excessive and unreasonable. We are hopeful that
the DOL should consider such factors in updating proposed revisions to
regulations being considered with ERISA Section 408(b)(2). An extensive
list of fee and expense data that plan sponsors could use effectively with
their service provider was provided by the witnesses. In sum, the general
thrust of these submissions was that a plan fiduciary should obtain
information from service providers to the plan on items such as what
services will be delivered; what will be charged for those services and
how these expenses will be allocated between the sponsor and participants;
and whether and to what extent the service provider receives compensation
from other parties in connection with providing services to the plan.
The need for detailed information was supported by the
testimony of one witness who stated that according to a recent survey
developed by Hewitt Associates, 77% of employer plan sponsors surveyed
were either very or somewhat likely to undertake a review of plan
expenses, revenue sharing and disclosure of these to participants.
As to the issue of developing a prototype model, the
sense of the Working Group is that if guidance is provided from a
standpoint of the information required of a potential service provider,
this would allow the plan sponsor to make an informed decision in this
area.
Summary of Testimony of Robert J. Doyle
Conclusions
ERISA and the Department of Labor have supplied
significant guidance to Fiduciaries of both single employer and
multiemployer plans relative to their utilization of Plan Assets to pay
reasonable expenses in administering the Plan.
Expenses related to traditional trust law settlor type
acts-plan formation issues i.e., plan design, plan amendment; plan
termination can not be charged to the Plan. Acts relative to managing the
plan and decision are fiduciary in nature and may be charged to the Plans.
FAB 2000-02 deals with Multiemployer plans allowing
those expenditures which are typically Settlor to be fiduciary acts if the
controlling documents provide those typical settlor functions to be
Fiduciary. If the documents are silent, then the general rules applicable
to settlor and fiduciary functions control. Traditional fiduciary
functions can’t be varied by plan documents to make them Settlor, they
remain fiduciary.
Where Trustees make plan design changes necessitated as
a result of information received because of PPA compliance and the
information was not developed solely to benefit the bargaining parties
but, rather benefits the participants, it should be fiduciary and
chargeable to the plan.
Testimony
Mr. Doyle testified that he believes ERISA and DOL
regulation pretty well define the obligations of fiduciaries with respect
to the proper disposition of plan assets. The fiduciary must be prudent
and act solely in the interest of participants and beneficiaries when
using plan assets to pay expenses. He identified the basic rules that
expenditures of Plan Assets can not benefit the plan sponsors/employers.
He also stated the expenditures must be (i) reasonable, (ii) used to
administer the plan or pay benefits and (iii) can’t be used to engage in
prohibited transactions.
The issues before the Working Group arose because the
DOL, the Fiduciaries and the plan sponsors are aware that expenses
incurred, whether as a single employer or multi employer plan, fall
outside the guidance, or might be expenses that directly or indirectly
benefit the employer or a contributing employer in the multi employer
context. Mr. Doyle elaborated on this statement by indicating that you
have to determine who is benefiting from the expenditure, if it is the
employer, it can’t be paid by the plan. He indicated that the DOL has
tried to draw lines between what are settlor functions, which result when
setting up a plan, and fiduciaries functions, which are attributable to
the plan and its participants.
He further testified that he has looked at the
definition of a fiduciary in ERISA Section 3(21) in a very broad manner,
with a possibility that this definition might involve a lot of decisions
made by a plan sponsor. He stated that the DOL has given guidance
regarding a certain group of discretionary acts which DOL characterized as
settlor, which could be engaged in without fiduciary implications. He
viewed these as traditional trust law settlor type acts-plan formation
issues i.e., plan design, plan amendment, plan termination. Additionally,
he next described other acts relative to managing the plan and decision
which he stated are fiduciary in nature. He indicated that this guidance
resulted in a lot of inquiries seeking clarification or guidance regarding
expenses attributable to each type of act. He provided that if they are
settlor in nature, they do not implicate ERISA’s fiduciary
responsibility provisions, and expenditure of plan assets for those
activities is not appropriate. He testified that the DOL’s intent was to
create a framework to provide certainty and flexibility on the part of
employers in terms of designing their plan without requiring that they
apply fiduciary standards for settlor expenditures. The DOL did this
because it recognized that plan sponsors may have had different motives in
terms of the establishment of the plan and what it was is trying to
accomplish when it adopted the plans. He stated that in the late 1990 and
early 2000, DOL investigations revealed that there was a lot of confusion
regarding the proper use of plan assets. He further stated that there was
yet more confusion when there was a multiple benefit to the plan and the
sponsor and the question of the proper allocation of expenses to the plan
and the sponsor. He stated that the DOL issued Advisory Opinion 2001-01A
with the hope that parties would understand the distinction between
settlor expenses and plan expenses even when a sponsor expends funds to
maintain the qualified status of the plan. Their intent was to further
clarify that the mere fact there was an incidental benefit to the employer
would not be enough to characterize the expense as sponsor not payable by
the plan.
Recognizing that this didn’t address all the
questions with respect to Multiemployer plans, Mr. Doyle stated that the
DOL issued Field Assistance Bulletin 2000-02 in an attempt to clarify the
fiduciary/settlor issues relative to Multiemployer plans. He addressed a
specific case where trustees were trying to allocate assets between two
plans which the DOL concluded could result in a prohibited transaction as
the trustees might be acting adversely to both sides of the transaction.
The FAB provided that the documents which govern the plans, i.e., the
trust documents, collective bargaining agreement and plan documents,
control and dictate the expectations of the parties who created the plan
as to the role of the trustee. He provided that if the plan documents
confer fiduciary status upon the trustees with respect to what the DOL
would normally view as settlor functions, then the DOL will honor that
treatment and assume the fiduciary is acting prudently and is only taking
into account the interest of participants and beneficiaries. He stated
that if that is the case, the DOL will allow these expenditures to be
charged against plans assets. If the documents are silent, then the
general rules applicable to settlor and fiduciary functions control.
Traditional fiduciary functions can’t be varied by plan documents to
make them settlor, they remain fiduciary. He stated that the DOL believes
that they gave significant amount of flexibility to trustees of
multiemployer plans to charge expenses to plans.
He stated his belief that, prior to and after PPA, the
trustees have been given a great deal of discretion with few constraints,
in terms of the information about the plan that they are permitted to
share with parties to the bargaining process. He stated his belief that
the DOL believes that fiduciaries do have a lot of ability and a lot of
discretion in terms of the information they share and how to develop the
information to improve the bargaining process. He stated that when the
trustees exercise this discretion, they must act prudently and solely in
the interest of the participants.
In conclusion, he testified that the DOL welcomes this
process to promote efficient effective plan administration to ultimately
benefit participants and beneficiaries and testified that if there are
impediments the DOL is receptive to reviewing such impediments in the
interest of improving the current situation.
In response to questions regarding the FAB and any
court cases concerning its use as precedent, Mr. Doyle stated that he
believed that one court reached a similar conclusion but did not
specifically give the FAB deference. He stated his belief that regulations
would generally have greater value but it really is a matter for a court
to decide if it makes sense as a matter of law. He stated his view that he
thinks the FAB is sufficient, but if the public believes that the DOL
needs to issue regulatory guidance on the issue of Settlor vs. Fiduciary
expenses, the DOL might consider doing so, not just in the Multiemployer
context but rather in a much broader context. He reiterated his earlier
belief that the DOL has given a great degree of flexibility in this area
which may be lost if regulations were promulgated.
Chairperson Archer stated that he has been involved in
three situations where the DOL local offices challenged the use of plan
assets incident to mergers and stated they were settlor. Mr. Archer
indicated that it was resolved favorably as fiduciary issues. Mr. Archer
asked for additional clarification on plan expense issues related to the
PPA and existing DOL guidance where the parties make plan design change
necessitated as a result of information received because of PPA
compliance. Mr. Doyle stated his belief that if the information was not
developed solely to benefit the bargaining parties but rather to benefit
the trustees for participants, it should be fiduciary and chargeable to
the plan. When asked about trustees having to provide additional benefit
schedules which might result in a plan design issue yet also respond to
the trustees’ PPA requirements, Mr. Doyle stated his belief that if the
schedules were created in the interest of the plan then they are plan
expenses.
Summary of Testimony of Louis Campagna
Conclusions
-
The DOL has been on record providing that
fiduciaries have an obligation to discover revenue sharing arrangements
that pay indirect compensation to service providers to get the total
picture on the reasonableness of compensation paid by a plan and potential
conflicts of interest related such providers.
-
DOL is in the process of amending the regulation to
change that result and redefine the parameters of the exemption to
specifically require service providers to make some disclosures. He stated
that there would be an obligation to disclose the fees and any
compensation that a service provider receives directly or indirectly as a
result of services provided by the plan. This disclosure will be mandated
on Schedule C to the Form 5500.
-
There is no inherent violation of ERISA involving
revenue sharing except where a service provider takes the payment for
itself. There is no requirement under ERISA to allocate these payments to
participants.
-
In the absence of statutory guidance, allocation
decision must be made taking into account the terms of the plan and the
obligations of plan fiduciaries to act prudently and in the sole interest
of the participants and beneficiaries. Plan sponsors have considerable
discretion as a matter of plan design, how revenue sharing proceeds will
be allocated to and among plan participants.
-
The principles set forth in two DOL FABs can be
utilized by fiduciaries to lay the foundation for allocation of revenue
sharing to participants. These FABs, taken together, could provide three
options for prudent allocation of proceeds: (i) reduce overall expenses,
(ii) allocate among all participants on a pro rata or per capita basis, or
(iii) allocate to particular participants and beneficiaries accounts who
generated the revenue sharing.
Testimony
Mr. Campagna set the tone by indicating that his
testimony will look at two topics, the first, what the fiduciary, both
single employer and multiemployer need to know regarding revenue sharing
and disclosure under ERISA. The second topic will be offsets of revenue
sharing payments. He also would discuss what, if any, obligations the
fiduciary has to allocate the proceeds of a revenue sharing arrangement to
participants.
He testified that fiduciaries when engaging a service
provider must understand the basic framework of ERISA and understand ERISA’s
exclusive purpose and prudence requirements. He testified that ERISA’s
prudence requirements apply to all fiduciary decisions including the
selection and monitoring of all types of service providers as well as
payment of expenses for such service providers. He believes that the DOL
has provided various forms of guidance concerning how the fiduciary must
discharge their selection and monitoring duties.
He stated that the DOL has gone on record over the
years providing that it is a fiduciary’s obligation to identify revenue
sharing arrangements that pay indirect compensation to service providers
in order for the fiduciary to determine the reasonableness of the
compensation that the plan pays. He further stated that the fiduciary must
be aware of any other arrangements which arise because the service
provider may have internal conflicts of interest and the fiduciary must be
aware of any conflict situation in which the plan is involved when
addressing compensation issues.
Mr. Campagna testified further regarding the obligation
of the fiduciaries to determine if there are any conflicts of interest
that the service providers have with their affiliates. He then discussed
the work done with the SEC, which resulted in ten questions which should
be answered when hiring a pension consultant. He identified the governing
law concerning engagement of service providers as Section 408(b) (2). This
Section provides the statutory exemption from the prohibited transaction
rules. He described Section 408(b) (2) requirements for service provider
and the rules related to a provision of service by a party in interest. He
stated that the DOL regulation looks for compensation to be paid pursuant
to a reasonable arrangement, and if that is achieved there really is not
much to disclose. Currently, the regulation requires no disclosure by the
service provider although it requires the fiduciary to obtain it.
Mr. Campagna stated that the DOL is in the process of
amending the regulation to change that result and redefine the parameters
of the exemption to specifically require service providers to make some
disclosures. He stated that there would be an obligation to disclose the
fees and anything that they receive as a result of services provided to
the plan including indirect revenue sharing. If the service provider fails
to disclose the required information they will be subject to excise taxes.
He stated that the regulation as modified will require the service
provider to disclose potential conflicts of interests, where any material
financial interest could affect their judgment on some of the services
they supply to the plans. This requirement will be placed on service
providers, who are fiduciaries as well as non fiduciaries, which provide
advice to plan fiduciaries.
He indicated that this regulation project will work in
conjunction with the DOL project seeking to revise Schedule C to the Form
5500 in which DOL wants reported the indirect compensation that a service
provider receives.
Mr. Campagna next addressed his second topic that of
Revenue Sharing payments with offsets. He testified that there is no
inherent violation of ERISA involving revenue sharing with one exception
which he would discuss. Nor is there any requirement under ERISA to
allocate these payments to participants.
He testified that the DOL view is that revenue sharing
may be good, in that it reduces overall plan costs and provides the plans,
especially small ones, with services and benefits which might not be
affordable.
He then discussed the exception which could result in a
violation. He described a situation where a plan fiduciary through its
discretion causes payments to itself or an affiliate or other interested
party. He testified that this transaction could result in an act of self
dealing under the prohibited transaction rules unless the revenue sharing
payments are given to the plan or used to offset the plan’s obligation
to that advisor with any excess above that amount returned to the plan. He
indicated that this offset could best be handled in the negotiation
process with the service provider.
Mr. Campagna followed this testimony with a discussion
of ERISA’s requirement to allocate revenue sharing payments back to
participants. He stated that if revenue sharing payments are returned to
the plan, they are plan assets subject to all of ERISA’s fiduciary and
prohibited transaction rules. However, he further indicated that nothing
in ERISA addresses the proper allocation of these payments to participants
or describes the process by which such allocations are made. He stated
that in the absence of statutory guidance, allocation decision must be
made taking into account the terms of the plan and the obligations of
[plan fiduciaries to act prudently and in the sole interest of the
participants and beneficiaries. He stated that plan sponsors have
considerable discretion as a matter of plan design how revenue sharing
proceeds will be allocated to and among plan participants.
He discussed that the principles set forth in Field
Assistance Bulletin 2003-03 and FAB 2006-01 can lay the foundation for a
proper allocation among participants. He said the principles in these FABs
provide the fiduciaries three options; they can (i) be used to reduce
overall expenses, (ii) be allocated among all participants on a pro rata
or per capita basis, or (iii) they can be allocated to particular
participants and beneficiaries accounts who generated the revenue sharing.
He further testified that when a plan is silent or ambiguous on how
proceeds might be allocated, fiduciaries must be prudent in their
selection of an allocation method. This means that the fiduciary using a
rational basis must weigh the competing interests of the various classes
of participants and the effects of the allocation method on each group. He
also addressed a need to consider the cost and benefit to the plan and
participants in implementing any allocation method.
He further stated that if an allocation method has no
reasonable relationship to the revenues generated, it could be argued that
a fiduciary breached his duty to act prudently, or, engaged in a
prohibited transaction if not solely in the interest of participants. He
stated that this might be the case, when an allocation benefits a plan
sponsor, a party in interest or a fiduciary, who is also a plan
participant, in more than an incidental manner.
Mr. Campagna and Mr. Doyle addressed various questions
from the Council Members regarding various service provider scenarios
which could arise and how they can be handled. Mr. Campagna addressed the
proposed DOL guidance stating that it will specifically require service
providers in a contract proposal or actual contract between the plan and
the service providers to make certain disclosures regarding direct and
indirect compensation, the services to be provided, indirect compensation
and a provision that the service provider will disclose internal
conflicts. It will be a prohibited transaction issue for the service
provider and will allow for a contract action by the plan if the provider
breaches the contractual provision. The DOL believes this is necessary
because plan fiduciaries need to have this information in order to judge
the reasonableness of compensation and the onus should not be on plan
sponsors to go out and track this information down. Mr. Doyle stated that
the DOL is charged with the responsibility to create a framework where the
plan fiduciary has certainty that they are getting the requisite
information and the service providers have some degree of certainty that
they have satisfied the requirements for the exemption from a prohibited
transaction.
They concluded their testimony by emphasizing that this
is a very hard issue to address stating that the DOL has to review what is
that the participants need to know.
In the case of an individual account plan, he further
stated that the DOL wants to develop a public record in terms of
suggestion and approaches because it is an extremely important issue. Mr.
Doyle stated further that the DOL wants to come up with a framework that
gives participant information they need but that the cost to obtain such
information will not outweigh the ultimate benefit derived from
information. Mr. Doyle indicated that the DOL’s obligation is to
determine what it is that participants need to know to make an informed
decision; at what cost to the individual; and how the DOL and SEC can
identify types of disclosure that would serve to benefit participants and
beneficiaries.
Summary Of Testimony Of Barry S. Slevin
Barry S. Slevin, a principal in the firm of Slevin
& Hart, testified before the Working Group regarding fiduciary and
settlor functions in the context of multiemployer plans. In presenting his
testimony, Mr. Slevin indicated that he was presenting his own views and
not necessarily the views of his clients or others in his firm. Mr. Slevin
provided both oral and written testimony.
Mr. Slevin began his testimony by discussing the rules
that apply when a plan sponsor of a single employer plan amends a plan. He
indicated the fact that the plan sponsor in the context of a single
employer plan can make a decision, put it in the plan document and make it
immune from second guessing is an extremely important function and a way
to reduce litigation risks and controversies. He noted that under ERISA,
the plan sponsor of a multiemployer plan is defined as the board of
trustees. He indicated that the question then becomes why the Board of
Trustees of a multiemployer plan shouldn’t be able to amend the plan
document and have the benefit of the same protection.
He then discussed the Department of Labor’s Field
Assistance Bulletin 2002-2. He indicated that the Bulletin, in effect
says, that the Board of Trustees can chose how it wants those functions
defined, but that if it decides to be treated as a settlor, it may not use
plan assets to make the decision. According to Mr. Slevin, this creates a
conundrum for the Board of Trustees. Should they make the decisions as
settlors in the dark and not ask their lawyers and their actuary for
advice because they can’t pay their lawyer and actuary if they are
acting as settlors? Or, should they give up the protection that the law
gives the rest of the world that is a settlor decision and declare
themselves to be fiduciaries and therefore use plan assets, the upside
being they make better decisions? Mr. Slevin indicated that this is an
impossible choice.
He next focused his testimony on the ability of
multiemployer fiduciaries to provide information to collective bargaining
parties. It is his view that multiemployer plans should be able to provide
information to collective bargaining parties and not be worried that they
are going to be subject to criticism by Department of Labor investigators.
He thinks that this should apply to already existing information, as well
as to the decision to develop information for the collective bargaining
parties. He noted that the basic information the plan may develop for the
Board of Trustees may not be the type of information the collective
bargaining parties need.
According to Mr. Slevin, it is far from clear in terms
of the Department’s enforcement perspective whether that development of
information at plan expense and providing it to the collective bargaining
parties would clearly be appropriate. He believes that specific guidance
on this issue would be helpful. He indicated that he would be in favor of
a field assistance bulletin confirming that a board of trustees can
provide information to bargaining parties as long as they do so paying
reasonable compensation.
Mr. Slevin then discussed the Pension Protection Act of
2006 (“PPA”). He noted that the PPA creates a required method of
communication between the board of trustees and the collective bargaining
parties when a plan is in endangered or critical status. He explained that
the Board of Trustees is required to develop a funding solution to the
plan’s financial problems called a rehabilitation plan for plans in
critical status. The Board of Trustees is required to come up with a set
of potential options to give to the collective bargaining parties and the
collective bargaining parties are then required to decide and negotiate
over those options. If the bargaining parties don’t agree, then one
option that is the default plan will go into effect.
He indicated that this can be very contentious area. In
Mr. Slevin’s opinion, whether the decision is settlor or fiduciary is
important not only because of the question raised by Field Assistance
Bulletin as to whether the fiduciaries can use plan assets to get advice,
but also on the substantive question once they make the decision and if
they are subject to criticism. If they don’t have settlor protection, he
indicated that this can be an extremely contentious debate and subject to
litigation for those participants who are unhappy with the schedules that
have been adopted. It is Mr. Slevin’s view that troubled plans should
not be saddled with more litigation in terms of defending these actions.
Mr. Slevin indicated that he doesn’t think that
multiemployer plans should be required to make the choice that the Field
Assistance Bulletin sets up. He believes that they should be able to make
settlor decisions and use plan assets. In making settlor decisions, he
believes that the trustees of a multiemployer plan should be able to get
the same protection that a plan sponsor in a single employer context gets.
He indicated that they should be able to use plan expenses to get good
advice and that they shouldn’t be put in the ridiculous position of
making the decision without advice. He indicated that he thinks that it
makes a lot more sense to say that it’s a settlor decision and we are
not going to question the substantive decision under fiduciary structures,
but that the process is still going to be subject to fiduciary standards.
He noted that the fact that the Board of Trustees as
settlors would be able to use plan assets to make these decisions to
implement the PPA doesn’t mean that they are beyond regulation. In this
regard, he stated that they would still be subject to the fiduciary
responsibility provisions in terms of retaining professionals, paying them
reasonably, and getting information that is only necessary to properly
operate the fund.
Summary of Testimony of Marc LeBlanc
Marc LeBlanc, who is the Fund Administrator and General
Counsel for the Sheet Metal Workers’ National Pension Fund (“National
Pension Fund”), appeared before the Working Group and presented
testimony regarding settlor and fiduciary functions in the context of
multiemployer plans, the use of plan assets by multiemployer plans to pay
for the performance of settlor type expenses, and the payment of expenses
associated with complying with the requirements of the Pension Protection
Act of 2006 (“PPA”). In presenting his testimony, Mr. LeBlanc
indicated that the views he was expressing were his personal views and did
not necessarily reflect the views of the National Pension Fund or its
Board of Trustees. Mr. LeBlanc presented both oral and written remarks.
Mr. LeBlanc stated that it is appropriate for
multiemployer plan assets to be used to pay for expenses that have
traditionally been treated as settlor functions, even if the trust
agreement specifically says that these functions are settlor functions. He
noted that a plan may pay from plan assets the reasonable expenses of
carrying out functions that are for purposes of providing benefits to
participants and beneficiaries or defraying the reasonable expenses of
administering the plan. He expressed the view that this should be so even
though the relevant plan document makes it clear that the board of
trustees does not act in a fiduciary capacity when it modifies the plan or
makes decisions regarding the composition, design, form or structure.
Through law, regulation or some other form of guidance,
Mr. LeBlanc believes that the issue should be clarified to permit
multiemployer plans to cover the expenses incurred by trustees when they
act analogously to settlors, subject to certain conditions and safeguards.
These safeguards would include plan provisions that direct trustees to
undertake certain due diligence both before and after they make a plan
design decision.
He explained that ERISA does not describe fiduciaries
simply as administrators, managers or advisors, but that the test is
functional. A person is a fiduciary to the extent they have discretionary
authority or responsibility in plan administration. He suggested that the
premise that an act may be fiduciary or settlor in nature depending upon
how the plan document characterizes it is without substantial support in
trust law, ERISA, and several court rulings. He then proceeded to discuss
applicable case law, including Hartline v. Sheet Metal Workers’ National
Pension Fund.
With respect to the PPA, Mr. LeBlanc stated that the
PPA gives Trustees new tools to avoid funding difficulties. Because these
tools require settlor type decisions that will change benefits and
contribution structures, he indicated that the plan must be able to pay to
use these tools.
He noted that under the PPA, plans sponsors are
required to provide the bargaining parties with a set of schedules for
contribution increases or benefit cuts. He indicated that he doesn’t
believe that it is realistic to pass these expenses back onto the
bargaining parties and observed that the DOL has previously placed
significance on the decision to make a payment out of plan assets on the
lack of resources to pay for it.
According to Mr. LeBlanc, the costs of implementing the
PPA requirements should be paid out of plan assets as expenses for the
provision of benefits, as necessary administrative expenses, and as
expenses in the best interests of participants. He stated that the
expenses to develop a funding improvement plan or rehabilitation plan
properly may be paid from plan assets because they are incurred for the
purpose of providing benefits or administering the plan.
He indicated that the whole purpose of the PPA is to
protect participants and beneficiaries and that compliance expenses should
therefore be payable out of plan assets. He also believes that it is in
the participant’s best interest to expect the trustees to obtain and
oversee professional guidance and for the trustees to be authorized to pay
those related expenses from plan assets.
He indicated that the plan sponsor of a multiemployer
plan lacks the financial resources to pay these expenses to carry out
settlor type functions. He also advised that the number of contributing
employers and participating local unions in large multiemployer plans
makes it impractical to obtain payment from the bargaining parties for
these design related decisions.
He also expressed the view that increased disclosure
obligations under the PPA will lead to second guessing of the trustees’
decisions. As an example, he indicated that a funding improvement plan may
be required to reduce ongoing benefit accruals enough for the plan to meet
its funding benchmarks. According to Mr. LeBlanc, participants will
doubtless debate whether a cut is necessary.
Mr. LeBlanc indicated that the Department’s approach
to these vital expenses disregards an important policy function served by
the settlor doctrine. He advised that plan design choices are not easy,
they’re not simple, and they’re not universally acceptable. The law,
however, has long accepted that tough choices deserve deference. He
believes that the position that Department takes is really unsupportable
and that we should be encouraging people to seek guidance, rather than
telling them they cannot. At a minimum, he would like to see the
Department revisit the field assistance bulletin.
Summary of Testimony of Troy K. Saharic
Mr. Saharic is a Principal and West Zone Business
Leader with Mercer Investment Consulting, Inc. in Seattle, and a member of
the National Association of Government Defined Contribution
Administrators. Mr. Saharic serves as the lead investment consultant to
defined contribution (DC) plan sponsors with assets totaling over $30
billion. His testimony was focused primarily on the mid to large segment
of the participant-directed DC market (defined as plans with assets
greater than $500 million) and addressed the fee transparency issues
facing plan fiduciaries seeking to understand total DC plan costs, and the
desire for more transparent fee disclosures to participants.
Mr. Saharic began his testimony by providing some
context – he shared that the US DC market is just over $4 trillion in
size and expected to grow. He then pointed out that Americans are
increasingly reliant on these plans for retirement readiness, and that it
is ultimately the contributions to the plans and the net returns on these
savings that will get them there. He testified that plan sponsors are
looking for ways to enhance returns by adopting strategic investment
structures, retaining high quality investment options and reducing
investment / administrative costs borne by participants.
Mr. Saharic then described the service components
required to offer a DC plan: Record keeping / Administration, Investment
Management, and Custody/Trust Service. While these services were largely
bundled (sold together) in the past, over the last 10-15 years there has
been a migration towards unbundled DC plan management, particularly in the
large ($1 billion+) segment of the market. The migration has occurred as
these sponsors have been able to isolate and reduce costs of each service
component. Mr. Saharic observed that in spite of this migration, bundled
providers still manage 44% of DC assets in proprietary funds, representing
53% of DC plan accounts. Mr. Saharic commented that the bundled providers
have maintained market share by providing services at what appears to be
low cost – this apparent low cost achieved by economies of scale, growth
in DC assets and the use of revenue sharing on arrangements with
non-proprietary investment offerings.
Mr. Saharic indicated that revenue sharing has
proliferated as a result of the increased offerings of non-propriety
investment options, and is typically made available through (1) 12b-1 fees
and / or sub-transfer agency fees paid from the assets of the mutual fund,
or (2) revenue sharing arrangements negotiated between the investment
manager and service provider. The negotiated arrangements, while better
disclosed over the last few years, are not always transparent to the plan
sponsor.
Mr. Saharic advised that plan sponsors need (1) to
examine the economics of their 401(k) service provider arrangements, (2)
understand the actual costs of each the service components being provided
(e.g. administrative vs. investment management) and (3) determine whether
overall fees are reasonable, can be reduced through utilization of lower
cost investment vehicles/rebating to reduce investment expenses, or
optimized by gaining additional services for the plan. In order to
understand the level of cost and reasonability, Mr. Saharic demonstrated
through example, that plan sponsors needs to seek to understand the
various revenue sharing arrangements in place for each investment option.
Mr. Saharic testified that plan sponsors are supportive
of promoting and providing transparent fee disclosures to participants but
struggle with:
-
Providing concise information on the complex and widely
varying arrangements for revenue sharing in an format that can be easily
understood, at a reasonable cost
-
The lack of a simplified “best practice” fee
disclosure in the market
-
Competing priorities for DC participant communication
(e.g. getting more eligible employees to participant, increasing savings,
improving investment decisions)
In conclusion, Mr. Saharic stated that plan sponsors
who have the appropriate tools, have been diligent in their efforts to
fully evaluate the total costs of the DC plans that they offer and that
these plan sponsors will continue to proactively look for ways to improve
participants’ net returns by reducing all costs borne by their plans.
Next, he pointed out that revenue sharing arrangements
are a reality of the DC industry. He encouraged the investment management
community to continue to develop lower cost vehicles to use in DC plans.
Third, he asserted that fee disclosures can become
transparent to participants if plan sponsors and advisors are diligent in
gathering information. He acknowledged that some transparency issues still
exist with respect to the revenues received and costs incurred by some record keepers
/ administrators that make understanding the fees a
difficult task for some plan sponsors.
Finally, he stated that plan sponsors are fully
supportive of providing transparent fee disclosure and plan expense to
participants, however they are seeking direction for a more simplified
consolidated fee disclosure.
Summary of the Testimony of Judy Mazo
Judy Mazo of The Segal Company agreed to testify before
the Working Group on Fiduciary Responsibilities Update and Revenue
Sharing. Specifically, Ms. Mazo directed her remarks to the ‘clash’
between settlor and fiduciary functions and the use of plan assets to pay
for functions needed to run, operate and administer a multiemployer plan,
particularly in light of the Pension Protection Act of 2006.
Ms. Mazo testified that there are four non-exclusive
functions considered as ‘settlor’ functions. They are plan formation,
plan design, plan amendment and plan termination. These four require
expert, unbiased advice from attorneys, actuaries and accountants. The
crux of the issue, she testified, is that plan assets may be used to pay
for fiduciary functions but not for settlor functions. This is
well-settled case law and regulatory interpretation. The conundrum for
consideration is that the four settlor functions enumerated above are
perceived by Labor as being so closely related to a fiduciary function as
to require the use of plans assets in the retention of experts in order to
properly discharge formation, design, amendment and termination exercises
in the best interests of plan participants while Management views the
very same functions as being non-fiduciary items for which plans assets
cannot be used in the payment of fees. Ms. Mazo testified that plan
participants view all of the money that goes into the plan as something
that’s been negotiated and the employers view the money as all coming
from their capital and their profitability. She stated that the ‘truth’
is probably somewhere in the middle.
Ms. Mazo discussed at length the Field Advisory
Bulletin issued by the Labor Department in 2002. Up to that point, she
stated, DOL had always couched its guidance as “for single employer
plans” or “except for multiemployer plans.” The ’02 FAB stated
that if plan assets were to be used for settlor functions then plan
trustees would have to acknowledge that they were willing to be
accountable on a fiduciary basis for those settlor decisions to use plan
assets to engage experts in the matters of plan formation, design,
amendment and termination. In essence, electing to heighten scrutiny and
accountability to a fiduciary level for what had always been a plan
management decision. The bottom line, Ms. Mazo stated was that to have
trustees give up the liability shield in order to use plan assets for settlor
functions. She testified that in the multiemployer world, nobody
makes use of this particular FAB.
Ms. Mazo spent a great amount of time discussing the
sensitive and political issues surrounding the use of plan assets and the
need for a liability shield. First, she discussed with several examples
that it isn’t really that hard to come up with a clear rationale that
would allow multiemployer trustees acting as settlors to use plan assets
to pay for the cost of doing their job correctly. She intimated that under
Taft-Hartley, the charge to trustees is to administer the fund and its
assets and that charge under most all trust agreements includes plan
design to some degree. From a public policy perspective, Ms. Mazo laid out
three reasons for allowing settlor functions to be paid for with plan
assets. First, trustees must make sometimes controversial and always very
sensitive decisions. Such decisions must be made without the threat of
second-guessing. For instance the decision of increasing or decreasing
benefits is always going to disturb one side or the other. Nevertheless,
such a decision, she stated should be made without the threat of fiduciary
litigation. Secondly, Ms. Mazo stated that the question of “what’s
fair and unfair” is something inherent within the political process of
the multiemployer pension plan world and is between the bargaining
parties. The trustees should be able to mediate, she felt, and pay for
expert guidance with plan assets. Third, and final, the point was raised
as to the settlor v. fiduciary function and its effect upon fiduciary
insurance. Carriers are pricing into the coverage the effects of electing
fiduciary status per the FAB and also the effects of making settlor decisions without expert guidance. In any event, the premiums are being
driven higher and higher.
In summary, Ms. Mazo stated that there were no clear
answers. A problem exists. She stated that the Walling case was indicative
of numerous court decisions holding that plan design is a settlor function. Likewise, Ms. Mazo alerted the Council to the fact that the
Katarino case stated that the very same plan design function was a
fiduciary function. The very essence of a solution must be found whereby
DOL and Congress do not create an impregnable shield for trustees to do
whatever they want in a self-interested way. The resolution lies in
balancing risk, fairness and accountability.
Summary of Testimony by Mark Lotruglio
Mr. Lotruglio is vice president and principal with Quan-Vest
Consultants, an investment management consulting firm that serves small to
mid size multiemployer benefit plans.
He opened his remarks by noting that most decision
makers of small to mid size defined benefit plans are not sophisticated
regarding investment management. Such employers should hire experts to
advise them.
Plan sponsor decision makers tend to be conservative.
Historically, many have had strong preferences for domestic holdings,
versus a strategic combination of domestic and foreign holdings. Such a
preference has been especially prevalent with union organizations because
of their pro-American stance. Low interest rates in recent years have
forced plan sponsors into considering larger equity exposure, which has
made many of them increasingly uncomfortable. He suggested that the use of
additional asset classes, such as international stocks and real estate,
has the desired impact of higher expectations of return and lower
expectations of risk.
Mr. Lotruglio outlined three general ways to improve a
given plan’s funding situation: improve returns, cut benefits or
increase contributions. Improving return potential is difficult because of
the likely corresponding increase in risk. Employers are seeking new
investment ideas that can generate higher returns, while keeping risk in
check. The accelerated funding requirements of PPA of 2006 have increased
the challenges facing defined benefit plan decision makers. He feels that
interaction between investment decision makers and plan actuaries is now
even more critical than before PPA of 2006.
He recommends that the DOL issue guidance that
specifies fiduciary responsibilities for plan sponsors, in light of
movement within the defined benefit industry to more sophisticated
investment vehicles. Many plan sponsors are now utilizing alternative
investments which are often highly leveraged, non-transparent and
complicated. Investment responsibility can be delegated to a third party
by the plan sponsor, but only if acknowledged in writing by the service
provider.
It is critical that plan sponsors be able to use plan
assets to pay for investment management and investment consulting
services, says Mr. Lotruglio. Otherwise, plan sponsors will not be able to
manage their plans adequately, given the increased need that plans now
have for higher returns, due to PPA of 2006.
He reiterated that the most important point of his
testimony is that the increasing usage of alternative investments requires
clarification and guidance from the DOL for plan sponsors. If the DOL does
not issue such guidance, Mr. Lotruglio believes that the unfortunate
consequence for employers will simply be higher contribution requirements.
Summary of Testimony of Joyce Mader
Joyce Mader, a partner with the firm of O’Donoghue
& O’Donoghue, testified regarding settlor and fiduciary functions
and the use of plan assets. Ms. Mader provided oral testimony, as well as
written remarks.
Ms. Mader indicated that it has become much more
difficult to advise trustees since the Department of Labor began issuing
guidance in this area. She indicated that multiemployer trustees have a
choice now, it appears, between acting as fiduciaries or acting as
settlors. When they ask what’s the best way to go, she indicated that
the answer is, “Well, that depends.” Ms. Mader indicated that is very
frustrating and unsettling to trustees, particularly when they ask
questions about whether they are protected, covered by insurance and
whether they can use plan assets.
Ms. Mader indicated that up until the time of Field
Assistance Bulletin 2002-2, there hadn’t been any real specific issues
addressed to multiemployer plans. Instead, she advised that there seemed
to be an effort to say that these are the rules except for multiemployer
plans, and it was never very clear what the rules for multiemployer plans
were.
She then provided a brief overview of the differing
case law in this area. For example, she indicated that in one batch of
cases, the courts said that multiemployer plans amending plans are not
doing so as fiduciaries. In another batch of cases, she indicated that
courts found that multiemployer plans amending the plan were doing this as
fiduciaries.
She also discussed guidance provided by the Department
of Labor regarding settlor and fiduciary functions, including the
Erlenborn letter dated March 13, 1986 and the Maldonado letter issued
March 2, 1987, wherein the Department reviewed the kinds of activities
that would be considered settlor functions for which plan assets could not
be properly expended. When discussing the Maldonado letter, she noted that
there was no discussion of multiemployer plans. She also indicated that it
is not clear how this characterization of these functions as settlor
because they relate to the business activities of an employer relate to
the functions of a multiemployer board making specific decisions on plan
design.
She stated that she has been mystified that the
Department would characterize a plan amendment to increase benefits as
something benefiting the employer. She advised that her
experience has been that usually it is the employer fighting to avoid the
increase and the union and/or trustees fighting to get it. And yet she
indicated that the analysis as to why this is a settlor function versus a
fiduciary function is because it benefits the employer.
She then discussed Advisory Opinion 97-03A. She
indicated that it became apparent in this advisory opinion that the
Department viewed expenditures for a function that it classified as a
settlor function as “inuring to the benefit of an employer” and that
the Department believes the reason it is a settlor function is because the
function benefits the employer, in violation of Sections 403(c)(1) and 404
of ERISA. She noted that the language, "except in the
case of multiemployer plans,” was in the opinion.
She testified that she doesn’t believe that the
Department’s analysis is really supported by the language of ERISA. She
indicated that Section 403(c)(1) of ERISA provides that the assets of the
plan must be held for the exclusive purpose of providing benefits to plan
participants and beneficiaries and defraying the reasonable administrative
expenses of the plan and that Section 404(a)(1)(A) of ERISA requires that
fiduciaries discharge their duties for the same exclusive purpose. She
advised that for a number of years prior to the 1997 Advisory Opinion,
both courts and the Department of Labor had recognized that fiduciaries
could, in fact, incidentally benefit the employer through the incidental
benefit rule. As an example, she cited Interpretative Bulletin 94-1
regarding economically targeted investments.
When responding to a question regarding what the rule
should be, she indicated, in part, that court cases would not have to be
overturned to find that something is not a settlor function because the
language of Sections 403 and 404 of ERISA says that plans assets may be
expended for the purpose of paying benefits and doesn’t say it has to be
a fiduciary function. She testified that a straight-on reading of the
language says that plan assets may be expended for the purpose of paying
benefits and for defraying the reasonable expenses of plan administration.
She then discussed Field Assistance Bulletin 2002-2.
She described the Bulletin as allowing multiemployer plans pick. She
indicated that they can either decide that they are going to function as a
fiduciary and then can spend plan assets or they can decide that they are
not functioning as a fiduciary and then can’t spend plan assets.
In her written testimony, Ms. Mader concluded that it
is not clear to her why multiemployer trustees should not be able to
expend plan assets for settlor functions. She indicated that such an
expenditure is not prohibited by ERISA which permits expenditures for the
purpose of providing benefits as well as for the reasonable expenses of
plan administration.
Summary of Testimony of Gene Kalwarski
Gene Kalwarski, who is the CEO and a consulting actuary
with Cheiron, appeared before the Working Group and presented testimony
regarding the Pension Protection Act (“PPA”).
He indicated that about two thirds of about 75
Taft-Hartley plans that are his clients are going to be facing critical or
endangered status from the get-go and that for the balance, it takes only
a single year of a bad investment return to send them into endangered or
critical status. He is concerned that there is so much responsibility on
the actuary to guide these funds though rehabilitation plans and funding
improvement plans that actuaries are going to be overwhelmed and there is
going to be a greater fear of liability exposure.
As an example, he indicated that they are being asked
to classify for a pension fund by March 30, 2008 , whether a plan is
critical or in danger. However, he indicated that there are ambiguities in
the law and that they have no guidance. He advised that the IRS has told
them that guidance probably isn’t coming until the first quarter. He
indicated that actuaries have to go in there and be certifying whether a
plan is in red, yellow or green without having answers for how to project
an ‘07 evaluation to ‘08. According to Mr. Kalwarski, there are
different techniques and if they do it one way and another actuary does it
another way, there is going to be fear down the road that there will be
lawsuits.
He stated that asking the actuary to do projections is
the best part of the PPA. However, he indicated that in the 1980s, there
was a situation where one of the largest insurance companies nearly
toppled and the actuaries were performing projections all the time. He
advised that one of the problems was that actuaries were making
best-estimate assumptions, whether it be 9 percent, 6 percent or 5
percent.
He advised that a straight-line assumption is useful,
but it doesn’t indicate any level of risk and the reality is markets go
up and down. He indicated that what happened in that industry since the
1980s was the creation of a technique called dynamic financial analysis,
which forces the life insurance actuaries not only to do projections based
on straight-line assumptions, but to also do projections based on
up-and-down markets. He indicated that this is something that is
desperately needed in the pension area.
Summary of Testimony of David Blitzstein
David Blitzstein, who is a Special Assistant for the
Multiemployer Funds Collective Bargaining Department of the United Food
& Commercial Workers International Union, testified before the Working
Group regarding the fiduciary/settlor distinction in the context of
multiemployer plans. Mr. Blitzstein provided both oral and written
comments.
Mr. Blitzstein is a multiemployer trustee who currently
serves on five pension plans and advises an additional multiemployer pension plan. He indicated that he has also
acted as a negotiator of employee benefits on behalf of two international
unions.
Since the issuance of Field Assistance Bulletin 2002-2,
he indicated that he has become less comfortable with the definitions of
fiduciary and settlor. He indicated that he is concerned about the
confusion over the issue of whether a multiemployer plan trustee is a
fiduciary or settlor when making decisions that in a single employer
context are clearly settlor in nature.
He indicated that the Field Assistance Bulletin and
some subsequent actions by the Department of Labor seem to confirm his
belief that the Department does not completely appreciate the delicate and
complex relationship between multiemployer plans and collective bargaining
parties. As an example, he advised that the Department issued a letter to
a multiemployer pension plan taking the position that it had violated
ERISA in paying its actuarial consultant fees related to costing benefits
which was used in collective bargaining. He indicated that this made no
sense to him and that it sent a chill through the multiemployer plans and
collective bargaining parties who knew about it.
He indicated that he believes that the passage of the
Pension Protection Act (“PPA”) blurs and fundamentally changes the
pre-PPA fiduciary/settlor distinctions. According to Mr. Blitzstein, the
funding rules and procedures established by the PPA anticipated a closer
consultative relationship between plan trustees and bargaining parties.
However, he indicated that based on the Department of Labor’s current
position, if a Board of Trustees took the position that trustee decisions
were settlor-type decisions, that would mean that the trustees could not
use plan assets to pay fund professionals to assist the trustees in
fulfilling their statutory responsibilities under the PPA. Mr. Blitzstein
indicated that does not make sense and is not in the best interest of plan
participants.
He also expressed the view that shifting the
responsibility and cost of calculating benefit design and contribution
levels to the collective bargaining parties is dangerous public policy. He
indicated that consultants retained by collective bargaining parties have
no ethical or professional commitment to the pension plan or its
participants and may offer short-term, risky solutions that are not
necessarily in the best interest of participants.
He proposed that a decision made by fiduciaries under
the PPA that is a plan design decision, including decisions regarding
which classes of participants’ benefits should be adjusted, would not be
subject to fiduciary standards, as this is classically the type of
decision that settlors have been given flexibility to make without having
to justify it on fiduciary grounds. He stated that the fact that the PPA
directs the trustees to make these decisions means that plan assets may be
used to do so. He indicated that this proposal also anticipates that the
normal fiduciary standards would apply to the expenditure of plan assets,
including the principles of reasonable compensation and the provision of
necessary services.
He next addressed investment issues related to the PPA’s
mandated funding standards, including what may be appropriate alternative
investments to meet those funding requirements. He indicated that the PPA’s
funding standards will require boards of trustees to reduce risk and
decrease return volatility in their plans. According to Mr. Blitzstein,
this is a difficult challenge that can’t be accomplished with the
traditional 60/40 equity/bond asset allocation.
Even before that passage of the PPA, he advised that
some plans had started using risk-budgeting tools to measure their market
exposures in risk in an effort to avoid the risk of shortfall funding. He
indicated that this drove some boards of trustees to invest or consider
investing in alternative assets that are non-correlated with stocks and
bonds, such as real estate, private equity, global inflation-linked bonds,
commodities, hedge funds, and infrastructure.
He indicated that his biggest fear is that boards of
trustees will hesitate to make these fundamental decisions to more
aggressively diversify their asset portfolio because they may be viewed as
an outlier in the pension community, raising the risk of fiduciary
liability. He urged the Working Group to address that concern and give
boards of trustees the confidence that prudent diversification investment
strategies are encouraged by the Department of Labor and protected under
fiduciary standards.
Finally, he proposed that a U.S. Government task force,
including the Department of Labor, Department of the Treasury, Pension
Benefit Guaranty Corporation, and the Federal Reserve Bank, address market
failures and dislocations that potentially threaten the retirement
security of tens of millions of Americans. He indicated that the task
force could consider ways to better manage asset bubbles and severe market
volatility, promote market transparency, and encourage the development of
investment products in the private sector that would assist pension
trustees in managing inflation risks, interest rate risks, and mortality
risks.
Summary of Testimony of Michael Malone
Mr. Malone is the founder of MJM401k, which is a
consulting firm and a Registered Investment Advisor that specializes in
serving middle market 401(k) plans. In his experiences, he has seen
revenue sharing used both appropriately and inappropriately. The concept
is abused at times by some providers and advisors.
In a majority of cases, the employer is “unconscious”
about revenue sharing that is taking place because the employer has not
been a party to the discussion or decision making as to how it is applied.
However, the employer is the entity that is ultimately responsible and has
the greatest fiduciary liability exposure.
Mr. Malone explained a “solving for x” culture
whereby the goal of advisors and plan providers may be the development of
a plan that has no “billable” expenses. Thus, a given plan sponsor may
view the plan as “free” because the sponsor is unaware of total plan
costs. Inappropriateness occurs when the plan sponsor is not engaged in
decisions which affect plan participants. Mutual fund share class
selection is an example of an area where plan sponsors are often not
involved in the selection process, but should be. Different share classes
of the same mutual fund can vary by as much as 100 basis points in total
annual cost. Share class selection has fiduciary consequences.
He emphasized that revenue sharing can be a very useful
tool with significant benefits for participants. The DOL should issue
written guidance that demands strict disclosure of all revenue sharing
agreements between 401(k) service providers. Plan fiduciaries should be
put on notice by the DOL that they are legally responsible for controlling
all expenses paid by 401(k) plan participants. Mr. Malone feels that such
guidance should explicitly state that a plan sponsor has a fiduciary
responsibility to understand any revenue sharing within a plan, and
sponsors must determine whether compensation paid to service providers is
reasonable.
Guidance from the DOL should specify required
disclosure of all plan expenses, including compensation to service
providers, on both the IRS Form 5500 and the SAR. Service providers should
be required to disclose all available share classes of recommended funds,
and the breakdown of how fees would be allocated or shared, depending on
which share classes are selected. Service providers should disclose to
plan fiduciaries any and all compensation that they receive. Analyzing the
profitability or efficiency of a given provider is not necessary. Instead,
plan sponsor fiduciaries should have a full understanding of all costs and
all compensation, and determine whether the resulting costs to the plan
and participants are reasonable.
Mr. Malone’s experience has been that most service
providers will, when asked, provide specific and complete information
regarding revenue sharing. One exception he noted involves the use of
guaranteed investment contracts and “fixed accounts” which are often
used by insurance company plan providers.
The DOL needs to provide education to plan sponsors to
help them better understand 401(k) plan pricing and the role of revenue
sharing in such pricing. Such educational material should address: 1.)
full explanation of investment vehicle expense ratios, 2.) potential
unreasonable compensation to plan service providers, 3.) multiple share
classes, 4.) expense ratios which often pay for more than just investment
cost, 5.) “wrap fees” which are often undesirable because they are
usually disclosed to participants, whereas revenue sharing arrangements
usually are not, and 6.) selection of funds based only on the lowest
expense ratios or the greatest revenue sharing, which can be detrimental
to participants. Mr. Malone feels that if too much attention is focused on
plan expenses and revenue sharing, important issues such as quality and
value returned for cost can be lost.
While time did not permit for Mr. Malone to complete
his testimony before the Council, his written remarks indicate a strong
opinion that the DOL should develop a model prototype for the disclosure
of revenue sharing payments. He further noted that participant level
disclosure of revenue sharing would be either “unread at best” or “misunderstood
at worst.” As such, Mr. Malone believes the burden of understanding
revenue sharing, and making sound decisions accordingly, falls upon the
shoulders of plan sponsor fiduciaries, not plan participants.
Summary of Testimony of Francis X. Lilly
Mr. Lilly is the chairman and CEO of Independent
Fiduciary Services, Inc., a Washington D.C.-based investment consulting
firm providing investment consulting advice to institutional investors.
Mr. Lilly previously served as Solicitor of the Department of Labor from
1983-1985. Mr. Lilly presented testimony to the Working Group on Fiduciary
Responsibilities and Revenue Sharing regarding revenue sharing practices
and disclosure of plan fees and expenses in connection with defined
contribution plan investment management expenses.
Mr. Lilly summarized the current judicial and
regulatory environment regarding defined contribution plan fee
disclosures. He noted that recent legal actions filed concerning plan fees
have been of two types: (1) those filed against plan sponsors alleging
failure to disclose and/or monitor fees and expenses; and (2) those filed
against plan service providers alleging that the service providers did not
disclose revenue sharing arrangements and that the proceeds of such
arrangements should have been used for the benefit of plan participants.
In the face of many pending court cases challenging fee disclosure or fee
reasonability, Mr. Lilly cautions that the lack of specific defined
contribution plan fee disclosure requirements from the Department of Labor
could lead to conflicting and inconsistent requirements dictated by the
courts. Mr. Lilly also summarized the current disclosure requirements on
Form 5500 Schedule C and the current requirements of ERISA Section
408(b)(2) regarding reasonability of compensation paid to parties in
interest for services necessary for plan operation. Proposed revisions to
these requirements would presumably provide for greater compensation
reporting by plan service providers of amounts paid by the plans and by
parties other than plans, such as investment managers, consultants,
brokers or trustees.
In addition, Mr. Lilly highlighted the confusion that
surrounds use of the term “revenue sharing” in the defined
contribution plan context, and the lack of a clear understanding of all
fees paid by defined contribution plans or earned by and between service
providers for these plans. Mr. Lilly offered a generally accepted
definition of revenue sharing – an arrangement by which a portion of the
internal fees associated with an investment product is paid to an entity
that either provides services to the defined contribution plan in which
the investment product is included or distributes the investment product.
Revenue sharing, so defined, is thus separate and distinct from any
payments made directly to a defined contribution plan by the plan’s
bundled service provider. Such payments to the plan are considered rebates
in the investment community’s vernacular. Mr. Lilly further offered
generally-accepted definitions of several common elements of fees, costs
and revenues that are paid and/or earned by defined contribution plans,
their service providers and mutual funds/investment companies –
including expense ratios, management fees, 12b-1 fees and their
components, sub-transfer agent fees, and shareholder servicing fees. Mr.
Lilly asserted that it is imperative that the Department of Labor take the
lead in formally defining these and other fee terms in the defined
contribution plan context in order to improve recognition of the full
panoply of such fees and to avoid potential confusion of conflicting court
decisions regarding their meaning.
Inherent in the Department’s effort to fully
understand the cost structure of defined contribution plan programs, and
in the industry’s efforts to serve such plans in a profitable manner, is
the key question in Mr. Lilly’s opinion – what are the real costs of
plan administration and mutual fund investment management in the defined
contribution environment and what is the most efficient and effective way
to disclose those costs? The answer to this question is complicated by
several factors, such as the implications of rebates to plans, the layers
of fee categories and sub-categories among providers and the degree to
which stated fees are fixed and non-negotiable. As to the last factor, Mr.
Lilly notes that fees are not generally fixed and non-negotiable because
defined contribution plan providers share fees with investment managers in
a variety of ways. Fee application and disclosure is further complicated
by market forces – large plans may simply have more options than small
or mid-sized plans with regard to fee arrangements because of their
relative negotiating positions. One prevailing issue is that there are a
number of ways that a provider can raise revenue. The challenge is to
determine how plan fiduciaries can best determine that all the fees
imposed are for the cost of real and necessary services to the plan.
Mr. Lilly acknowledged that fees must, at least in
part, be driven by the market economy. Improvements in services for
defined contribution plan services and technology must be reflected in the
prices of those services to plans. Mr. Lilly asserted that service
providers should not be required to disclose the profit margin in their
pricing models. However, Mr. Lilly recognized that plan fiduciaries have a
right and a responsibility to understand the actual cost of specific
services provided to the plan.
Mr. Lilly noted that although defined contribution plan
fiduciaries must meet the ERISA fiduciary standard of care, many lack
sufficient information regarding fees to adequately meet this standard. To
remedy this situation, Mr. Lilly recommended standardization of the
terminology used in the defined contribution fee context. Mr. Lilly stated
that his clients would welcome direction and guidance from the Department
in this area to establish an industry-wide standard for disclosure of fee
information. Mr. Lilly also recommended that the Department lead the
defined contribution plan service industry toward greater clarification of
costs and services, requiring service providers to state the specific cost
for certain plan services. This would, in Mr. Lilly’s opinion,
contribute to greater transparency regarding plan fees. Such transparency
would enable plan fiduciaries to make informed decisions by comparing
providers on a level playing field and would enable plan fiduciaries to
better carry out their responsibilities.
Summary of Testimony of Allison Klausner
Allison Klausner is the Assistant General Counsel
Benefits at Honeywell International, Incorporated, responsible for legal
matters, including litigation, compliance and corporate transactions
related to employee benefits. She testified representing the American
Benefits Council, and was accompanied by Lynn Dudley of the American
Benefits Council. The American Benefits Council is a public policy
organization that represents principally Fortune 500 companies and other
organizations that assist employees of all sizes in providing benefits.
Collectively, the Council’s members either sponsor or provide services
to more than 100 million Americans.
Ms. Klausner addressed 401(k) fees, with a focus on two
areas – (1.) the dialogue between plan sponsors and participants, and
(2.) the dialogue between providers and plan sponsors.
Ms. Klausner noted that communication with participants
is broader than fees, and that communication is key to achieving
sufficient levels of participant savings in plans. She warned that
participants need to understand fees within the context of services
received, and that fees are just one factor to consider when choosing an
investment fund. Fees should not be elevated to the extent that other
factors, like potential returns, time horizon, risk tolerance, etc., are
ignored. She testified that granular disclosures of fees could increase
cost to the plan/complexity to the participant, and could, at worst,
mislead or dissuade participants from trying to understand the plan or
available funds. As a large plan sponsor, she recommended that disclosure
should be focused on investment objectives, risk level, fees and
historical returns of investment options.
Ms. Klausner also recommended that the rules regarding
electronic communications need to be reformed to enable more efficient
forms of communication, including internet and intranet postings. She also
observed that participant level disclosure rules should apply to
participant directed plans. She added that the information should be
disclosed in a manner in which fees are charged, rather than artificial
divisions of a single fee into multiple parts. Where disclosures of the
exact dollar amounts would be costly, uses of estimates should be allowed.
With respect to provider-to-plan sponsor disclosures,
Ms. Klausner noted that plan fiduciaries are already taking extensive
steps to ensure that fee levels are fair and reasonable for participants.
She cited a Hewitt survey where 77 percent of plan sponsors surveyed were
either “very” or “somewhat likely” to undertake a review of fund
expenses, revenue sharing and disclosure to participants. She related this
to her specific experience at Honeywell where the due diligence process
includes interviews with providers to gain insights on how processes are
completed and where there are opportunities to be more cost effective. She
discouraged plan sponsors using “check lists” to determine whether
fees are reasonable due to the wide variance among plans.
Ms. Klausner noted that when assessing fee levels, a
best practice for large plan sponsors is to negotiate with each provider
of services, to best understand the fee for each portion of plan service.
This also enables the sponsor to measure performance against the fees
being charged for the various services (record keeping, investments, etc.)
Effectively, the model moves away from bundling and revenue sharing. For
the smaller sized market, bundling of services has resulted from desires
to get economies of scales, sometimes among a group of service providers.
In this case, it can be more difficult for the sponsor to asses exactly
which piece of service a specific fee is for – and in that case it makes
sense for the sponsor to assess the total fee for the menu of services
that is required for the plan.
Summary of Testimony of Sam Brkich
Sam Brkich is Vice President at The Newport Group and a
member of the Board of the Coalition of Independent 401(k) Record keepers
(CIKR). His testimony on revenue sharing made the following points.
Revenue sharing is a common practice and is paid by
many, but not all, mutual funds. However, disclosure to clients varies
widely. There is nothing inherently “wrong” with revenue sharing, but
it should be transparent. Generally, there is nothing in contracts
regarding revenue sharing unless revenue sharing is part of the fee. It is
not uncommon for there to be excess revenue sharing, although the amount
is normally small. It can be expected if the average account balance of
the plan exceeds $40,000. CIKR understands that a number of non-fiduciary
service providers do not offset fees by revenue sharing, although CIKR
members agree that excess revenue sharing should be returned to plan
participants. A fiduciary is required to disclose revenue sharing and
apply it to the benefit of the plan. However, this requirement does not
apply to a non-fiduciary. But it is not clear whether it would be
violation of regulations if a non-fiduciary retains revenue sharing that
has not been disclosed. The question is whether amounts received by the
provider are amounts paid by the plan. In Opinion Letters 97-15A and
97-16A the DOL appeared to take the position that revenue generated by a
plan’s investment in a mutual fund that are paid to a service provider
are amounts being paid to the plan indirectly. In any case, it would seem
that amounts received indirectly through revenue sharing would need to be
disclosed to the fiduciary in order for the statutory exemption for
reasonable service arrangements to be available. There are limitations on
a provider’s ability to identify and allocate revenue sharing,
particularly in some investment types, e.g., stable value funds. Some CIKR
members are working on a model to identify revenue sharing payments.
Securities law creates some issues with revenue sharing being a plan
asset.
CIKR would like clarification and guidance from the
Department of Labor to address (1) whether providers can or must use
excess revenue sharing to benefit plans, (2) whether excess needs to be
held in trust, and (3) if so, how quickly, and (4) whether the receipt of
revenue sharing needs to be disclosed in the Plan’s 5500. Further, a
ruling from the IRS on the effect of a rebate on the tax-qualified status
of the plan would be helpful. The existing rulings from the DOL do not
address whether revenue sharing might violate the regulations because the
DOL considers it be a factual question. CIKR believes the guidance should
provide that:
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Service providers may agree to rebate excess revenue
sharing, and the time and manner of crediting should be part of the
fiduciary’s determination that the services arrangement is reasonable.
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If revenue sharing is not rebated, the determination
of reasonableness should be based on provider disclosed estimates of
expected revenue sharing, and the provider should have a contractual
obligation to provided updates.
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Payment of revenue sharing should not be a
prohibited transaction, and should become a plan asset when it is required
to be paid to the plan under the terms of the service agreement.
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Plans should be permitted to allocate excess revenue
sharing among participants on a reasonable basis.
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DOL should facilitate the IRS providing guidance or
regulations on the character in the plan of revenue sharing payments.
Summary of Testimony of Mary Podesta
Ms. Podesta is the Senior Counsel for Pension
Regulation with the Investment Company Institute (ICI), a national trade
association representing mutual funds, unit investment trusts, and
closed-end funds.
Ms. Podesta began her testimony by noting that the
401(k) plan has been a great success over the past 25 years and that
research done by ICI and the Employee Benefits Research Institute shows
that 401(k) participants make very sensible choices in allocating their
assets (Ms. Podesta cited a recent ICI survey that found that, on an
asset-weighted basis, 401(k) investors in stock mutual funds incur an
expense ratio of 74 basis points versus 88 basis points for retail stock
fund investors). Ms. Podesta noted that employer plan sponsors have played
a critical role in this success and according to a 2006 survey by Deloitte
and others, 75% of plan sponsors have chosen to use a full-service, or “bundled”,
arrangement to obtain investment products and administrative services for
their 401(k) plan.
Ms. Podesta focused much of her testimony on the
reasons why employers choose to use bundled arrangements and why
asset-based fees paid to record keepers in the form of revenue sharing are
consistent with ERISA and can serve to reduce overall plan costs.
Ms. Podesta testified that in the plan context,
asset-based fees mean that new participants and those with lower wages and
lower account balances can participate in plans without the cost of plan
administration falling disproportionately on their shoulders as a
percentage of their account balance. Ms. Podesta also noted that
asset-based fees are a way for a plan to spread out the payment of
start-up expenses of a new plan or transition expenses when a plan moves
from one record keeper to another, with these payments spread over time as
assets grow.
Ms. Podesta noted that as with any service arrangement,
plan fiduciaries need to monitor the arrangement to make sure that it
remains reasonable over time. In this regard, Ms. Podesta stated that a
plan and a service provider have the following options if growth of plan
assets supports a revision of the service arrangement: (1) reduce costs by
selecting lower-cost investment options or share classes, (2) require
additional services that may not have been affordable originally, (3)
negotiate with the record keeper to receive a share of the record keeper’s
revenue and use the refunded revenue in a manner consistent with ERISA, or
(4) put the arrangement out to bid to see if other service providers would
offer comparable services at a lower cost.
Ms. Podesta testified that the ICI supports the
Department of Labor’s initiative to revise its 408(b)(2) regulations to
clarify what information plan fiduciaries need to make sure that a service
arrangement is reasonable. In that regard, ICI’s view is that the DOL
should require that plans receive information from their service provider
on the services that will be delivered, the fees that will be charged, and
whether and to what extent the service provider receives compensation from
other parties in connection with the plan servicing. Ms. Podesta further
noted that a plan need not look at the cost to the service provider since
the plan fiduciaries are not required under ERISA to assess a service
provider’s profitability.
Ms. Podesta next testified that a service provider that
offers a number of services in a package should not be required to assign
fees to the components of the package. In response to a question regarding
a plan sponsor’s desire to know the component costs in order to be able
to make comparisons to other service providers, Ms. Podesta responded that
if the services are offered in a package then what the plan sponsor needs
to know is the total cost of the package.
With regard to revenue sharing, Ms. Podesta testified
that a service provider should disclose compensation that it receives from
an unaffiliated party because that will allow the plan sponsor to
understand the service provider’s total compensation and to appreciate
any conflicts of interest. With regard to services provided by affiliates
of the service provider, Ms. Podesta noted that plan sponsor should
understand all of the services and the aggregate compensation paid, but
the sponsor need not look at how those payments may be allocated among
those affiliates since such an allocation is artificial given that
affiliate transactions are not market-based transactions.
In response to a question regarding potential future
changes to the rules governing rule 12b-1 fees, Ms. Podesta pointed out
that at a recent Securities and Exchange Commission roundtable on 12b-1
fees, there was general consensus that modest changes may be needed but
not radical reform. In response to another question around what might be
the effect if a draconian rule were imposed to eliminate the practice of
revenue sharing, Ms. Podesta pointed out that such a drastic rule change
is not needed, especially given the fact that the 401(k) marketplace is
very competitive and dynamic marketplace that has encouraged positive
innovation over the year.
Summary of Testimony of Fred Reish
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Revenue Sharing is prevalent and generally most
participants pay revenue sharing in some form through their investments.
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Currently, Service providers, that include revenue
sharing expense in their costs, are knowledgeable plan people, who have no
obligation or incentive to share their knowledge with the fiduciaries,
although the fiduciary must disclose revenue sharing and possibly include
such funds as plan assets when reimbursed.
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When Plan fiduciaries receive better fee disclosure;
they are better educated and can better assess the Service Providers and
their Revenue Sharing expenses, which should benefit plan participants.
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Regardless of whether the provider is a bundled or
unbundled record keeper, there should be full disclosure of cost and fees
because it is participant’s money. There should be full disclosure of
the services and benefits attributable to the fees charged. This
disclosure will permit fiduciaries to determine the reasonableness of the
fees and compare these fees with those of other providers.
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With respect to fee rebates, in current practice,
the allocation on a pro rata basis is proper, but in the future, the best
practice will be to allocate the funds back to the participant’s
accounts, which actually generated the fees.
Testimony
The Chairman read into the record, Mr. Reish’s
background and requested that Mr. Reish focus on the problem of compliance
with respect to Revenue Sharing fees. He sought Mr. Reish’s perspective
on when these funds constitute Plan Assets. Mr. Reish stated that “Revenue
Sharing is prevalent. Of the 401(k) and 403(b) plans that I am the general
ERISA attorney for, every one of them pays revenue sharing.” This results
in most participants paying Revenue Sharing in some form through their
investments. In addition, he testified that of the providers he
represents, all of them receive some form of Revenue Sharing. However, he
stated that most fiduciaries do not realize or recognize that the plans
they are responsible for have Revenue Sharing expense. He indicated that
he believes that the plan asset advisers and providers are aware and do not
disclose it to the fiduciaries. The law has clearly placed the obligation
on the wrong party. However, that process is changing and the
responsibility to disclose Revenue Sharing expense is shifting from the
fiduciary to the provider to disclose it to the fiduciary.
This shift will start with the new rules for schedule C
of 5500 and will also change because of the 408(b) (2) regulations when
they are issued. Although the burden will shift to disclose, the fiduciary
is still charged with the responsibility to determine if a fee is
reasonable. DOL is now bifurcating the responsibility for fees and
expenses, especially for indirect expenses. He did identify one issue with
respect to his belief on the revised Schedule C requirements. Currently,
because Schedule C must only be filed by employers with 100 or more
employees, the requirement will only capture 20 percent of the plans. He
believes it should be extended to all plans. He also raised a
question regarding the proper disclosure of information by providers,
whether bundled or unbundled and, requested that the DOL apply one
consistent standard regardless of the business model employed by such
provider. He testified that there are two principles that fiduciaries must
address regarding expenses; (i) whether or not they are reasonable as they
are allocated out and (ii) whether or not there are conflicts of interest
of the Service Provider, they need to consider in their decision making as
to the reasonableness. He also indicated that by receiving this
information annually, they will be better educated to operate the plan and
this information will educate them on the cost and expenses relative to
the asset growth in the plan which might generate additional fees. This
knowledge will enable the fiduciaries to negotiate better and provide for
a comparison of each provider and the revenue sharing attributable to
them.
He next described the various forms of revenue sharing
fees and their impact on various size plans, i.e., (i) 12b-1 fees, (ii)
sub-transfer agency fees and (iii) payments derived from investment
management fees.
He testified that in large plans you almost never see
broker-dealers operating as brokers so there are no 12b-1 fees for that
purpose but the 12b-1 fees may be used to offset plan fees and expenses.
He stated that you will see sub-transfer agency fees, which pay for
transfer agent and shareholder services and may also subsidize record keeping
services depending upon the share classes. He said this is
an area ripe for investigation because the lawsuits raised this issue. He
stated that fiduciaries must be better educated on the reasons for
different share classes and associated fees.
He testified that in middle market plans you get a mix
of the types of fees, but they are generally the sub-transfer agency fees
or the investment management service type. If there is a broker, there may
be 12b-1 fees, all of which increase the cost to the participant. He
stated that with the small plans, you get a combination of sub-transfer
agency fees and 12b-1 fees, especially where you have an annuity product
with offsets and then after the offset amount is obtained a brokers charge
is added back as a contract charge. This result may still be okay because
there are usually much more services needed by a small plan.
Mr. Reish next engaged in a lively debate with several
members of the Council regarding the need for full disclosure concerning
bundled and unbundled providers’ fees and what type of disclosure must
be made Mr. Reish indicated that it was his perspective that all cards
should be placed on the table explaining the cost of the services provided
to the fiduciaries so they could properly compare the various potential
provider of services to the Plan. He indicated that full disclosure should
not include the provider’s profitability but if there are any incentive
payments made or crediting fees to an affiliate which might be a conflict
of interest, they must be disclosed. He testified that there should be
full disclosure as it is participant’s money. He stated that there
should also be full disclosure of the services and benefits attributable
to the fees charged so fiduciaries can test their reasonableness for the
expense of these services against other providers. He testified that the
burden should be shifted to the providers, the ones who can best supply
the information. He testified that transparency should be the rule
regardless of a plan’s size.
The final area addressed by Mr. Reish related to the
when and how to utilize unallocated reimbursements received by a plan. He
stated that one area of concern is that the IRS and DOL each have their
own set of rules and they need more coordination. He believes that the DOL
rules are much more realistic in their approach to the allocation issue.
He stated that there is a need for additional guidance maybe in the form
of a Field Assistance Bulletin to walk people through the issue. He
recommends that in current practice, the allocation on a pro rata basis is
proper, but in the future, the best practice will be to allocate rebates
back to the participant’s accounts that actually paid them. He thinks
under a cost benefit approach allocation on a per account basis is proper.
However, he testified if a record keeper's systems become sophisticated
and capable of analyzing such fees, then the rebates generated must be
directed to the specific accounts which generated the cost in the first
place.
Summary of Testimony of Laura Gough
Conclusions
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“Revenue Sharing” has different meanings for
different agencies, i.e. SEC, DOL and FINRA and it is important that you
recognize the proper meaning when you are addressing DOL issues and not
SEC issues.
-
The term, “Revenue Sharing” in an employee
benefit context encompasses anything that a plan might receive from a
third party, other than the employer or plan sponsor, i.e., revenue from
12b-1 fees, servicing fees or sub-transfer agency fees.
-
The DOL must make sure in its guidance that its
guidance recognizes the unique distinction in the definition between its
guidance and other bodies so confusion does not result. The DOL must
delineate what types of payments it is talking about when it issues its
guidance.
-
The DOL initiative must clearly state for providers
what information is required by the fiduciaries with respect to Revenue
Sharing and ensure that the guidance is in line with the guidance from
other regulatory bodies that govern investments that are made in
retirement plans.
Testimony
Ms Gough was testifying on behalf of the Securities
Industry and Financial Markets Association. Ms Gough testified that she
wanted to clarify what exactly is “Revenue Sharing” because different
people and different agencies use the term but it does not have the exact
same meaning for each group of people or agency.
It is her belief that revenue sharing arrangements and
the services they have supported have created greater flexibility within
the marketplace. Revenue Sharing has enabled many plans, even small plans,
a great amount of flexibility to choose from a multitude of different
investment options. It allows all plans to select from outside of the
proprietary investment options previously required by bundled providers.
Revenue Sharing provides a more democratic manner to allocate expenses
with larger shareholders accepting the larger burden of expenses. Revenue
Sharing has also enabled a number of smaller third party administrators to
be able to maintain a competitive position in the marketplace
When the SEC and FINRA use the term Revenue Sharing, it
has a very specific meaning and it is a payment from a fund adviser or a
fund distributor and it comes from such person’s net revenues or profits
and such payment is made to a broker-dealer for overall marketing
services, training services, educational services and is not attributable
to one particular client(s). The term Revenue Sharing, in an employee
benefit context, encompasses anything that a plan might receive from a
third party other than the employer or plan sponsor, i.e., revenue from
12b-1 fees, servicing fees or sub-transfer agency fees. In the securities
sense, there can any number of different types of revenue that could
result i.e., float, loaning of securities, or any types of payments that
could be attributable to any one customer payable out of the fund adviser’s
net profit. In the plan sense, it is any fees that are part of the net
asset value, part of the expense ratio of the plan or fund not paid
directly out of the plan assets.
Consequently, the DOL must make sure in its guidance
that it is specific and recognizes the distinction in the various agencies’
applications of the term so that confusion does not result and the DOL
must be careful to delineate what types of payments it is addressing when
it uses the term Revenue Sharing.
Ms. Gough next addressed the area of the proper use and
allocation of revenue sharing for an ERISA plan. In a plan context,
revenue sharing is paid or servicing payments are paid to a plan provider,
and then such servicing payments are then used to offset legitimate plan
expenses. Generally, the provider will set up an expense account to
receive in payments and then the provider deducts the plan expenses out of
that expense account. Any additional excess expenses are paid either by
the provider, the plan sponsor, or allocated in a prudent manner and paid
by the participants. If there is excess revenue or an excess credit, then
there may be issue because if revenue sharing is not a plan asset, how do
you reallocate it to participant’s accounts. Another issue arises
because the Office of the Comptroller of the Currency, the IRS and state
insurance laws, each have rules which provide that if you have a share
class in a mutual fund, you can not treat different shareholders in
different ways with respect to payments. Each shareholder in a share class
must receive funds in the same manner. The Internal Revenue Service might
also inquire whether a preferred dividend was paid if one group was
treated differently than another group with the possible result that all
dividends paid to the mutual fund would be taxed.
In response to a question, Ms. Gough indicated that she
has seen these credits either, (i) reallocated back to participants, (ii)
reallocated to offset expenses and then used to reduce fund expense or
(iii) some plans state that these are not plan assets and will not
allocate back to the participants. Ms. Gough responded to another question
if there has been any regulatory action concerning the preferential
dividends by stating that this could an IRS issue and SEC issue. She
testifies to her knowledge only the SEC has issued a no action letter
which allows 12b-1 fees to b e rebated back to certain client accounts.
Ms. Gough then testified regarding share classes
stating that it is up to the Plan Sponsor to negotiate the fees and terms
of the various share classes by asking the right questions; do we qualify;
what are the elements of the servicing payments, what is the most
appropriate share class for my participants and how much revenue can be
used to offset expenses. The provider must determine what its systems can
do to reallocate excess revenue to participants and at what cost working
with the Sponsor. She testified that it is up to the Plan sponsor to
negotiate all the terms up front, in order to determine; what is the most
appropriate share class for the plan and how the Plan might achieve
different levels of the share class. She also agreed with a question
stating it is a fiduciary duty to determine and negotiate the reasonable
expenses of an investment fund before participation in a particular share
class.
-
Hughes Aircraft Co. v. Jacobson, 525
U.S. 432, 434-444 (1999) as cited in the testimony of Marc LeBlanc.
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See September 20, 2007 testimony of
Joyce A. Mader, page 19
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The first initiative involves the
revision of Schedule C (service provider information) to form 5500
annual return/report. The second initiative involves an
amendment of the regulations under the statutory exemption for
services provided in Section 408(b)(2) of ERISA.
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