Category Archives: 408(b)(2)

Consequences of Failure to Comply


408(b)(2), fiduciary, plan sponsors, prohibited transaction, service providers

This is another in the series of articles about the 408(b)(2) disclosures – and the consequences of a failure to comply.  This article discusses the legal responsibilities of plan sponsors.

If a service provider fails to make the required disclosures, then under ERISA both the service provider and the plan sponsor (that is, the responsible plan fiduciary) have engaged in a prohibited transaction. The 408(b)(2) regulation provides a procedure where plan sponsors can obtain relief for the failures of service providers; however, there is no similar provision for service providers.

What if the disclosures are made, but are not reviewed by the plan sponsor? Then the plan sponsor will have committed a fiduciary breach . . . since there is an affirmative obligation on fiduciaries to review and evaluate the compensation of service providers.

To take it a step further, what if the plan sponsor either fails to review the information, or does review the information, but fails to spot that excessive compensation is being paid to the covered service provider (for example, the recordkeeper or advisor). In that case, both the plan sponsor and the service provider will have engaged in a prohibited transaction. The service provider’s prohibited transaction is the receipt of the excessive compensation; the plan sponsor’s prohibited transaction is that it allowed the plan to pay unreasonable compensation. In these circumstances, there is not relief for the plan sponsor or for the service provider.

As a result, if the DOL or a plaintiff’s attorney spots the issue and files such a claim, both the plan sponsor and the service provider will be in a position of bearing the burden of proving that the compensation was reasonable. With benchmarking services and other comparative information, it will be easier for the Department of Labor and the plaintiff’s attorneys to identify cases where compensation may be excessive.

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DOL Investigations: Broker-Dealers and RIAs as Targets


408(b)(2), broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers

Together with Bruce Ashton and Summer Conley, I have authored an article titled “DOL Investigations: Broker-Dealers and RIAs as Targets.” To see the full text of the article, click on the link included here:

http://www.drinkerbiddle.com/resources/publications/2011/dol-investigations-broker-dealers-and-rias-as-targets

In the article we discuss that in recent months, we have heard of at least eight, and been involved in three, Department of Labor (DOL) investigations of broker-dealers related to their services to ERISA retirement plans. These investigations appear to be part of the DOL’s ongoing Consultant/Adviser Project (CAP). The CAP initiative is a national enforcement project designed to focus on “the receipt of improper or undisclosed compensation by employee benefit plan consultants and investment advisers.” This article discusses the background that led to the creation of CAP, the issues that financial advisers need to focus on and steps they may wish to take now to avoid liability exposure under ERISA.

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Expanded Discussion on Failure to Disclose


408(b)(2), prohibited transaction, service providers

This is another in a series of articles about interesting issues under the 408(b)(2) disclosure regulation.

In a previous article, I described the likely consequences of a failure to comply with the disclosure requirements—that is, the compensation paid to the service provider would need to be restored to the plan, together with interest. In that article, I also mentioned that there would be penalties imposed by the government. This article expands on that discussion.

The failure to provide the disclosures on a timely basis causes the relationship between the plan and the service provider to be a prohibited transaction. The prohibited transaction rules are found in both the Internal Revenue Code and ERISA . . . and each law has its own requirements and penalties.

Under the Internal Revenue Code, an excise tax of 15% is imposed on the “amount involved.” In the case of a 408(b)(2) disclosure failure, the amount involved would be the compensation. Thus, for the first year of the failure, the tax would be 15% of the compensation paid that year. In the second year, there would be an additional 15% tax imposed on the amount that was paid in the first year, together with a new 15% tax on the amount that was paid in the second year. The tax would continue to grow in that fashion from year to year until it is corrected.

In addition, once the IRS discovered the failure, it would demand that the transaction be reversed and corrected and, if that was not done within 90 days, the IRS could impose an additional tax equal to 100% of the amount involved.

The IRS would also require that tax returns be filed and that the tax be paid. Since, under the circumstances, the tax would not have been paid on a timely basis (since, in all likelihood, the service provider would not have recognized the failure on a timely basis), and thus there would be additional penalties for failure to file and failure to pay taxes.

The DOL could also impose penalties. Under Section 502(l) of ERISA, the DOL can impose a 20% penalty on amounts recovered for an ERISA-governed retirement plan. Thus, if the DOL investigated and identified the failure, it would demand that the “amount involved” be restored to the plan and, when the service provider complied, the DOL, depending upon the circumstances, could would impose an additional 20% penalty since it would have “recovered” the money for the plan. Fortunately, the IRS imposed taxes can be offset against the DOL penalty.

It goes without saying that these penalties are severe. As a result, service providers need to make every effort to comply with the 408(b)(2) disclosure requirements.

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More Issues Presented Under 408(b)(2) Regulations


408(b)(2), fiduciary, plan sponsors, prohibited transaction, recordkeeper, service providers, TPA

This is another in a series of articles on interesting issues presented under the 408(b)(2) regulation and its disclosure requirements.

It has become fairly common for plans to have expense recapture accounts (which are also known as ERISA budget accounts, PERAs—plan expense recapture or reimbursement accounts, and by a variety of other names). Typically, those accounts are established within a plan when a service provider (most often the recordkeeper) receives compensation through revenue sharing in excess of its reasonable charges. For example, if a reasonable charge for the recordkeeping/TPA services was $50,000 and the recordkeeper received $60,000 in revenue sharing, the excess amount would be deposited into the expense recapture account—thereby avoiding the prohibited transaction issue of excess compensation.

However, sometimes the recordkeeper/TPA places the money in its corporate account and tells the plan sponsor that the money can be spent for the benefit of the plan . . . at the direction of the plan sponsor. While that presents a number of fiduciary and prohibited transaction issues, it also presents an interesting, and problematic, 408(b)(2) compliance issue for service providers.

For example, when an accounting firm audits a 401(k) plan, it is usually compensated by the plan or the plan sponsor . . . and in that context, the accounting firm is not a “covered” service provider for 408(b)(2) purposes. Since the accounting firm is not covered by the 408(b)(2) regulation, it is not required to make the disclosures under the regulation. However, when an accountant receives “indirect compensation” (which, generally stated, is a payment from anyone other than the plan or plan sponsor), the accounting firm becomes a “covered” service provider and thus must make the required disclosures. Since a payment from a recordkeeper/TPA is not from the plan or the plan sponsor, it is “indirect compensation,” and as a result the accounting firm has become a covered service provider and must make the 408(b)(2) disclosures. But, what happens if the accounting firm hasn’t made those disclosures? The answer is simple . . . the arrangement is a prohibited transaction and the compensation belongs to the plan and not to the accounting firm. But, what if the accounting firm didn’t realize that it was being paid from an account of the recordkeeper/TPA? Unfortunately, there doesn’t seem to be any relief from the prohibited transaction consequences.

Similar issues exist for attorneys, actuaries, consultants and others who receive indirect payments.

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Short article about interesting issues under the DOL’s new disclosure requirements


408(b)(2), broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers

This is another in a series of short articles about interesting issues under the DOL’s new disclosure requirements.

If a covered service provider (for example, an RIA or a broker-dealer, or their individual advisers) fails to timely provide the disclosures required under 408(b)(2), the “arrangement,” or relationship, between the service provider and the plan is a prohibited transaction. But, what are the consequences? Unfortunately, the law is not clear. Here are some possibilities:

  • The entire arrangement must be unwound . . . investments, services, compensation, and so on. This would be Draconian . . . especially since it would probably be asserted after the investments had suffered losses. In that case, to unwind the arrangement the provider would have to bear those investment losses. However, I do not think this is the likely outcome (except, perhaps, in egregious cases).
  • All of the compensation received by the provider (plus interest) would have to be restored to the plan. This appears to be the likely outcome.
  • Only the non-disclosed part of the compensation would need to be restored to the plan. If the compensation that was not disclosed to the fiduciary was insignificant (that is, would not have affected the decision of a reasonable fiduciary), this interpretation has some appeal.

In addition to those payments, there are 15% and 100% taxes under the Internal Revenue Code and a  20% penalty under ERISA. Those will be discussed in a future article.

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Interesting 408(b)(2) Disclosure Issues


408(b)(2), fiduciary, plan sponsors, prohibited transaction, registered investment advisers, service providers

This is another in a series of emails about interesting issues related to 408(b)(2) disclosures. Since we are doing a considerable amount of work helping service providers comply with 408(b)(2), we have run across a number of less common, or even unusual, situations where the rules may—or may not—apply.

Occasionally, retirement plans invest in partnerships, limited partnerships and LLCs. As a general rule, if 25% or more of a class of equity interest in the entity is held by “benefit plan investors,” the entity is deemed to hold plan assets. As a result, the managing partner will be a fiduciary under ERISA’s rules (similar in concept to a collective trust, in the sense that the assets are held outside the plan, but nonetheless constitute plan assets). In those cases, the managing partner will be a covered service provider under the 408(b)(2) regulation and must make the required disclosures concerning services, status and compensation. The failure to do so will cause the arrangement to become a prohibited transaction.

On the other hand, if less than 25% of the entity is held by benefit plan investors, the holdings of the entity will not be plan assets and, as a result, the managing partner will not be considered to be a covered service provider. Similarly, under ERISA, the assets in a mutual fund are not considered to be plan assets and, as a result, the investment manager of a mutual fund is not a plan fiduciary and is not a covered service provider.

Interestingly—or perhaps curiously—however, plan sponsors must still report compensation arrangements about non-ERISA entities (such as hedge funds with less than 25% benefit plan investors) and mutual funds on Schedule C to the Form 5500. That creates the odd circumstance where plan sponsors are required to report that information on Schedule C, but unlike the arrangements that are subject to 408(b)(2) disclosures, those entities are not required, at least by ERISA, to provide the necessary information to plan sponsors. In other words, we have a regulatory regime that does not fully integrate.

I make these points for several reasons. First, it may be that some people don’t understand that the Schedule C reporting requirements are slightly different than the 408(b)(2) disclosure requirements. That is, while they are identical in most regards, there are also some significant differences, such as the ones described in this article. Secondly, it is likely that some service providers—perhaps RIAs—are managing investments in partnerships or other entities that could be subject to these rules—but that may not realize it. As a result, anyone who manages investments in an entity that is outside retirement plans, but which accepts retirement plan investments, should work with their ERISA counsel to evaluate their status, both under the fiduciary laws and under 408(b)(2).

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Extension to Compliance Date for 408(b)(2)


408(b)(2), broker-dealers, DOL, service providers

Last week, the Department of Labor (DOL) extended the compliance date for 408(b)(2) to April 1, 2012. While that only gives us another three months (from the current deadline of January 1), it is welcome relief. We have several observations about the extension:

  • Generally speaking, our service provider clients were on course to provide disclosures to their ERISA plans and to modify their intake procedures for new clients. However, they were feeling pressure to complete the work by the January 1 deadline.
  • The pressures primarily related to compensation disclosures. That is, our clients, by and large, have completed the work on the disclosures about services and status. However, the compensation disclosures are complex and often voluminous . . . particularly for broker-dealers and recordkeepers. At this point, the procedures for most of the easier compensation disclosures have been determined. However, work remains to be done on more complex compensation disclosures, for example, brokerage accounts and open architecture compensation disclosures by broker-dealers.
  • It is unlikely that there will be another extension. In its release, the DOL explained that the reason for this extension was that it had not released its final guidance under 408(b)(2) and, as a result, many service providers would need to make additional systems changes once the guidance is published. At this point, that will likely be October or possibly even November, depending on when the amended regulation is sent to the Office of Management and Budget.
  • It appears that the holdup is that the DOL is having difficulty resolving the new “summary and roadmap” disclosure requirements, which we understand is provided for in the amendment. The Department will need to either resolve the methodology for that disclosure or will need to eliminate the provision. We assume it will be the former.

The DOL thinks that the 3 month extension will be adequate because it will not take significant additional effort to incorporate the changes into the work already being done.  This suggests that the changes will either be relatively minor or possibly that some of the changes will make the regulation easier, rather than harder, to implement.

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Another in a series of discussions of interesting issues regarding disclosures under new DOL rules


408(b)(2), broker-dealers, DOL

The 408(b)(2) regulation requires that covered service providers disclose all “compensation.” On the face of it, that seems clear, but in practical application, it is more difficult. For example, must broker-dealers and others disclose all compensation, including revenue sharing? The answer is “yes.” Must all revenue sharing be disclosed? The answer is, “It depends on whether it is compensatory.”

While the regulation provides little guidance on what is “compensatory,” the DOL has explained its position in guidance about Schedule C to the 5500 Form:

“If a person providing services to the plan is provided a meal or other entertainment based on a general business relationship that includes both ERISA and non-ERISA business, is it required to be reported on Schedule C?

It depends.  The Schedule C instructions state that indirect compensation would not include compensation that would have been received had the service not been rendered to the plan or the transaction had not taken place with the plan and that cannot be reasonably allocated to the services(s) performed or transaction(s) with the plan.  However, if a person’s eligibility for receipt of a gift (such as meals, travel, or entertainment) is based, in whole or in part, on the value (e.g., assets under management, contract amounts, premiums) of contracts, policies or transactions (or classes thereof) placed with ERISA plans, the gift would constitute reportable indirect compensation for Schedule C purposes.  Where the eligibility for or amount of the gift is based on a book of business, including ERISA plan business, a pro rata share of the value of the gift should be treated as indirect compensation for the ERISA plans involved.”

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Interesting Issues under 408(b)(2)


408(b)(2), broker-dealers, DOL, fiduciary, registered investment advisers

This is the second in a series of short articles about disclosures to plan sponsors and participants under the new DOL regulations for disclosures to plans and to participants.

FACT: Many investment advisers (RIAs) and broker-dealers (BDs) use asset allocation models (AAMs) to help participants invest appropriately.

RULE: The DOL regulations require certain disclosures about “designated investment alternatives” (DIAs), including the performance history of the investments (to participants).

ISSUE: Are asset allocation models considered to be DIAs, which would invoke the disclosure requirements under both regulations?

ANSWER: Based on informal discussions with the DOL, it appears that they are leaning toward the conclusion that models are DIAs. If so, the disclosure requirements would include, among other things, reports from recordkeepers about the performance history of the models.  However, we believe that most recordkeepers have not been, and may not be able to (on a reasonable basis), calculate and report those returns. (Similar difficulties may exist for AAMs for other disclosures required by the regulations.) This could result in the inability to continue to use those models.

However, if the model is “managed” by a discretionary fiduciary, it appears that the DOL may conclude that is not a model, but instead an investment management service–which apparently would not be considered a DIA.

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Overlooked Issues Under 408(b)(2)


408(b)(2), broker-dealers, registered investment advisers, service providers

As we do work for “covered’ service providers to ERISA plans, we have seen a number of issues that we think are “flying under the radar.” As a result, I plan to write a series of short articles, like this one, about those issues.

The first is the “related parties” and “subcontractor” issue. Under the 408(b)(2) regulation, if a service provider pays money to an affiliate or a subcontractor, it may be necessary to separately report that payment. Without going into too much detail, the regulation requires that the payment be disclosed in writing if it is incentive compensation or is charged directly to the investments.

While this can affect several of types of service providers, it occurs most often in connection with broker-dealers. Let me explain. While the large wirehouses may treat their financial advisers (or registered representatives) as employees, many broker-dealers treat some or all of their financial advisers as independent contractors. The independent contractor financial advisers typically receive a percentage of the commission paid to the broker-dealer. In other words, they receive incentive compensation. As a result, the payment to the independent contractor financial adviser must be separately disclosed to the plan.

This could also apply to RIAs—investment advisers—where, for example, an IAR receives part of a solicitor’s fee for recommending an investment manager

The regulation is going to be amended before it becomes effective. As a result, some of the 408(b)(2) requirements could change.

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