On February 2, 2012, the U.S. Department of Labor (the "DOL") issued final regulations under ERISA's "necessary services" exemption (the "Final Regulations"). The Final Regulations require that certain service providers to pension plans disclose, before any service arrangement becomes effective, a variety of details regarding the services they will provide and the direct and indirect compensation they will receive. Failure to comply with the Final Regulations could result in a service provider's arrangements with, and receipt of fees from, a pension plan constituting a prohibited transaction. The Final Regulations become effective on July 1, 2012 and will apply to arrangements entered into both before and after that date. The Final Regulations generally follow the interim final regulations, which were released by the DOL on July 16, 2010. A copy of the Final Regulations marked to show the differences between the interim final regulations and the Final Regulations can be found here. The remainder of this memorandum focuses on the applicability of the Final Regulations to managers of plan asset funds and pension plan separately managed accounts ("SMAs").

Overview of the Final Regulations

The following is a high-level summary of the key items that asset managers must disclose in writing under the Final Regulations (the timing for providing these disclosures is described further below):

  • A description of the services to be provided;
  • Whether the asset manager is a fiduciary with respect to the plan asset fund or SMA and, with respect to SMAs, whether the asset manager will provide services as an investment adviser registered under the Investment Advisers Act of 1940 or any state law;
  • A description of all direct compensation (e.g., management fees and any incentive fees or allocations) and a description of all indirect compensation (e.g., soft dollars, gifts and entertainment, etc.) that the asset manager will receive;
  • A description of certain compensation shared with affiliates or subcontractors;
  • A description of compensation payable by the pension plan upon termination of the service arrangement, including information as to how any prepaid fees will be calculated and refunded; and
  • For plan asset funds only (not applicable to SMAs):
    • A description of any compensation that will be charged directly against invested amounts (e.g., commissions, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees and purchase fees);
    • A description of the annual operating expenses (e.g., expense ratio), if the return of the fund is not fixed, and any ongoing expenses (e.g., wrap fees, mortality fees and expense fees) or, for plan asset funds that constitute 401(k) plan menu options, the total annual operating expenses expressed as a percentage and calculated in accordance with the DOL's participant-level disclosure regulation;1 and
    • For plan asset funds that constitute 401(k) plan menu options, any other information or data about the investment option that is within the control of, or reasonably available to, the asset manager and is required for the plan sponsor to comply with its obligations described in the participant-level disclosure regulation.2

Asset managers must provide these disclosures to their pension plan clients reasonably in advance of the date an arrangement is entered into, extended or renewed. To the extent there are revisions to the information disclosed, the asset manager must disclose those revisions within various timeframes set forth in the Final Regulations, generally, either within 60 days of the change or as part of annual updates, depending on the type of information to which the change relates. Because the Final Regulations also apply to existing arrangements, these disclosures will need to be provided to pension plan clients with respect to existing arrangements reasonably in advance of July 1, 2012.

Key Takeaways for Asset Managers

Will disclosures made in a fund's PPM or other documents be sufficient to comply with the Final Regulations?

A frequent question has been whether existing PPM and SMA disclosures will be sufficient to satisfy the Final Regulations or whether the Final Regulations require information to be provided in a particular format (e.g., summary disclosure document) separate and apart from current documentation. As an initial matter, the Final Regulations do not require information to be disclosed in any particular format – they continue to allow asset managers to satisfy the disclosure requirements by providing the relevant information in documents that were prepared for other purposes (e.g., PPM, ADV, audited financials, etc.). However, the DOL strongly encourages service providers to prepare a guide or summary disclosure document for plan fiduciaries to help identify the pieces of information that comply with the disclosure rules. While the DOL provides a model summary disclosure in the Final Regulations, the provision of a summary is not required at this time. However, the DOL has announced that it will be proposing further regulations on the topic later this year.

For now, although it may be practicable for certain asset managers to rely solely on existing disclosures, some requirements of the Final Regulations may make doing so difficult. For example, under the Final Regulations, the DOL has retained its position that an asset manager's receipt of gifts of $250 or more over the course of an arrangement (rather than annually) must be disclosed at the outset of the arrangement. Thus, given that the dollar amount of any gifts that may be received over the life of an arrangement will almost never be known in advance, many asset managers will likely need to provide their pension plan clients with general information regarding the terms of their gifts and entertainment policies beyond what is typically provided in a PPM or an SMA agreement. Similarly, the Final Regulations continue to require the disclosure of total annual operating expenses of a plan asset fund. Although this information may be available in a fund's audited financial statements, it would not generally be available in a PPM or any other document furnished to the potential pension fund investors before they invest in a fund. Finally, many asset managers may disclose to pension plan investors much of the information required by the Final Regulations as part of their annual Form 5500 Schedule C reporting obligations. However, because the Final Regulations require disclosure before an agreement is entered into and require updates relatively contemporaneously with any changes, asset managers will likely have to treat the new requirements as additive to their Form 5500 disclosure obligations.

Special Issues for Asset Managers Providing Services to 401(k) Plan Menu Options

For asset managers who provide services to 401(k) plan clients (e.g., running an SMA for a 401(k) plan),3 the Final Regulations present some special challenges. As noted above, asset managers that provide these types of services must also disclose the information that is required by the participant-level disclosure regulation. For example, asset managers must disclose the following investment information about the 401(k) plan menu option to the extent applicable and available: identifying information such as the name and type or category of the option, performance data, benchmarks, the name of the option's issuer, the option's objectives or goals, the option's principal strategies and principal risks and the option's turnover rate. Certain of this information may not be provided in existing documents. Thus, asset managers who provide services to 401(k) plan clients would likely need to create additional disclosures for their 401(k) plan clients.

Next Steps

Asset managers should immediately start reviewing their existing plan asset funds and SMAs and determine whether they previously disclosed enough information to comply with the Final Regulations and whether it would be appropriate for them to create a summary disclosure document in light of the Final Regulations. Although the effective date of the Final Regulations has already been delayed a number of times, it seems unlikely that the DOL will be granting any further extension of the July 1, 2012 deadline.

Footnotes

1 The relevant portion of the participant-level disclosure regulation can be found at 29 CFR § 2550.404a-5(h)(5).

2 The relevant portion of the participant-level disclosure regulation can be found at 29 CFR § 2550.404a-5(d)(1).

3 Asset managers should also consider with counsel how these rules might apply to plan asset funds that constitute part of a 401(k) plan menu option in reliance on the no-action letter issued by the SEC to the H.E. Butt Grocery Company (May 18, 2001).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.