Fees and Compensation of Advisers and Providers

By Fred Reish

The DOL is focused on the disclosure of fees and expenses charged by service providers—both advisers and plan providers—and on the reporting of that information. By “disclosure,” I am referring to the information that must be provided to plan fiduciaries and sponsors before their decisions to purchase the investments and services for their retirement plans. By “reporting,” I am referring to the information that must be reported on the Form 5500 after the end of each year.

Under the current requirements, the most comprehensive reporting of adviser compensation is found on the Schedule A for the Form 5500—for insurance-based products, like group annuity contracts. The current Schedule C to the 5500 Form requires limited reporting by so-called “large” plans, that is, plans covering 100 or more participants. For example, the instructions to the Schedule C requires that finder’s fees paid to advisers and brokers be reported. However, practically speaking, very few advisers and providers give that information to plan sponsors; as a result, finder’s fees are seldom reported on the Schedule C, even though it is required.

A few months ago, the DOL issued a proposed Schedule C for the 2008 Form 5500. That proposal would dramatically increase the information to be supplied to plan sponsors by advisers and plan providers.

Also included in the proposed are changes to Schedule A and Schedule C is a requirement that plan sponsors report whether any of their service providers failed to give them the information necessary to complete the Schedules. If so, the plan sponsor would be required to identify the service provider on the Schedule.

The DOL is currently considering comments filed by the private sector and will, in the next few months, issue the final version of the 2008 Form 5500.

We assume that the final version will be similar to the proposal. However, based on the comments filed by the private sector, including us, the DOL may permit simplified reporting for certain costs and revenue where it would be expensive or difficult to provide more detailed information.

In addition to the revisions to the 5500, the DOL is also working on a “point-of-sale” disclosure requirement under section 408(b)(2) of ERISA. Simply stated, the proposal (which has not yet been issued) would require that, if advisers and providers do not disclose their compensation, both direct and indirect, prior to the point of sale, the transaction would be prohibited by law. As a result, any compensation received by an adviser or provider would need to be returned to the plan. That would include, for example, finder’s fees, 12b-1 fees, subtransfer agency fees, and other revenue sharing. (For the purpose of this article, I use the term “advisers” to refer to brokers, investment advisers and consultants, which would include third party administrators. I use “providers” to refer to the entity that performs the recordkeeping function for participant-directed plans. In ERISA, all of these are referred to as service providers, who are parties in interest to a plan.)

It is expected that the DOL will issue its proposal in the next few months (but, because of the impact on the 401(k) industry, it is difficult to accurately predict when the proposal will be released and it is even more difficult to predict when it will be effective). At this point, we doubt that it could be effective before 2009.

The purpose of the new guidance is twofold. The intention of the DOL is to require full disclosure to plan fiduciaries of all information (i) that might affect their decision about whether to purchase the services of the adviser or provider for the plan, and (ii) that would allow the fiduciaries to determine whether there were any conflicts of interest. As a result, the DOL is looking for complete disclosure of direct and indirect payments, as well as all expenses. The best way to anticipate the specific reporting and disclosure that will be required by these changes is to look at guidance that the DOL has already issued concerning disclosures of fees, expenses and revenue sharing. As a starting point, let’s look at the current requirement for disclosures on the Schedule A, as explained in Advisory Opinion 2005-02A:

“... Schedule A [of the Form 5500] requires the plan administrator to report information about each agent, broker, or other person who was paid commissions or fees, including the amount of commissions and fees paid.

“Further, non-monetary forms of compensation, such as prizes, trips, cruises, gifts or gift certificates, club memberships, vehicle leases, and stock awards, must be reported....

“... Similarly, classifying fees or commissions attributable to a contract or policy as ‘profit-sharing’ payments, delayed compensation, or as ‘reimbursements’ for various marketing or other expenses would not justify a failure to disclose such amounts.”

The proposed 2008 Schedule C will require additional disclosure for large plans. For example, in the instructions for the proposed Schedule, the DOL states that the following must be reported:

“[M]oney or any other thing of value (for example, gifts, awards, trips) paid by the plan or received from an entity other than the plan or the plan sponsor by a person who is a service provider in connection with that person’s position with the plan or services rendered to the plan.

“[F]inder’s fees, placement fees, commissions on investment products, transaction-based commissions, sub-transfer agency fees, shareholder servicing fees, 12b-1 fees, soft-dollar payments, and float income. Also, brokerage commissions or fees (regardless of whether the broker is granted discretion) are reportable whether or not they are capitalized as investment costs.”

We believe that the point-of-sale disclosures required by the 408(b)(2) proposal will be similar. However, the difficulty with point-of-sale disclosure is that it is required before the plan has actually selected the services. As a result, the proposal may require narrative descriptions of how the compensation is earned and calculated, rather than reporting dollar amounts.

Over the next two or three years, there will be a dramatic increase in the transparency of fees, expenses and revenue sharing for retirement plans. The first step is for the DOL to require point-of-sale disclosure to plan sponsors and fiduciaries. The second step will be after-the-fact reporting of the actual amounts of those fees, expenses and revenue sharing on the Form 5500. The third step, which is further down the line, will be to disclose that information to the plan participants.

Advisers and providers should be aware of these potential changes and should be monitoring them carefully. In fact, our recommendation is that advisers and providers should transition to a fully transparent model, to the extent that they are not already doing so.

© 2007 Reish Luftman Reicher & Cohen. All rights reserved. The ADVISER REPORT is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.

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