On July 23, 2008, the Department of Labor issued proposed regulations setting forth the information that plan fiduciaries will soon be required to provide (and the manner in which such information must be provided) to participants who are allowed to direct the investment of their accounts in defined contribution plans. This is the third and final piece of guidance in a three-part initiative by the DOL (starting with regulations finalized in November 2007 regarding Form 5500 reporting, and followed by regulations proposed in December 2007 on the information service providers must disclose to plan sponsors) designed to improve the transparency of fees and expenses in participant-directed defined contribution retirement plans (such as 401(k) plans and 403(b) arrangements) that are subject to ERISA.
The proposed regulations would require plan fiduciaries to disclose plan and investment-related information (including information regarding fees and expenses) to participants and beneficiaries on a regular and periodic basis — generally when a participant first becomes eligible to participate in the plan and annually thereafter. The stated purpose of the regulations is to ensure that participants (and beneficiaries) in participant-directed individual account plans are (i) made aware of their rights and responsibilities regarding the investment of their accounts, and (ii) provided enough information about the plan and its investment alternatives to make informed decisions about managing their accounts. Plan fiduciaries would satisfy these requirements by disclosing two types of information: (1) plan-related information, and (2) investment-related information. The regulations are proposed to be effective for plan years beginning on or after January 1, 2009.
Under the proposed regulations, a plan fiduciary would be required to provide (on or before the date of plan eligibility and at least annually thereafter) the following three types of plan-related information, based on the latest information available to the plan:
1. General plan information, including:
a. an explanation of how participants and beneficiaries may give investment instructions, and any limitations on those instructions (including any restrictions on transfers to or from a particular investment option);
b. a description of the participant’s right to exercise certain voting, tender, and similar rights; and
c. identification of the investment alternatives (and investment managers) offered under the plan.
2. Administrative expenses, including:
a. an explanation (both initially and annually) of any fees or expenses and how they are charged (i.e., pro rata or per capita); and
b. a quarterly statement that includes the dollar amount of fees and expenses charged to the participant’s account during the preceding quarter, and a description of the services provided for those fees (i.e., record keeping, custodial services, etc).
3. Individual expenses, including:
a. a description (both initially and annually) of any “event fees” (such as fees for loans, withdrawals, or QDROs) that may be charged; and
b. a quarterly statement that includes the dollar amount actually charged to the participant’s account during the preceding quarter, and a description of the services provided for those fees.
Under the proposed regulation, a plan fiduciary (or a person designated to act on the fiduciary’s behalf) would also be required to provide certain information about plan investments automatically (both initially and annually thereafter), and certain information upon request. This investment-related information must be provided in a format, such as a chart, that makes it easy to compare the plan’s investment alternatives. The regulation includes a “model” chart that may be used for this purpose. (A copy of the model comparative chart is posted on the DOL’s website.) The initial disclosure (which must be provided on or before the date of plan eligibility) may be satisfied by providing the most recent annual disclosure.
The investment-related information that must be provided automatically would include:
1. Identifying information – including the name of the investment option, a web address for additional information about the investment, the category of investment (e.g., large cap value), and whether the investment is actively or passively managed;
2. Performance data – including the rate of return and the term on fixed accounts, and 1-, 5- and 10-year performance results for non-fixed accounts such as bonds or stock mutual funds. The data must include the now-standard disclaimer that an investment’s past performance is not necessarily an indication of future returns.
3. Benchmarks – including 1-, 5- and 10-year performance of an appropriate index for each non-fixed account alternative.
4. Fee and expense information – for non-fixed accounts, this would include:
i. the amount and description of each shareholdertype fee (i.e., fees charged directly against the participant’s investment) such as sales loads, sales charges, deferred sales charges redemption fees, surrender fees, surrender charges, exchange fees, account fees,purchase fees, and mortality and expense (“M&E”) fees;
ii. the total annual operating expenses (e.g., the “expense ratio”); and
iii. a statement to the effect that fees and expenses are only one of several factors that participants should consider when making investment decisions.
5. Fee and expenses information – for fixed accounts, this would include a description of any shareholder-type fees that may be applicable to the purchase, transfer or withdrawal of the investment, in whole or in part.
6. Information on voting or tender rights – subsequent to investment, the fiduciary must provide such information if voting or tender rights are passed through to participants.
The information that must be provided upon request would include:
1. Prospectuses or similar documents (if no prospectus exists);
2. Financial statements or reports, such as Statements of Additional Information and shareholder reports, to the extent such materials are provided to the plan;
3. Share or unit values; and
4. A list of underlying assets and their values, to the extent those assets are plan assets (i.e., the underlying assets in separate accounts or collective funds).
FORM OF DISCLOSURE
The information may be provided as part of the plan’s summary plan description (“SPD”) or as part of the quarterly participant benefit statement now required by ERISA, so long as those documents are provided at the appropriate intervals. The quarterly disclosure of administrative and event fees may also be made on the quarterly participant benefit statement.
Use of the model disclosure form constitutes “safe harbor” compliance with the requirement to disclose information about plan investments in a “comparative” format, but plans are not required to use the model form. Except for the quarterly dollar amount disclosures, fees and expenses may be expressed in terms of a monetary amount, a formula, a percentage of assets, or a per capita charge. However, the disclosure materials must be written in a manner calculated to be understood by the average plan participant.
The disclosures may be provided electronically, if the distribution method satisfies the current DOL requirements regarding the electronic distribution of disclosure materials.
FIDUCIARY DUTIES AND COMPLIANCE WITH ERISA SECTION 404(C)
The regulations clarify that the new disclosure requirements do not relieve a plan fiduciary of the duty to prudently select and monitor service providers and the designated investment alternatives offered under the plan. Even if the plan otherwise satisfies the requirements of Section 404(c) (which relieves plan fiduciaries from liability for a participant’s own investment decisions), the fiduciary remains responsible (and liable) for the selection and monitoring of the investment alternatives made available under the plan.
Thus, if a participant decides to invest all of his or her money in a single fund, and that asset class does not perform well in a given year, the fiduciary is not liable for the lost investment opportunity attributable to the participant’s poor allocation of investments. However, if a participant suffers poor performance in a fund because the fiduciary did not prudently select or monitor that fund, the plan fiduciary may be held accountable for the participant’s losses, even in a 404(c) plan.
The regulations do make some conforming changes to the Section 404(c) regulations. The current list of information that must be provided automatically or upon request (in order for plan fiduciaries to avail themselves of the protections afforded by Section 404(c)) would be replaced by a simple requirement to comply with the new participant disclosure requirements described above.
Significantly, plan fiduciaries would no longer be required to automatically provide a prospectus, either immediately before or immediately after a participant’s first investment in a fund, as is required under the current 404(c) regulations. Instead, the fiduciary would have to provide certain investment information automatically, and certain other information (including a prospectus) only upon request (as described above).
The basic concept of these proposed regulations is that fiduciaries of participant-directed plans have an affirmative obligation (apart from Section 404(c)) to ensure that participants and beneficiaries have enough information to make informed investment decisions. The proposed regulations prescribe both the format and the content of the information that must be provided to participants to satisfy that duty. They also make clear that fiduciaries remain responsible for the selection and monitoring of the investment options made available under the plan, and that Section 404(c) protection is not available unless the basic disclosure requirements of the proposed regulations are satisfied.
In combination with the soon-to-be-finalized rules regarding the disclosure of fees and expenses (to plan sponsors) by service providers, and the already finalized requirements for the reporting of fees and expenses on Schedules A and C of Form 5500, the DOL hopes that these recently proposed regulations will create a culture of fee transparency — with an emphasis on outcomes. This is important, since an increasing number of participants will be depending on their 401(k) and 403(b) accounts to fund their retirement, and the participants’ understanding of the investment options available to them (and the fees and expenses related to those investment options) will be important in helping them maximize the return on their investment in those accounts and, consequently, the amount available to them at retirement.