DOL proposes full disclosure plan

Ambrose Bierce, the famous American journalist, defined the word “oath” as a “solemn appeal to the deity, made binding upon the conscience by a penalty for perjury.”

Providers of services to employee benefit plans governed by the Employee Retirement Income Security Act might soon be called upon to tell the truth, the whole truth and nothing but the truth about key business practices, and stand ready to be held accountable for the veracity of their representations.

Under a proposed Department of Labor regulation pertaining to ERISA Section 408(b)(2), service providers would have to provide in writing full and fair disclosure of compensation and conflicts. Also, they would be subject to prohibited-transaction penalties if they failed to fulfill the terms of their engagement or were found to have represented their compensation arrangements and affiliations improperly.

The penalty for a prohibited transaction generally involves getting the service provider to pay back any compensation it received. The prospect of both being fired and having to give back all prior compensation should be a sufficiently strong inducement to gain compliance with the rule.

Employee benefit plan sponsors, fiduciaries of the plans and just about every financial services firm doing business with retirement and other types of employee benefit plans would be affected by the rule. The term “service providers” includes investment advisers, banks, insurance companies, custodians, record keepers, brokers, investment managers and third-party administrators, among others. Even accounting, legal and actuarial firms receiving indirect compensation are included.

Why the change? Section 408(b) (2) is a provision of ERISA that requires the “responsible plan fiduciary” (such as a named fiduciary for a retirement plan) to determine that contracts and arrangements made with service providers are “reasonable.”

The problem with the current requirement is that it provides very little guidance about what is deemed “reasonable.” In fact, it states only that it would not be reasonable to have a contract that couldn’t be terminated on relatively short notice.

Undoubtedly influenced by fee and expense litigation, and growing Congressional and regulatory scrutiny in this area, the Labor Department determined that plan fiduciaries must have access to reliable compensation and conflict-of-interest information to make a “reasonableness” determination.

The rule would also require service providers to identify whether they would be providing the services in a fiduciary capacity. By implication, the responsible plan fiduciary should take this into account when conducting a due-diligence process to select or retain service providers.

The rule would do more than give plan fiduciaries better information; it would provide them with relief from prohibited-transaction rules if the selection of a non- performing provider were due to the service provider’s failure to satisfy the disclosure requirements. This would be a welcome change for plan fiduciaries, who would then be able to devote less time to unraveling conflicted positions among parties in interest and uncovering hidden compensation arrangements.

Their time and attention could be much more productively applied to select and monitor service providers based upon data that all competing firms would be required to produce.

Service providers, on the other hand, would have new burdens under the proposed changes to ERISA Section 408(b)(2) regulations. They would need to be more forthcoming about all forms of compensation that they received from other service provides and paid to them.

They would also need to provide disclosures that were sufficiently clear and concise for representatives to be able to explain the information and for plan fiduciaries to be able to decipher it.

Faced with the prospect of disclosing all forms of compensation and conflicts of interest, service providers would almost certainly find ways to simplify how the providers were paid and to eliminate conflicts that would damage the providers’ competitive positions. Finally, service providers would be forced to take an unequivocal stand as to whether they were operating in a fiduciary capacity or not.

When the service providers sign contracts and arrangements with employee benefit plans, they effectively take an oath of full disclosure. They had best be sure that the defenders of that oath know what they are talking about.

Blaine F. Aikin is president and CEO of Fiduciary 360 LP in Sewickley, Pa.

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