# Reasonable Contract or Arrangement Under Section 408(b)(2)-Fee Disclosure

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2010-16768

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** July 16, 2010
- **Citation:** 75 FR 41600

## Text

DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB08
Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure

AGENCY:

Employee Benefits Security Administration, Labor.

ACTION:

Interim final rule with request for comments.

SUMMARY:

This document contains an interim final regulation under the Employee Retirement Income Security Act of 1974 (ERISA or the Act) requiring that certain service providers to employee pension benefit plans disclose information to assist plan fiduciaries in assessing the reasonableness of contracts or arrangements, including the reasonableness of the service providers' compensation and potential conflicts of interest that may affect the service providers' performance. These disclosure requirements are established as part of a statutory exemption from ERISA's prohibited transaction provisions. This regulation will affect employee pension benefit plan sponsors and fiduciaries and certain service providers to such plans. Interested persons are invited to submit comments on the interim final regulation for consideration by the Department of Labor.

DATES:

Effective date.
This interim final rule is effective on July 16, 2011.

Comment date.
Written comments on the interim final rule must be received by August 30, 2010.

ADDRESSES:

To facilitate the receipt and processing of comments, EBSA encourages interested persons to submit their comments electronically to
e-ORI@dol.gov,
or by using the Federal eRulemaking portal
http://www.regulations.gov
(following instructions for submission of comments). Persons submitting comments electronically are encouraged not to submit paper copies. Persons interested in submitting comments on paper should send or deliver their comments (preferably three copies) to: Office of Regulations and Interpretations, Employee Benefits Security Administration, Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210, Attention: 408(b)(2) Interim Final Rule. All comments will be available to the public, without charge, online at
http://www.regulations.gov
and
http://www.dol.gov/ebsa,
and at the Public Disclosure Room, Employee Benefits Security Administration, U.S. Department of Labor, Room N-1513, 200 Constitution Avenue, NW., Washington, DC 20210.

FOR FURTHER INFORMATION CONTACT:

For further information on the interim final regulation, contact Allison Wielobob or Fil Williams, Office of Regulations and Interpretations, Employee Benefits Security Administration, (202) 693-8510. This is not a toll-free number.

SUPPLEMENTARY INFORMATION:

A. Background

1. General

In recent years, there have been a number of changes in the way services are provided to employee benefit plans and in the way service providers are compensated. Many of these changes may have improved efficiency and reduced the costs of administrative services and benefits for plans and their participants. However, the complexity resulting from these changes also has made it more difficult for plan sponsors and fiduciaries to understand what service providers actually are paid for the specific services rendered.

Despite these complexities, section 404(a)(1) of ERISA requires plan fiduciaries, when selecting or monitoring service providers and plan investments, to act prudently and solely in the interest of the plan's participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. Fundamental to a plan fiduciary's ability to discharge these obligations is the availability of information sufficient to enable the plan fiduciary to make informed decisions about the services, the costs, and the service provider. Although the Department of Labor (Department) has issued technical guidance and compliance assistance materials relating to the obligations of plan fiduciaries in selecting and monitoring service providers,
1

the Department continues to believe that, given plan fiduciaries' need for complete and accurate information about compensation and revenue sharing, both plan fiduciaries and service providers would benefit from regulatory guidance in this area. For this reason, the Department published a notice of proposed rulemaking in the
Federal Register
(72 FR 70988) on December 13, 2007. On the same day, the Department also published a proposed class exemption from the restrictions of section 406(a)(1)(C) of ERISA in the
Federal Register
(72 FR 70893). The Department proposed the exemption on its own motion pursuant to section 408(a) of the Act, and in accordance with the procedures set forth in 29 CFR part 2570, subpart B (55 FR 32836, August 10, 1990).

1

See, e.g.,
Field Assistance Bulletin 2002-3 (November 5, 2002), Advisory Opinions 97-16A (May 22, 1997) and 97-15A (May 22, 1997),
http://www.dol.gov/ebsa/publications/undrstndgrtrmnt.html,
and
http://www.dol.gov/ebsa/newsroom/fs053105.html.

2. Public Comments on Proposed Regulation and Class Exemption

The Department's proposal required that reasonable contracts and arrangements between employee benefit plans and certain providers of services to such plans include specified information to assist plan fiduciaries in assessing the reasonableness of the compensation paid for services and the conflicts of interest that may affect a service provider's performance of services. The proposal also was designed to assist plan fiduciaries and administrators in obtaining the information they need from service providers to satisfy their reporting and disclosure obligations.
2

Interested persons were invited to submit comments on the proposal. In response to this invitation, the Department received over 100 written comments on the proposed regulation and class exemption from a variety of parties, including plan sponsors and fiduciaries, plan service providers, financial institutions, and employee benefit plan and participant industry representatives. These comments are available for review under “Public Comments” on the “Laws & Regulations” page of the Department's Employee Benefits Security Administration Web site at
http://www.dol.gov/ebsa.

2
The Department also implemented changes to the information required to be reported concerning service provider compensation as part of the Form 5500 Annual Report. These changes to Schedule C of the Form 5500 complement the interim final rule under ERISA section 408(b)(2) in assuring that plan fiduciaries have the information they need to monitor their service providers consistent with their duties under ERISA section 404(a)(1).
See
72 FR 64731;
see also
frequently asked questions on Schedule C, at
http://www.dol.gov/ebsa/faqs/faq-sch-C-supplement.html
and
http://www.dol.gov/ebsa/faqs/faq_scheduleC.html.

Due to the large number of public comments received, the importance of this regulatory initiative, and its potentially significant effects on the provision of services to employee benefit plans, the Department held a public hearing on March 31 and April 1, 2008, in order to further develop the public record and the Department's understanding of the issues raised in the

public comments. As a result of the public hearing, the Department received a significant number of additional comments to supplement the public record for this regulatory initiative. These supplemental materials also are available for review on the Department's Web site.

Set forth below is an overview of the interim final regulation and the public comments received on the proposal and during the Department's public hearing.

B. Overview of Interim Final Regulation Under ERISA Section 408(b)(2) and Public Comments

The Department's interim final regulation (for simplicity, the interim final regulation also is referred to herein as the final regulation) retains the basic structure of the proposal by requiring that covered service providers satisfy certain disclosure requirements in order to qualify for the statutory exemption for services under ERISA section 408(b)(2). The furnishing of goods, services, or facilities between a plan and a party in interest to the plan generally is prohibited under section 406(a)(1)(C) of ERISA. As a result, a service relationship between a plan and a service provider would constitute a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a “party in interest” to the plan. However, section 408(b)(2) of ERISA exempts certain arrangements between plans and service providers that otherwise would be prohibited transactions under section 406 of ERISA. Specifically, section 408(b)(2) provides relief from ERISA's prohibited transaction rules for service contracts or arrangements between a plan and a party in interest if the contract or arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and no more than reasonable compensation is paid for the services. Regulations issued by the Department clarify each of these conditions to the exemption.
3

3

See
29 CFR 2550.408b-2.

This rule amends the regulation under ERISA section 408(b)(2) to clarify the meaning of a “reasonable” contract or arrangement for covered plans. Currently, the regulation at 29 CFR 2550.408b-2(c) states only that a contract or arrangement is not reasonable unless it permits the plan to terminate without penalty on reasonably short notice. The final regulation establishes a requirement under section 408(b)(2) that, in order for certain contracts or arrangements for services to be reasonable, the covered service provider must disclose specified information to a responsible plan fiduciary, defined as a fiduciary with authority to cause the plan to enter into, or extend or renew, a contract or arrangement for the provision of services to the plan. The specific disclosure requirements are described in more detail below.

The final regulation differs from the proposal in a number of significant respects, each discussed in this rule. First, unlike the proposal, the final rule does not require a formal written contract or arrangement delineating the disclosure obligations, even though the disclosures must be made in writing. The final rule focuses instead on the substance of the disclosure that must be provided. Second, the final rule treats separately pension and welfare plans. Paragraph (c)(1) of the rule published today provides disclosure requirements applicable to contracts or arrangements with pension plans. The Department reserves paragraph (c)(2) of the rule for future guidance on disclosure with respect to welfare plans.

Third, the final rule modifies the categories of service providers that must comply with the disclosure requirements, including fiduciaries, investment advisers, and recordkeepers or brokers who make investment alternatives available to a plan. It also applies to providers of other specified services who receive either “indirect compensation” (generally from sources other than the plan or plan sponsor) or certain types of payments from affiliates and subcontractors. The final rule includes in its definition of “covered service providers” fiduciaries to investment vehicles that hold plan assets and in which a covered plan has a direct equity investment. However, the definition makes clear that furnishing non-fiduciary services to such vehicles, or services to vehicles that do not hold plan assets will not cause a person to be a covered service provider. In addition, the regulation requires fiduciaries to plan asset investment vehicles in which plans make direct equity investments, as well as parties that offer designated investment alternatives to a participant-directed individual account plan as part of a platform, to furnish investment-related compensation information.

Fourth, the final rule, unlike the proposal, does not contain specific narrative conflict of interest disclosure provisions, but rather relies on full disclosure of the circumstances under which the covered service provider will be receiving compensation from parties other than the plan (or plan sponsor), the identification of such parties, and the compensation that is expected to be received. As discussed below, the Department is persuaded that plan fiduciaries will be in a better position to assess potential conflicts of interest by reviewing these specific parties and the actual or expected compensation to be received from such parties. Fifth, the final rule includes a new provision requiring that certain providers of multiple services disclose separately the cost to the covered plan of recordkeeping services. Sixth, the final rule specifically addresses the application of the requirements of the regulation to section 4975 of the Internal Revenue Code (the Code). And, lastly, the exemptive relief for plan sponsors or other responsible plan fiduciaries, originally proposed as a separate exemption, is now incorporated into the final rule for ease of reference and consideration by interested parties. A more detailed discussion of the final rule, including these changes, is set forth below.

As required by Executive Order 12866, the Department evaluated the benefits and costs of this final rule. The Department believes that mandatory proactive disclosure will reduce sponsor information costs, discourage harmful conflicts, and enhance service value. Additional benefits will flow from the Department's enhanced ability to redress abuse. Although the benefits are difficult to quantify, the Department is confident they more than justify the cost. The Department estimated costs for the rule over a ten-year time frame for purposes of this analysis and used information from the quantitative characterization of the service provider market presented below as a basis for these cost estimates. This characterization did not account for all service providers, but it does provide information on the segments of the service provider industry that are likely to be most affected by the rule (
i.e.,
those with contracts listed on the Form 5500). In addition to the costs to service providers, the Department also considered, and discusses below, the potential costs to plans.

In accordance with OMB Circular A-4,
4

Table 1 below depicts an accounting statement showing the Department's assessment of the benefits and costs associated with this regulatory action.

4
Available at
http://www.whitehouse.gov/omb/circulars/a004/a-4.pdf.

Table 1—Accounting Table

Category

Primary
estimate

Year dollar
Discount rate

Period
covered

Benefits

Annualized Monetized ($millions/year)
Not Quantified.

Qualitative: The final regulation will increase the amount of information that service providers disclose to plan fiduciaries. Non-quantified benefits include information cost savings, discouraging harmful conflicts of interest, service value improvements through improved decisions and value, better enforcement tools to redress abuse, and harmonization with other EBSA rules and programs.

Costs

Annualized Monetized ($millions/year)
58.7
2010
7%
2011-2020

54.3
2010
3%
2011-2020

Qualitative: Costs include costs for service providers to perform compliance review and implementation, for disclosure of general, investment-related, and additional requested information, for responsible plan fiduciaries to request additional information from service providers to comply with the exemption and to prepare notices to DOL if the service provider fails to comply with the request.

Transfers
Not Applicable.

A more detailed discussion of the need for this regulatory action, consideration of regulatory alternatives, and assessment of benefits and costs are included in Section K—“Regulatory Impact Analysis” below.

1. General

The final regulation, like the proposal, amends paragraph (c) of § 2550.408b-2 by moving, without change, the current provisions of paragraph (c) to a newly designated paragraph (c)(3) and adding new paragraphs (c)(1) and (2) to address the disclosure requirements applicable to a “reasonable contract or arrangement.” Paragraph (c)(1) describes the disclosure requirements for pension plans. Paragraph (c)(2) has been reserved for future guidance concerning the disclosure requirements for welfare plans.

The general paragraph of the final rule, paragraph (c)(1)(i), provides that no contract or arrangement for services between a covered plan and a covered service provider, nor any extension or renewal, is reasonable within the meaning of ERISA section 408(b)(2) and this regulation unless the requirements of the regulation are satisfied. The terms “covered plan” and “covered service provider” are defined in paragraph (c)(1)(ii) and (iii), respectively. The general paragraph also provides that the regulation's disclosure requirements are independent of a fiduciary's obligations under section 404 of ERISA.

2. Scope—Covered Plans

Paragraph (c)(1)(ii) defines a “covered plan” to mean an employee pension benefit plan or a pension plan within the meaning of ERISA section 3(2)(A) (and not described in ERISA section 4(b)), except that such term shall not include a “simplified employee pension” described in section 408(k) of the Code, a “simple retirement account” described in section 408(p) of the Code, an individual retirement account described in section 408(a) of the Code, or an individual retirement annuity described in section 408(b) of the Code.

Under the proposal, all employee benefit plans subject to Title I of ERISA, including employee pension benefit plans and welfare benefit plans, were subject to the regulation's disclosure requirements. The Department received many comments and heard testimony from parties concerned about the implications of subjecting defined benefit plans, welfare benefit plans, and individual retirement accounts (IRAs) to the regulation.
5

5
A few commenters suggested that the Department not extend the final rule to small plans (for example, those with less than 100 participants). The Department was not persuaded that any policy rationale exists for excluding small plans.

Commenters questioned the proposal's application to defined benefit plans for a variety of reasons, suggesting that the Department consider separate guidance for defined benefit plans. Commenters argued that sponsors of defined benefit plans and their service providers have only recently joined the public policy discussion regarding fee disclosure for retirement plans. They believe that a thorough examination of the issues that affect defined benefit plans is warranted before disclosure rules apply with respect to their service providers.

In advocating for separate rules for defined benefit plans, some commenters focused on the differences in the legal structures of defined benefit plans and defined contribution plans. In addition, commenters noted that services are provided to defined benefit plans in ways that are materially different than they are for defined contribution plans. Other commenters noted that employers have incentives to monitor and negotiate service provider fees and expenses for defined benefit plans, because these plans primarily rely on employer contributions; excessive fees and expenses would make it more expensive for the employer to fund promised benefits. In contrast, defined contribution plans are funded primarily by employee contributions, and employers may pass on up to 100 percent of plan costs to employees.

After careful review of the comments, the Department is not persuaded that the information fiduciaries of defined benefit plans need to make informed decisions about their service providers is fundamentally different from the information fiduciaries of defined contribution plans need to make informed decisions. Nor is the Department persuaded that the service provider relationships between the two types of plans are so different as to justify exclusion of defined benefit plans from the regulation's disclosure requirements. Moreover, the Department does not believe that compliance with the disclosure requirements, particularly as modified from the proposal, will present any unreasonable compliance burdens for service providers to defined benefit plans. For these reasons, the final rule, like the proposal, applies to contracts and arrangements with covered service providers to both defined contribution and defined benefit plans.

The Department also received many comments concerning the applicability of the proposal to welfare benefit plans. Many commenters recommended their exclusion from the scope of the final

rule. Some commenters believe that the Department's rationales for the proposed rule apply to pension plans but not to welfare benefit plans. Other commenters maintain that, if the Department creates a disclosure regime for welfare benefit plan service providers, it should be promulgated separately.

Commenters articulated specific concerns relating to welfare benefit plans, including the potential for negative effects on the insurance industry, which, they argue, is highly regulated by State laws. Many commenters asserted that, considering the high level of State regulation, subjecting welfare benefit plans to the disclosure regulation would be unnecessary and redundant because the disclosures contemplated in the regulation are already made available to plan fiduciaries through State regulatory processes. Other commenters pointed out that most State insurance laws do not require the types of disclosures addressed under the proposed rule and even where such State laws exist, they are loosely enforced. Still others asserted that there are “transparency problems” in general in the health and welfare industry.

Some commenters expressed views relating to prohibited transaction exemption (PTE) 84-24,
6

which they indicated is often misinterpreted and improperly utilized by service providers to suit their purposes. Those in favor of subjecting welfare benefit plans to the regulation said that it would eliminate the limitations of PTE 84-24. Other commenters asserted that PTE 84-24 has worked well and that welfare benefit plans should be allowed to continue without the impact of new disclosure obligations under the proposal.

6
49 FR 13208 (Apr. 3, 1984); amended at 71 FR 5887 (Feb. 3, 2006) (providing prohibited transaction relief for service arrangements and related plan transactions involving insurance agents and brokers, pension consultants, insurance and investment companies, and investment company principal underwriters; for example, PTE 84-24 permits these parties to place insurance products with plans when they are fiduciaries, or affiliated with fiduciaries, to the plans if certain conditions are met).

Still other commenters addressed specific concerns of pharmacy benefit managers (PBMs), which are intermediaries between drug manufacturers and health insurance plans. They believe that the reasons for disclosure discussed in the preamble to the proposed rule are inapplicable to PBMs. According to some commenters, the Federal Trade Commission has thoroughly evaluated the industry, finding that market forces provide sufficient information to plan fiduciaries and that excessive mandatory disclosure could weaken competition, such that the proposed regulation would negatively affect the delivery of prescription drugs to plan beneficiaries. Other commenters disputed the idea that PBMs should not be subject to the regulation, arguing that the discounts and rebates they received from drug companies were examples of undisclosed indirect compensation. Commenters offering this point of view did not present any further official comment or testimony at the public hearing.

In spite of these arguments, the Department believes that fiduciaries and service providers to welfare benefit plans would benefit from regulatory guidance in this area for the same reasons that apply to defined contribution plans and defined benefit plans. However, the Department is persuaded, based on the public comment and hearing testimony, that there are significant differences between service and compensation arrangements of welfare plans and those involving pension plans and that the Department should develop separate, and more specifically tailored, disclosure requirements under ERISA section 408(b)(2) for welfare benefit plans. Accordingly, the interim final rule published today includes a new paragraph (c)(2), which has been reserved for a comprehensive disclosure framework applicable to “reasonable” contracts or arrangements for services to welfare plans to be developed by the Department. The Department notes, however, that in the meantime, ERISA section 404(a) continues to obligate fiduciaries to obtain and consider information relating to the cost of plan services and potential conflicts of interest presented by such service arrangements.

Several commenters requested clarification regarding the regulation's application to IRAs or similar accounts. In some cases, commenters argued that the Department should exclude such accounts, as well as other plans that are not subject to Title I of ERISA, from the scope of the final regulation. The commenters observed that there are significant categories of arrangements that are subject to the prohibited transaction provisions of section 4975 of the Code, but not those of ERISA, and that do not have a fiduciary overseeing the plan. The comments asserted that owners of IRAs and other individual arrangements are more like individual plan participants than plan fiduciaries and that it would be inappropriate to impose the service provider-to-plan disclosure requirements in the context of non-ERISA arrangements. In contrast to participant-directed individual account plans, which typically offer a limited number of investment options, many IRAs offer a large number of investment options, such as brokerage accounts with essentially unlimited choices. Providing the disclosures set forth in the proposal could be quite burdensome and costly as a result. These costs, commenters argue, may drive service providers to limit the number of investment choices available in IRAs. In addition, some commenters pointed out that, under securities laws, the IRA accountholder is treated as the actual owner of the securities held in his or her IRA and is entitled to all securities law disclosures in the same manner as if the accountholder owned those securities directly. In contrast, with ERISA-covered plans, disclosure obligations under the securities laws extend only to the plan itself, not to individual plan participants.

The Department does not believe that IRAs should be subject to the final rule, which is designed with fiduciaries of employee benefit plans in mind. An IRA account-holder is responsible only for his or her own plan's security and asset accumulation. They should not be held to the same fiduciary duties to scrutinize and monitor plan service providers and their total compensation as are plan sponsors and other fiduciaries of pension plans under Title I of ERISA, who are responsible for protecting the retirement security of greater numbers of plan participants. Moreover, IRAs generally are marketed alongside other personal investment vehicles. Imposing the regulation's disclosure regime on IRAs could increase the costs associated with IRAs relative to similar vehicles that are not covered by the regulation. Therefore, although the final rule cross references the parallel provisions of section 4975 of the Code, paragraph (c)(1)(ii) provides explicitly that IRAs and certain other accounts and plans are not covered plans for purposes of the rule.

3. Scope—Covered Service Providers

The categories of service providers covered by the final rule, in paragraph (c)(1)(iii), vary slightly from those described in the proposal. The proposed regulation generally included service providers falling into one of the following categories: (1) Fiduciary service providers, whether under ERISA or under the Investment Advisers Act of 1940; (2) service providers that will perform banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping,

or third party administration services for the plan; or (3) service providers that will receive indirect compensation in connection with providing accounting, actuarial, appraisal, auditing, legal, or valuation services to the plan. The Department believed that these service arrangements, and their associated compensation structures, were the most likely to give rise to conflicts of interest.

The Department received a number of comments requesting clarification as to which entities were intended to be “service providers” for purposes of the proposal, both in terms of which service providers are responsible for complying with the proposal's written contract requirement, and who is considered a service provider such that their compensation and conflict of interest information must be disclosed to the responsible plan fiduciary. Some commenters argued that the proposal's disclosure requirements should be limited to service providers that deal directly with employee benefit plans, or that customarily are in contractual privity with the plan, and questioned the application of the rule to indirect service providers. These commenters were concerned that the proposed rule appears to apply, potentially without limit, to “indirect” service providers, for example a service provider to a direct service provider, or a service provider to an investment provider or mutual fund company; in some cases, they argue, the services provided by these indirect providers bear little or no relation to the particular plan service arrangement in question. For example, commenters questioned whether the proposed disclosure requirements would apply to a copy service, if a plan recordkeeper subcontracts with that copy service to perform administrative functions for both the recordkeeper and its plan clients, or to legal counsel to a registered investment company, when counsel's role is limited to ensuring that the company complies generally with applicable securities laws.

In connection with their request that the Department clarify whether providers of services to a plan service provider, or to an investment provider, are themselves service providers to the plan for purposes of the disclosure requirements of the proposed rule, some commenters note that confusion on this issue may stem from language of the proposed rule that adopted the view taken by the Department as to who is a “service provider” for purposes of reporting service provider compensation on the recent Form 5500, Schedule C, revisions. The new Schedule C reporting requirements are not limited to information concerning the compensation of persons with direct service provider relationships to a plan but also include compensation information regarding persons who provide services to investment vehicles in which plans invest. Commenters questioned whether a similar position is appropriate in the context of a prohibited transaction for which relief is obtained under section 408(b)(2).

Other commenters raised concerns about the proposal insofar as it was interpreted as raising technical issues under the Department's plan asset guidance.
7

For example, several commenters questioned whether and how the proposed disclosure requirements would apply to service providers to “non-plan asset” vehicles, an issue that often arises in the context of plan investments. For instance, commenters observed that mutual funds, real estate operating companies, venture capital operating companies, and private equity funds that do not have significant equity participation by “benefit plan investors” (
i.e.,
25% or more of any class of equity interest held by such investors) are not plan asset vehicles, and thus managers of these entities are not ERISA fiduciaries. These commenters argued that the proposed disclosure requirements also should not apply to any person who is providing services to a non-plan asset vehicle.

7

See
29 CFR 2510.3-101.

The Department believes that the definition of covered service provider contained in the final rule addresses the ambiguities raised by the commenters and reflects the Department's intent to focus on contracts or arrangements between covered plans and fiduciaries, platform providers and other specified service providers dealing directly with covered plans who may receive indirect compensation or certain compensation from related parties. The Department notes that the parties that must be reported as service providers for Schedule C purposes will not necessarily be the same as the parties that will be covered service providers for purposes of this rule.

The Department continues to believe that requiring every service provider to a plan to satisfy the disclosure requirements of this regulation may not be appropriate or yield helpful information to plan fiduciaries. The Department also believes that certain service providers, because of the nature of the services that they provide to pension plans, the potential influence they have on plan fiduciaries' decisions and on the plan services that they ultimately will provide, or the complexity of their compensation arrangements, must provide comprehensive information to plan fiduciaries about the compensation that they will be paid for their services. The Department is sensitive to the technical and practical issues raised by commenters about how the scope of this rule will be applied to various parties in the employee benefit plan industry. The Department also agrees with commenters that service providers and plan fiduciaries would benefit from more certainty as to whether any particular service contract or arrangement will be required to comply with this rule. The Department believes that the interim final rule, in terms of defining the service providers covered by the rule, responds to the concerns of these commenters. However, the Department welcomes comments from interested persons who continue to have concerns about the scope of service providers covered by the interim final rule.

Paragraph (c)(1)(iii) of the final rule defines the term “covered service provider.” Among other changes, the final rule establishes a $1,000 threshold for service providers otherwise coming within the definition of a covered service provider (regardless of whether the threshold is met by compensation received by the covered service provider, an affiliate, or a subcontractor that is performing one or more of the services to be provided under the contract or arrangement with the covered plan). A “covered service provider” is a service provider that enters into a contract or arrangement with the covered plan and reasonably expects to receive $1,000 or more in compensation, direct or indirect, to be received in connection with providing one or more specified services. The Department included the $1,000 threshold in response to commenters' request that the final rule exclude contracts or arrangements that involve de minimis amounts of compensation. In these circumstances, the Department is persuaded that the parties to these relatively small service contracts or arrangements may not need to provide the detailed disclosures required under this rule in order to ensure that plan fiduciaries have the information they need to make informed decisions about the services and cost of the services to be provided. Commenters did not suggest a particular minimum amount for such contracts or arrangements, but the Department believes that $1,000 is a reasonable threshold amount to address their concerns. As this is an interim final rule, the Department welcomes

additional input from commenters on our decision.

The types of service providers covered by the final regulation fall into three categories, and each category is discussed below. A service provider may be a covered service provider under the final rule even if some or all of the services provided pursuant to the contract or arrangement are performed by affiliates of the covered service provider or subcontractors. Further, as noted in paragraph (c)(1)(iii)(D)(
1
), service providers do not become “covered service providers” solely as a result of services that they perform in their capacity as an affiliate of the covered service provider or a subcontractor.

The first category of covered service providers, in paragraph (c)(1)(iii)(A), includes those providing services as an ERISA fiduciary or as an investment adviser registered under either the Investment Advisers Act of 1940 (Advisers Act) or any State law. This category is split into three subsections. Subparagraph (
1
) includes ERISA fiduciaries providing services directly to the covered plan.

Subparagraph (
2
) includes ERISA fiduciaries providing services to an investment contract, product, or entity that holds plan assets and in which the covered plan has a direct equity investment. These service providers are ERISA fiduciaries by virtue of providing services to a plan asset investment vehicle, rather than providing services directly to the covered plan. The Department placed these fiduciaries of plan asset vehicles in a separate subcategory because, under the final rule, these fiduciaries have an additional obligation to disclose compensation information about the investment vehicle for which they serve as a fiduciary.

This subcategory includes fiduciaries to the initial-level investment vehicle in which the covered plan makes a direct equity investment and which holds plan assets. However, it does not include fiduciaries to that initial vehicle's underlying investments, even though such down-level investment vehicles also may hold “plan assets.” The determination of whether an investment contract, product, or entity holds “plan assets” is made under sections 3(42) and 401 of ERISA and the regulation at 29 CFR 2510.3-101. The regulation uses the term “direct equity investment” to distinguish the covered plan's initial-level investment in an investment contract, product, or entity from investments made by such initial-level contract, product or entity in which the plan invests, without regard to whether the underlying, second-tier investment vehicles hold plans assets. Specifically, the regulation provides that a direct equity investment does not include investments made by the investment contract, product, or entity in which the covered plan invests.

Subparagraph (
3
) includes investment advisers providing services directly to the covered plan. This provision has been modified from the proposal to require disclosure from an investment adviser “registered” under either the Advisers Act or State law, rather than a “fiduciary” under the Advisers Act.

The Department received a number of comments concerning the requirement to identify services as “fiduciary” services under ERISA or the Advisers Act. In general, commenters argued that whether such services will be provided may be unclear, given the facts-and-circumstances nature of fiduciary status under section 3(21) of ERISA, creating an unnecessary level of uncertainty for both plan fiduciaries and service providers in terms of compliance with the regulation. Commenters also argued that by including fiduciaries under the Advisers Act, the proposal included advisers that may not be registered under the Advisers Act, thereby adding a degree of uncertainty as to which service providers might be covered by the rule. Other commenters argued that plan sponsors may be confused as to whether a particular service provider is acting as a fiduciary under ERISA or as a fiduciary under the Advisers Act. The Department believes that the modifications reflected in paragraph (c)(1)(iii)(A) of the final rule respond to these concerns. The Department continues to believe, however, that it is important for plan fiduciaries to know whether a party will be providing or reasonably expects to provide services to the plan as an ERISA fiduciary or as a registered investment adviser.
8

See paragraph (c)(1)(iv)(B) relating to the requirement that this status be disclosed to the responsible plan fiduciary.

8
To the extent a service provider is a “dual registrant” (
i.e.,
an investment adviser registered under the Advisers Act and a broker-dealer registered under the Securities Exchange Act of 1934, as amended), the service provider would be a covered service provider under paragraph (c)(1)(iii)(A)(
3
) only when acting as an investment adviser to a covered plan, and not when acting merely as a broker-dealer to such plan. However, broker-dealers to covered plans may be covered service providers under paragraph (c)(1)(iii)(B) or (C), as discussed further below.

The second category of covered service providers, in paragraph (c)(1)(iii)(B), includes providers of recordkeeping services or brokerage services to a covered plan that is an individual account plan (under ERISA section 3(34)) and that permits participants and beneficiaries to direct the investment of their accounts, if one or more designated investment alternatives will be made available (
e.g.,
through a platform or similar mechanism) in connection with such recordkeeping services or brokerage services. This category encompasses recordkeepers and brokers that offer, as part of their contract or arrangement, a platform of investment options, or a similar mechanism, to a participant-directed individual account plan. This category also encompasses service providers who provide recordkeeping or brokerage services that include designated investment alternatives independently selected by the responsible plan fiduciary and which are later added to the covered plan's platform. Under the proposal, these service providers had no disclosure obligations beyond those directly relating to the services they were providing as recordkeepers or brokers for the plan. Under the interim final rule, however, covered service providers in this category, as discussed later, must disclose to the responsible plan fiduciary compensation information regarding each of the designated investment alternatives for which they provide recordkeeping or brokerage services. See paragraphs (c)(1)(iii)(B) and (c)(1)(iv)(G). The term “designated investment alternative” is defined in paragraph (c)(1)(viii)(C), discussed below.

The third category of covered service providers, in paragraph (c)(1)(iii)(C), includes those providing specified services to the covered plan when the covered service provider (or an affiliate or a subcontractor) reasonably expects to receive “indirect” compensation or certain payments from related parties. As discussed below, the terms “affiliate”, “indirect compensation,” and “subcontractor” are defined in paragraph (c)(1)(viii) of the final regulation. The services included in this category are accounting, auditing, actuarial, appraisal, banking, consulting (
i.e.,
consulting related to the development or implementation of investment policies or objectives, or the selection or monitoring of service providers or plan investments), custodial, insurance, investment advisory (for plan or participants), legal, recordkeeping, securities or other investment brokerage, third party administration, or valuation services provided to the covered plan.

The services in the final rule's third category generally are the same as those in the proposal. However, whether or not these services will cause a service provider to be a covered service

provider under the rule depends upon the expectation by the covered service provider, its affiliate, or a subcontractor of receiving certain types of compensation, namely indirect compensation or compensation paid by related parties. A few commenters asked the Department to define the types of services referenced in the proposal. Although the Department understands that there may be, in some instances, subtle differences in how employee benefits services are described and, therefore, some clarification may be helpful, the Department also is concerned that too much specificity may have the undesirable effect of narrowing the application of the regulation solely on the basis of an overly technical definition. The Department believes that the financial industry and employee benefits community have a reasonable understanding of the services referenced in the regulation and that any remaining ambiguity will not result in undue burdens attendant to compliance with the final rule.

Nonetheless, the Department, in response to commenters, has attempted to narrow the scope of the term “consulting” by adding a parenthetical clarifying that “consulting” as used in the final regulation is consulting related to the development or implementation of investment policies or objectives, or the selection or monitoring of service providers or plan investments. Also, it should be noted that investment advisory services are included in both the first and third categories of covered service providers, but the investment advisers who are covered in each category may be different. The first category includes only
registered
investment advisers, even if they receive only direct compensation from the covered plan. The third category includes investment advisers that reasonably expect to receive compensation that is indirect or paid from related parties, whether or not they are registered investment advisers.

Paragraph (c)(1)(iii)(D) of the final regulation clarifies that, notwithstanding the preceding categories of “covered service providers,” no person or entity is a “covered service provider” solely by providing services (1) as an affiliate or a subcontractor that is performing one or more of the services to be provided under the contract or arrangement with the covered plan (see paragraph (c)(1)(iii)(D)(
1
)), or (2) to an investment contract, product, or entity in which the covered plan invests, regardless of whether or not the investment contract, product, or entity holds assets of the covered plan, other than services as a fiduciary described in paragraph (c)(1)(iii)(A)(
2
) (see paragraph (c)(1)(iii)(D)(
2
)). In other words, paragraph (c)(1)(iii)(D)(
1
) clarifies that the concept of a “covered service provider” captures only the party directly responsible to the covered plan for the provision of services under the contract or arrangement, even though some or all of such services may be performed by an affiliate or subcontractor. In the view of the Department, the service provider directly responsible to the plan for the provision of services is the appropriate party to ensure that the required disclosures under the regulation are made. Paragraph (c)(1)(iii)(D) addresses the possibility of multiple disclosure obligations with respect to the same services.

Paragraph (c)(1)(iii)(D)(
2
) further clarifies that, other than providers of fiduciary services to an investment contract, product, or entity holding plan assets with respect to which the covered plan has a direct equity investment (described above), the term “covered service provider” does not include a mere provider of services to an investment contract, product, or entity (regardless of whether or not the investment contract, product, or entity holds assets of the covered plan).

The Department believes that these clarifications resolve much of the uncertainty raised by commenters about the intended application of the proposal in the context of plan investments. Other than a fiduciary described in paragraph (c)(1)(iii)(A)(
2
), service providers that only provide non-fiduciary administrative, legal or other services to an investment vehicle, even one holding plan assets, are not covered service providers. For example, a recordkeeper servicing a collective investment fund is not a covered service provider to a plan investing in the fund merely because the fund holds plan assets. On the other hand, if that same recordkeeper provides services directly to a covered plan and receives indirect compensation or certain compensation from related parties, then it would be a covered service provider. Its covered status, however, would derive from the services it provides directly to the plan, not to the collective investment fund. A similar analysis would apply to an investment vehicle that does not hold plan assets, such as a registered investment company.

4.
Contracts or Arrangements Not Covered by Interim Final Regulation

The Department notes that some contracts or arrangements will fall outside the scope of the final regulation because they do not involve a “covered plan” and a “covered service provider.” ERISA nonetheless requires such contracts or arrangements to be “reasonable” in order to satisfy the ERISA section 408(b)(2) statutory exemption. ERISA section 404(a) also obligates plan fiduciaries to obtain and carefully consider information necessary to assess the services to be provided to the plan, the reasonableness of the fees and expenses being paid for such services, and potential conflicts of interest that might affect the quality of the provided services.
9

9

See, e.g.,
Field Assistance Bulletin 2002-3 (November 5, 2002), Advisory Opinion 97-15A (May 22, 1997), Advisory Opinion 97-16A (May 22, 1997), Understanding Retirement Plans Fees and Expenses, (
http://www.dol.gov/ebsa/publications/undrstndgrtrmnt.html.
), and Selection and Monitoring Pension Consultants—Tips for Plan Fiduciaries, (
http://www.dol.gov/ebsa/newsroom/fs053105.html.
)

5. Initial Disclosure Requirements

a. Overview of Initial Disclosure Requirements; Request for Comments on Format Requirement for Initial Disclosures

The proposed regulation would have required that the terms of the contract or arrangement for services between the covered plan and the covered service provider be in writing and that the writing delineate the specific disclosure obligations of the covered service provider under the regulation. The Department received a number of comments on the requirement that contracts and arrangements, as well as the disclosure obligations thereunder, must be in writing. Many commenters argued that such written documents are not used with respect to the provision of many services and that requiring formal written contracts adds complexity and costs, as well as potentially raising concerns under State contract law, without affecting the quality of such services. For example, these points were made by providers of insurance products and services, who explained that any amendments to their contracts, which are approved and regulated by State insurance agencies, would have to be submitted to such agencies; this would be a lengthy and burdensome process with an outcome that is not within the service providers' control.

While the interim final rule continues to require that the responsible plan fiduciary be furnished the required disclosures in writing, the rule does not require that a formal contract or arrangement itself be in writing or that any representations concerning the

specific obligations of the service provider be included in such written contract or arrangement. The Department is persuaded that, given the varying relationships between plans and their service providers, requiring such a formal contract or arrangement in every instance may result in unnecessary burdens, complexity, and costs. The Department continues to believe, however, that setting forth a covered service provider's disclosure obligations under the regulation in writing generally will help ensure that both the responsible plan fiduciary and the service provider clearly understand their respective responsibilities for purposes of compliance with the statutory exemption.

As discussed above, neither the proposal nor the interim final rule requires the covered service provider to make disclosures in any particular manner or format. Further, the preamble to the proposal specifically noted that the covered service provider could disclose using different documents from separate sources as long as the documents, collectively, contained all of the required information. Commenters on the proposal disagreed as to whether or not this would lead to an effective presentation to responsible plan fiduciaries, especially those for small plans. Commenters also disagreed as to the anticipated costs and burdens associated with more stringent format requirements and the extent to which those costs would be absorbed by service providers or passed through to plans, and therefore potentially to participants and beneficiaries. Some commenters encouraged the Department to retain its flexible approach, arguing that it is best left to the parties to service contracts or arrangements to determine the optimal way to fulfill the substantive disclosure requirements. Other commenters encouraged the Department to adopt a model form for disclosure or to otherwise mandate that the required information be conveyed in a summary or consolidated fashion, arguing that this would lead to more consistency in the way that information is disclosed and make it easier for responsible plan fiduciaries to review and analyze information received from plan service providers.

At this time, the Department has not determined whether it is feasible, as part of this regulation, to provide specific and meaningful standards for the format in which the required information must be disclosed, given the large variety of plan service arrangements that are covered by the interim final regulation and the variation in the way service providers currently disclose information to plan fiduciaries. The Department is persuaded that plan fiduciaries may benefit from increased uniformity in the way that information is presented to them. However, the Department does not want to unnecessarily increase the cost and burden for service providers to furnish required information, especially to the extent such cost may be passed along to plan participants and beneficiaries, unless it is clear that the benefit to plan fiduciaries outweighs such cost and burden. If the Department is convinced that the benefits would outweigh the costs, the final regulation may be revised. Specifically, the Department is considering adding a requirement that covered service providers furnish a “summary” disclosure statement, for example limited to one or two pages, that would include key information intended to provide an overview for the responsible plan fiduciary of the information required to be disclosed. The summary also would be required to include a roadmap for the plan fiduciary describing where to find the more detailed elements of the disclosures required by the regulation.

To assist the Department in its decision whether to include such a requirement in the final rule, interested persons are encouraged to submit comments on three issues: first, the likely cost and burden to covered service providers, and to any other parties, of complying with such a requirement; second, the anticipated benefits to responsible plan fiduciaries, whether due to time savings, cost savings, or other factors, of including a summary disclosure statement; and third, how to most effectively construct the requirement for a summary disclosure statement to ensure both its feasibility and its usefulness in helping the Department achieve its objectives.

As to the substance of the information required to be disclosed, the proposal generally required the disclosure of information intended to assist plan fiduciaries in understanding the services that will be furnished and in assessing the reasonableness of the compensation, direct and indirect, that the service provider would receive in connection with the provision of such services. The proposal also required the disclosure of specific information intended to assist plan fiduciaries in assessing any real or potential conflicts of interest that may affect the quality of the services to be provided. As discussed above, the proposal did not require that the information be furnished in any particular format. While the proposal did require that the required disclosures be furnished in advance of entering into a contract or arrangement, along with a representation that all of the required disclosures had been furnished to the responsible fiduciary, the proposal did not designate any specific time period for making such advance disclosure.

The proposal broadly defined compensation or fees
10

to include money and any other thing of monetary value received by the service provider or its affiliates in connection with the services provided to the plan or the financial products in which assets are invested. As noted, the proposal required the disclosure of both direct and indirect compensation, the latter including fees that the service provider receives from parties other than the plan, the plan sponsor, or the service provider. Service providers also would have been required to disclose compensation received by their affiliates from third parties. The proposal also addressed the manner in which compensation could be disclosed, permitting the use of formulas, references to a percentage of the plan's assets, or per capita charges.

10
For ease of reference, the interim final regulation refers only to “compensation” and not “compensation or fees” or “compensation and fees.” Given the broad definition of “compensation” contained in the final regulation, the Department does not intend any substantive distinction by changing from the phrase “compensation or fees” or “compensation and fees” to the term “compensation.”

With regard to the disclosure of compensation generally, the proposal contained a special rule for providers of multiple services (commonly referred to as “bundles” of services). In the case of bundled service arrangements, the proposal required only that the provider of the bundle make the prescribed disclosures. In such instances, the bundled service provider would be required to disclose information concerning all of the services to be provided in the bundle, regardless of who actually performs the service. Further, the bundled provider would be required to disclose the aggregate direct compensation that will be paid for the bundle, as well as all indirect compensation that will be received by the service provider, or its affiliates or subcontractors within the bundle, from third parties. The preamble explained that generally the bundled provider would be required to break down the aggregate compensation among the individual services comprising the bundle only when the compensation was separately charged against the plan's investment (such as management fees and 12b-1 fees) or was set on a

transaction basis (such as finder's fees and brokerage commissions).

While the Department retained many of the disclosure concepts of the proposal, the interim final rule contains a number of changes made in response to issues raised by commenters. Paragraph (c)(1)(iv) of the final rule describes the initial disclosure requirements that must be satisfied, in writing, by the covered service provider; paragraph (c)(1)(v) describes the timing requirements applicable to the initial disclosures and when changes to the initial disclosures must be furnished; paragraph (c)(1)(vi) describes the requirement that a covered service provider disclose information requested by the responsible plan fiduciary or covered plan administrator to comply with ERISA's reporting and disclosure requirements; and paragraph (c)(1)(vii) addresses inadvertent errors and omissions in disclosing the required information.

b. Description of Services

Paragraph (c)(1)(iv)(A) requires a description of the services to be provided to the covered plan pursuant to the contract or arrangement, but not including non-fiduciary services described in paragraph (c)(1)(iii)(D)(
2
). In other words, for purposes of this disclosure, “services” to the covered plan do not include services described in paragraph (c)(1)(iii)(D)(
2
),
e.g.,
services provided by non-fiduciary service providers to investment vehicles holding plan assets. Thus, in the case of a person that is a covered service provider by reason of paragraph (c)(1)(iii)(A)(
2
), paragraph (c)(1)(iv) would require a description of services provided as a fiduciary to the investment vehicle that holds plan assets and in which the covered plan has a direct equity investment.

Some commenters requested guidance as to the level of detail necessary when describing the services. For example, commenters asked whether general descriptions of the services would be acceptable, or whether detailed and itemized descriptions must be provided. It is the view of the Department that the level of detail required to adequately describe the services to be provided pursuant to a contract or arrangement will vary depending on the needs of the responsible plan fiduciary.

In certain instances, it may be well understood that a particular service necessarily encompasses, among other things, a variety of sub-services such that a description of the sub-services is unnecessary. For example, plan fiduciaries may understand that the execution of securities transactions includes, but is not limited to, valuation, safekeeping, posting of income, clearing and settling transactions, and reporting transactions, thereby eliminating the need to describe such sub-services. In an effort to clarify the flexibility inherent in this disclosure requirement, the final rule omits the word “all” from the required description of services.

Ultimately, though, the responsible plan fiduciary must, under sections 404 and 408(b)(2) of ERISA, decide whether it has enough information about the services to be provided pursuant to the contract or arrangement to determine whether the cost of such services to the plan is reasonable. Accordingly, if a particular description of services provided by a covered service provider lacks sufficient detail to enable the responsible plan fiduciary to determine whether the compensation to be received for such services is reasonable, the responsible plan fiduciary must request additional information concerning those services.

There is one provision of the interim final rule that includes a more specific standard for the level of detail that must be furnished when describing the provision of recordkeeping services in specified circumstances. See section (c)(1)(iv)(D)(
2
), discussed below.

c. Status of Covered Service Providers, Affiliates, and Subcontractors

Paragraph (c)(1)(iv)(B) of the regulation requires, if applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan (or to an investment vehicle that holds plan assets and in which the covered plan has a direct equity investment) as a fiduciary; and, if applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan as an investment adviser registered under either the Advisers Act or any State law. Thus, if a service provider will, or reasonably expects to, provide services as both a fiduciary and a registered investment adviser, the statement must reflect both of these roles. While the proposal contained a similar disclosure requirement, the requirement contained in the final rule reflects changes that are intended to address concerns raised by commenters.

Commenters on the proposal expressed concern that, given the factual nature of fiduciary status under ERISA, this requirement added a level of uncertainty to the statutory exemption. Commenters also expressed concern that disclosing fiduciary status by virtue of being an investment adviser involved similar uncertainties and, in addition, would only serve to confuse plan fiduciaries regarding the nature of the services that the plan would receive. As discussed above, the Department continues to believe that plan fiduciaries should understand whether a service provider will provide, or reasonably expects to provide, services as an ERISA fiduciary or services as a registered investment adviser in light of their heightened level of responsibility under ERISA and the Advisers Act, respectively. The Department, however, believes that the final disclosure provision addresses the concerns of the commenters. First, the final provision only requires disclosure if the provider will or
reasonably expects
to be providing services as a fiduciary or registered investment adviser. Service providers do not have to indicate that they will not be providing such services. Second, the disclosure with respect to services as an investment adviser is required only for investment advisers who are registered under the Advisers Act or any State law, thereby providing a degree of certainty as to who must make the required disclosure. The final provision does not require investment advisers to identify their services as “fiduciary services.”

d. Disclosure of Compensation

The Department received a number of comments on the compensation disclosure requirements of the proposal. Many of the commenters expressed concern about the parties for whom compensation might have to be reported under the proposal, such as providers of services to mutual funds and other investment products in which a plan might invest, and the increased level of complexity attendant to more detailed levels of disclosure generally. The Department believes that many of the issues raised by commenters in this area have been addressed in the final regulation by more specifically defining the parties that would be treated as “covered service providers” for purposes of the disclosure requirements.

The compensation disclosure requirements of the final rule are set forth at paragraph (c)(1)(iv)(C). While structured differently than the proposal, the final rule retains many of the same concepts of the proposal with respect to what types of compensation have to be disclosed for purposes of a reasonable contract or arrangement. The compensation disclosure requirement of

the final rule is divided into four subparagraphs to more clearly describe the compensation information that must be disclosed.

Paragraph (c)(1)(iv)(C)(
1
) requires a description of all
direct
compensation, as defined in paragraph (c)(1)(viii)(B)(
1
), either in the aggregate or by service, that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with the services described in paragraph (c)(1)(iv)(A). For purposes of the regulation, “direct” compensation is compensation received directly from the covered plan.
11

11
This definition, therefore, excludes from the term “direct” compensation any compensation received from a plan asset vehicle in which the covered plan has a direct equity investment.

This requirement to disclose direct compensation generally follows the requirement of the proposal, with a clarifying change. A number of commenters on the proposal questioned whether the proposal's definition of compensation, which referred to payments received “directly from the plan or plan sponsor” was intended to subject to ERISA section 408(b)(2) payments for services made solely by the plan sponsor and not out of plan assets,. The proposal's reference to payments received from plan sponsors was intended to distinguish direct compensation from indirect compensation. As reflected above, the final regulation omits the reference to the plan sponsor, so as to avoid the confusion raised by commenters. The final rule also clarifies that a covered service provider generally may disclose the direct compensation received from the plan either as a total for all services (
i.e.,
in the aggregate) or on an itemized, service-by-service basis. The Department continues to believe as a general matter that a fiduciary who understands the services the covered service provider is providing pursuant to the contract or arrangement and their aggregate cost is in a position to compare services and costs consistent with its obligations under sections 404 and 408(b)(2) of ERISA, and to determine the reasonableness of compensation paid for such services in the aggregate. There is one exception to this rule, discussed below, for the disclosure of certain compensation received in connection with recordkeeping services. See section (c)(1)(iv)(D) of the final rule.

Finally, in response to the concerns of some commenters about whether a failure to disclose unexpected compensation would result in a prohibited transaction by reason of losing relief under section 408(b)(2), the final rule requires disclosure only of compensation that the service provider, an affiliate, or a subcontractor “reasonably expects” to receive in connection with the services.

Paragraph (c)(1)(iv)(C)(
2
) of the final regulation provides for the disclosure of
indirect
compensation. Specifically, it requires a description of all indirect compensation (as defined in paragraph (c)(1)(viii)(B)(
2
)) that the covered service provider (or an affiliate or a subcontractor) reasonably expects to receive in connection with the services to be provided pursuant to the contract or arrangement. The rule also requires the covered service provider to identify the services for which the indirect compensation will be received and the payer of the indirect compensation. For purposes of the final regulation, “indirect” compensation is compensation received from any source other than the covered plan, the plan sponsor, the covered service provider, an affiliate, or a subcontractor (if the subcontractor receives such compensation in connection with services performed under the subcontractor's contract or arrangement with the covered service provider). See section (c)(1)(viii)(B)(
2
) of the final rule.

The proposal defined compensation or fees as “indirect” if received from any source other than the plan, the plan sponsor, or the covered service provider. The substance of the final rule with regard to disclosure of indirect compensation is similar to the proposed rule, but has been expanded to require disclosure of not only the indirect compensation that a covered service provider expects to receive, as proposed, but also identification of the services for which the indirect compensation will be received and identification of the payer of the indirect compensation.

Paragraph (c)(1)(iv)(C)(
3
) of the final rule provides specific guidance for when compensation paid among related parties,
i.e.,
among the covered service provider, its affiliates, and subcontractors, must be disclosed. The covered service provider must separately disclose such compensation if it is set on a transaction basis (
e.g.,
commissions, soft dollars, finder's fees or other similar incentive compensation based on business placed or retained) or is charged directly against the covered plan's investment and reflected in the net value of the investment (
e.g.,
Rule 12b-1 fees). The final rule also requires the covered service provider to identify the services for which such compensation will be paid, the payers and recipients of such compensation, and the status of each payer or recipient as an affiliate or a subcontractor. Under this paragraph (c)(1)(iv)(C)(
3
) of the final rule, compensation must be disclosed regardless of whether such compensation also is disclosed under paragraph (c)(1)(iv)(C)(
1
) or (
2
) (direct and indirect compensation) or (c)(1)(iv)(F) or (G) (investment disclosures). This provision does not apply to compensation received by an employee from his or her employer on account of work performed by the employee. Unless described in paragraph (c)(1)(iv)(C)(
3
) or elsewhere in the final rule, compensation paid among these related parties need not be disclosed. Such payments affect only how compensation is allocated among the parties and generally do not affect the total costs of services to the plan. Thus, the final rule responds to commenters' concerns that when services are provided by multiple parties and priced as a package, the covered service provider is not required to create an artificial allocation of compensation for services among the parties. However, if compensation is paid among related parties in the specific circumstances described in this paragraph (c)(1)(iv)(C)(
3
), the Department does not consider such compensation to be based on artificial methods, such as would be the case when allocations are driven by bookkeeping, tax, or other considerations of the related parties.

The disclosure of indirect compensation and certain compensation paid among related parties serves two purposes. First, the disclosures are intended to enable plan fiduciaries to better assess the reasonableness of the compensation paid for services to the plan by taking into account all of the compensation being received in connection with such services. Second, the disclosures are intended to enable plan fiduciaries to assess actual or potential conflicts of interest that may impact the quality of services provided to the plan.

The proposed rule required the covered service provider to furnish to plan fiduciaries specific information relating to conflicts of interest (see § 2550.408b-2(c)(1)(iii)(C) through (F), at 72 FR 71005). These provisions would have required disclosure of, among other things, information concerning: whether the service provider expects to participate in any transactions entered into with the plan; material financial relationships with certain parties related to the provision of services to the plan; whether the service provider will be able to unilaterally affect its own compensation

in connection with its provision of services; whether the service provider has policies or procedures that address actual or potential conflicts and, if so, an explanation of such policies and procedures.

A number of commenters expressed concern about the scope of the proposal's conflict of interest disclosures and the ultimate usefulness of the information to responsible plan fiduciaries in evaluating potential conflicts. Specifically, commenters asserted that the requirements, as proposed, were too broad, pointing out that having to disclose, in addition to actual conflicts, all potential conflicts, would create a potentially limitless, and therefore extraordinarily burdensome, requirement for service providers. Without a clear definition of what kinds of relationships may constitute a conflict and without knowing what other parties a covered plan may be engaging for other services, commenters argued such disclosure would be nearly impossible. Further, commenters pointed out that service providers likely would over-disclose in order to avoid a prohibited transaction, thus inundating plan fiduciaries with excessive, potentially confusing, and ultimately meaningless information. Commenters also requested additional guidance as to what would be a “material” relationship and argued that ambiguity surrounding this term would lead to inconsistent disclosures among various service providers.

Finally, the proposal required a covered service provider to disclose its ability to affect its own compensation. Commenters pointed out that ERISA's prohibited transaction rules preclude fiduciary service providers from engaging in such activity. They also noted that, to the extent that a service provider is not a fiduciary, exercising such discretion over its compensation likely would constitute a fiduciary act resulting in a separate prohibited transaction.

As an alternative to the disclosure regime of the proposed regulation, some commenters suggested that a better indicator of the existence and significance of a conflict of interest is information about the amounts and sources of compensation that service providers expect to receive in connection with the services provided to the plan. After careful consideration of the comments regarding the proposed requirement for narrative descriptions of conflicts of interest, the Department agrees that the final regulation's more detailed disclosure of compensation arrangements, particularly the additional information concerning the receipt of indirect compensation and compensation paid among related parties, will provide clearer and more meaningful information to the responsible plan fiduciaries about potential conflicts of interest than the narrative description of such conflicts required by the proposal. Accordingly, the final rule does not require the narrative disclosures about potential conflicts that were contained in the proposed regulation. Rather, the final rule requires that in conjunction with the description of the indirect compensation being received by the covered service provider (or an affiliate or subcontractor) in connection with the services provided to the plan, the covered service provider must disclose the services to which the indirect compensation relates and the payer of the compensation. Covered service providers similarly must identify the source and recipient of certain compensation paid among related parties, and the services to which such compensation relates. The Department believes that compliance with these disclosure requirements will ensure that fiduciaries have meaningful information with which to assess potential conflicts of interest on the part of their service providers.

Paragraph (c)(1)(iv)(C)(
4
), also consistent with the proposal, requires the covered service provider to describe compensation that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with termination of the contract or arrangement, and how any prepaid amounts will be calculated and refunded upon such termination. This provision, however, has been modified slightly from the proposal in an effort to clarify the requirement. Some commenters on the proposal expressed a general concern that fees and charges associated with contract terminations are not currently disclosed, as well as a specific concern that the proposed regulation was not clear as to whether disclosure of these fees and charges was required. In an effort to eliminate any ambiguity concerning the requirement to disclose such information, the requirement has been set forth in a separate paragraph of the final regulation.

e. Disclosures Regarding Recordkeeping Services

The final rule also includes a requirement concerning specific disclosures for recordkeeping services, which was not included in the proposal. Paragraph (c)(1)(iv)(D) provides that, if recordkeeping services will be provided to the covered plan, the covered service provider must furnish a description of all direct and indirect compensation that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with such recordkeeping services. In addition, if the covered service provider reasonably expects recordkeeping services to be provided, in whole or in part, without explicit compensation for such recordkeeping services, or when compensation for recordkeeping services is offset or rebated based on other compensation received by the covered service provider, an affiliate, or a subcontractor, the covered service provider must furnish a reasonable and good faith estimate of the cost to the covered plan of such recordkeeping services. The covered service provider must explain the methodology and assumptions used to prepare the estimate and describe in detail the recordkeeping services that will be provided to the covered plan. The estimate shall take into account, as applicable, the rates that the covered service provider, an affiliate, or a subcontractor would charge to, or be paid by, third parties, or the prevailing market rates charged, for similar recordkeeping services for a similar plan with a similar number of covered participants and beneficiaries.

The addition of this provision to the final rule reflects the Department's belief that information relating to recordkeeping services and the costs to covered plans of those services should be disclosed to responsible plan fiduciaries in a meaningful way. The availability of information sufficient to enable the plan fiduciary to make informed decisions about the costs of recordkeeping is fundamental to a responsible plan fiduciary's ability to satisfy its ERISA obligations. Especially in complicated service arrangements when a variety of services, including recordkeeping services, are provided to the covered plan and may be paid for through charges at the plan investment level or through revenue sharing, it is sometimes difficult for a plan fiduciary to determine the portion of aggregate charges that will be applied to recordkeeping services. The Department believes that requiring such information to be separately disclosed will better enable fiduciaries to make informed evaluations of a covered plan's recordkeeping costs. To the extent recordkeeping costs will not be covered by relatively straightforward direct or indirect compensation received by plan service providers, and to accommodate industry variation in how recordkeeping costs are otherwise absorbed by plan

service providers and investment-level charges, the Department included a standard for estimating recordkeeping costs in paragraph (c)(1)(iv)(D)(
2
). A covered service provider cannot avoid providing an estimate required by paragraph (c)(1)(iv)(D)(
2
) merely by disclosing a de minimis amount of direct or indirect compensation for recordkeeping under paragraph (c)(1)(iv)(D)(
1
) when such amount has no relationship to the cost of such services. In such instances, a covered service provider would be required under the final rule to provide an estimate pursuant to paragraph (c)(1)(iv)(D)(
2
) to reasonably reflect the cost to the covered plan of recordkeeping services. The Department believes these estimates, which must be reasonable and made in good faith by the covered service provider, will help responsible plan fiduciaries compare recordkeeping costs among a variety of service providers and service arrangements.

f. Manner of Receipt of Compensation

Paragraph (c)(1)(iv)(E) of the final rule, consistent with the proposal, requires a description of the manner in which the compensation described in paragraphs (c)(1)(iv)(C) and (D) will be received, such as whether the covered plan will be billed or the compensation will be deducted directly from the covered plan's account(s) or investments.

g. Investment Disclosure—Fiduciary Services and Recordkeeping and Brokerage Services

The definition of compensation under the proposal was very broad and encompassed not only the compensation and fees received by service providers, but also compensation attendant to plan investments and investment options. Disclosures concerning investment-related compensation (
i.e.,
investment management and similar fees charged against investment returns) are particularly significant in that they typically constitute a large portion of the total expenses incurred by a plan and its participants. These disclosures may directly impact the cost of plan services as a result of revenue sharing and similar arrangements between the issuer of a particular investment product and plan service providers. Understanding the fees and expenses attendant to plan investments is particularly significant for fiduciaries of individual account plans that permit participant and beneficiaries to direct their own investments, because it is those fiduciaries who ultimately select the plan's investment options and upon whom the participants and beneficiaries depend to make informed choices concerning their investments. Because investment-related fees and expenses can dramatically reduce the retirement savings of participants and beneficiaries, plan fiduciaries must carefully assess investment fees and expenses, among other factors, in selecting investment options to be made available in participant-directed individual account plans.

The Department received a number of comments concerning the disclosure of investment-related compensation. Most of the comments focused on what information should be disclosed and by whom it should be disclosed. The final regulation addresses the major issues raised by commenters through changes to the scope of the term “covered service provider.” For example, the concerns relating to uncertainty as to whether issuers of investment products, and certain service providers to those issuers or products, are themselves covered service providers for purposes of the regulation have been addressed by clarifying who does not constitute a “covered service provider” in the final rule. See above discussion relating to paragraph (c)(1)(iii)(D) of the final rule. Other comments expressed concern about some of the terminology used in the proposal. For example, one commenter expressed the view that the proposal left unclear whether a component of a charge called an “investment management fee” that actually pays recordkeeping or other non-management costs is required to be separately disclosed. The commenter explained that some service providers construe “revenue sharing” which would be required to be disclosed to include only the items specified in the preamble to the proposal, notwithstanding that there may be components of an expense ratio that actually pay for non-investment management services. Other commenters favorably characterized the proposal's definition of fees and expenses as comprehensive. Again, many of these commenters' concerns are addressed by the revisions reflected in the final rule concerning who does (and who does not) constitute a “covered service provider.” The Department also believes that the final rule's requirements, discussed below, establish clear standards as to what information concerning plan investments must be disclosed and by whom such information must be disclosed.

As discussed above, the final rule defines the term “covered service provider” to include fiduciaries to certain investment vehicles holding plan assets (paragraph (c)(1)(iii)(A)(
2
)) and providers of recordkeeping and brokerage services to a participant-directed individual account plan if they make available one or more designated investment alternatives for the covered plan (paragraph (c)(1)(iii)(B)). In addition to imposing an obligation to disclose compensation information concerning the services they provide (
i.e.,
as a fiduciary or as a recordkeeper or broker), the final rule requires these covered service providers to disclose compensation information concerning the investments with respect to which they are a fiduciary or provide recordkeeping or brokerage services pursuant to the contract or arrangement with the covered plan. After careful consideration of all of the comments, the Department concluded that these service providers, because they have a relationship with both the investment vehicles and the covered plan, are in the best position to ensure that responsible plan fiduciaries have the information they need about the investments represented by the covered service provider. These investment-related disclosures are described in paragraphs (c)(1)(iv)(F) and (G) of the final rule and are not limited as to who will receive such investment-related compensation. The Department also notes that ERISA section 404(a) obligates plan fiduciaries who invest in vehicles holding plan assets (paragraph (c)(1)(iii)(A)(
2
)) to consider the effect on the plan's rate of return of fees and expenses associated with that vehicle's underlying investments, including any lower tiered entity in which the plan asset vehicle invests.

Paragraph (c)(1)(iv)(F) sets forth the investment-related disclosure obligations of fiduciaries to investment vehicles holding plan assets. These covered service providers (as described in paragraph (c)(1)(iii)(A)(
2
)) must provide, with respect to each investment contract, product, or entity that holds plan assets and in which the covered plan has a direct equity investment, the following information, unless such information is disclosed to the responsible plan fiduciary by a covered service provider described in paragraph (c)(1)(iii)(B) (recordkeeping and brokerage services): (
i
) a description of any compensation that will be charged directly against the amount invested in connection with the acquisition, sale, transfer of, or withdrawal from the investment contract, product, or entity (
e.g.,
sales loads, sales charges, deferred sales

charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees); (
ii
) a description of the annual operating expenses (
e.g.,
expense ratio) if the return is not fixed; and (
iii
) a description of any ongoing expenses in addition to annual operating expenses (
e.g.,
wrap fees, mortality and expense fees).

Paragraph (c)(1)(iv)(G) requires disclosure of the same investment-related compensation information described above from recordkeepers and brokers that make available investment alternatives for participant-directed individual account plans. This information must be provided with respect to each designated investment alternative for which recordkeeping or brokerage services will be provided pursuant to the contract or arrangement with the covered plan. Paragraph (c)(1)(viii)(C), discussed below, defines the term “designated investment alternative” for purposes of the final rule.

The Department recognizes that recordkeepers and brokers, unlike fiduciaries to investment vehicles holding plan assets, are not directly involved in the day-to-day management of the investment vehicles they represent, but rather, merely serve as intermediaries between plans and the issuers of these investment vehicles for purposes of furnishing such information; the final rule limits their liability under the regulation for the completeness and accuracy of the disclosed information. Specifically, paragraph (c)(1)(iv)(G)(
2
) of the final rule provides that a covered service provider may comply with this investment-related disclosure requirement if the covered service provider provides to the responsible plan fiduciary current disclosure materials of the issuer of the designated investment alternative that include the information described in this paragraph, provided that such issuer is not an affiliate, the disclosure materials are regulated by a State or federal agency, and the covered service provider does not know that the materials are incomplete or inaccurate.

h. Timing of Initial Disclosure Requirements; Changes

With regard to the timing of the required disclosures, the proposed regulation required that service contracts or arrangements include a representation by the service provider that all required information was provided to the responsible plan fiduciary before the contract or arrangement was entered into. This requirement was intended to ensure that the responsible plan fiduciary had the opportunity to consider all required disclosures before entering into a contract or arrangement with a service provider. The Department did not specify any time frame for this disclosure, believing it was best left to the responsible plan fiduciary and its potential service providers to work out the amount of time, prior to entering into the contract or arrangement, that the responsible plan fiduciary would need to review the disclosures. Some commenters suggested that the final regulation provide a more specific timeframe for the disclosures. However, the Department continues to believe that the flexibility described in the proposed regulation is appropriate and that the parties to the contract or arrangement can determine what is reasonable; accordingly, the Department did not adopt the suggestion.

Consistent with the proposal, the final rule, at paragraph (c)(1)(v), requires that a covered service provider provide the initial disclosures required by paragraph (c)(1)(iv), discussed above, to the responsible plan fiduciary reasonably in advance of the date the contract or arrangement is entered into, extended or renewed. The final rule, however, contains an exception for certain persons who become covered service providers within the meaning of paragraph (c)(1)(iii)(A)(
2
) of the final rule subsequent to a plan's investment in an investment vehicle. This situation would arise when a plan invests in an investment vehicle that, at the time of the plan's investment, does not hold plan assets, but that subsequently, for reasons such as another plan's investment in the vehicle, is determined to hold plan assets, thereby causing a fiduciary to such vehicle to be a covered service provider pursuant to paragraph (c)(1)(iii)(A)(
2
). To accommodate such instances, the final rule provides that such a fiduciary service provider must disclose the information required by paragraph (c)(1)(iv) as soon as practicable, but not later than 30 days from the date on which the service provider knows that such investment contract, product or entity holds plan assets.

The final rule also includes a special timing provision for disclosure related to recordkeeping and brokerage services pursuant to paragraph (c)(1)(iv)(G). Information described in paragraph (c)(1)(iv)(G) relating to any investment alternative that is not designated at the time the contract or arrangement is entered into must be disclosed as soon as practicable, but not later than the date on which the investment alternative is designated by the responsible plan fiduciary.

In addition to requiring that certain information be disclosed to responsible plan fiduciaries before the parties enter into, or extend or renew, a contract or arrangement, the proposal included an ongoing obligation for the service provider to disclose to the responsible plan fiduciary any material change to the required information not later than 30 days from the date on which the service provider acquired knowledge of the change. A number of commenters requested additional guidance on what would be considered a “material” change. Some of the commenters' concerns related to the potential breadth of disclosures required by the proposal, with commenters expressing concern as to whether 30 days would provide sufficient time to identify material changes, especially in the context of packaged or bundled services that may involve parties other than the contracting service provider. Some commenters, especially large institutions with multiple affiliations, argued that 30 days was not enough time to discover changes to information relating to all of their business units or affiliates. Commenters also asserted that this requirement would result in voluminous, costly, and inefficient monitoring of disclosures, as well as potential “over-disclosure” of all changes to the extent it is not clear whether a particular change is material. Finally, commenters argued that disputes may result between various parties as to the beginning date for the 30-day compliance period, which may be subjective. Commenters suggested alternative approaches, for example defining materiality for this purpose, extending the 30-day period, or requiring an annual updating of all information in lieu of periodic disclosure of material changes. In response to these comments, the Department has made a number of changes.

Specifically, paragraph (c)(1)(v)(B) of the final rule requires that a covered service provider disclose a change (as opposed to a “material” change) to the initial information required to be disclosed pursuant to paragraphs (c)(1)(iv) as soon as practicable, but not later than 60 days from the date on which the covered service provider is informed of such change, unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider's control, in which case the information must be disclosed as soon as practicable. The Department was persuaded by commenters' concerns that it may take

more than 30 days to accurately identify and disclose changes to information that previously was disclosed, especially in the context of large institutions with multiple affiliates. However, the Department does not believe that a covered service provider should have an unlimited period of time to disclose changes to the responsible plan fiduciary; a certain level of timeliness and efficiency is expected in the marketplace, and covered service providers should be in a position to ensure that the information they disclose to responsible plan fiduciaries about the services they are providing and the compensation they are receiving continues to be accurate. Therefore, disclosure of changes must be made as soon as practicable, but not later than 60 days from the date on which the covered service provider knows of such change unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider's control, in which case the information must be disclosed as soon as practicable.

The Department also eliminated the concept of materiality, persuaded by commenters that, without more specific definition, this standard would not add to a covered service provider's understanding of what types of changes must be disclosed. Accordingly, if information previously disclosed to a responsible plan fiduciary changes, the responsible plan fiduciary must be notified. The Department believes that a responsible plan fiduciary should be made aware if any change occurs, for example, in the services that the covered service provider will be providing for the plan, the fiduciary status of the service provider, or the compensation that the service provider will be paid.
12

12
Nothing in the final rule or this preamble relieves a service provider from other obligations or limitations under ERISA, for example other prohibited transactions or, in the case of service providers that are ERISA fiduciaries, the restrictions of ERISA sections 404 or 406(b).
See, e.g.,
Advisory Opinion 97-16A (May 22, 1997) (the Department stated that, in the context of a service provider who retains some authority over the investment options selected by plans by deleting or substituting, in its own discretion, certain unrelated mutual funds, a plan fiduciary must be provided advance notice of the change, including disclosure of fee information, and must be afforded a reasonable amount of time in which to accept or reject the change).

i. Reporting and Disclosure Information; Timing

Paragraph (c)(1)(vi) of the final rule addresses the obligations of the covered service provider to provide, upon request of the responsible plan fiduciary or plan administrator, any other information relating to the compensation received in connection with the contract or arrangement that is required for the covered plan to comply with the reporting and disclosure requirements of Title I of ERISA and the regulations, forms and schedules issued thereunder. This provision is very similar to the proposal. A few commenters asked the Department to provide that only “reasonable” requests from the responsible plan fiduciary or plan administrator must be accommodated under this provision. The Department did not include this concept in the final rule, because it did not want to create issues as to the “reasonableness” of a particular request. The Department believes that the final rule minimizes the potential for abuse by restricting covered service provider's disclosure obligation to information that is “required” for the covered plan to comply with its reporting and disclosure obligations. Commenters also requested guidance from the Department that the responsible plan fiduciary or plan administrator may not request that this information be disclosed or presented in any particular format. The Department expects that the covered service provider will furnish the information in a manner that enables effective use of the information to satisfy ERISA's Title I reporting and disclosure requirements; no further obligation should be inferred from this requirement.

Finally, a few commenters asked that the Department clarify that this disclosure obligation was limited to information specifically required by a responsible plan fiduciary or plan administrator to complete a Form 5500 annual report. The Department declined to accept this suggestion; the Department expects that this provision will require service providers to disclose information that is necessary in order to comply with ERISA's reporting and disclosure obligations in circumstances other than the Form 5500 annual report, for example in making required disclosures concerning plan and investment fees and expenses to participants and beneficiaries. The Department notes that this is not a limitless obligation; the rule limits this provision to information relating to the contract or arrangement, and the compensation received thereunder, that is “required” for the covered plan to comply with the reporting and disclosure obligations of Title I.

The proposal required that the service provider disclose information requested by the responsible plan fiduciary or plan administrator in order to comply with ERISA's reporting and disclosure obligations, but did not specify any time frame for the service provider to respond to such a request. Some commenters requested additional guidance concerning when the covered service provider would be obligated to provide such information. In response, the Department added a new timing requirement in paragraph (c)(1)(vi)(B) of the final rule. A covered service provider must disclose the requested information not later than 30 days following receipt of a written request from the responsible plan fiduciary or covered plan administrator, unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider's control, in which case the information must be disclosed as soon as practicable. The Department believes that this provision will provide more specificity to the parties in complying with this disclosure requirement, but also accommodate the practical reality that a covered service provider may, because of extraordinary matters beyond its control, be unable to satisfy the general standard.

j. Disclosure Errors

The proposed regulation did not provide specific relief for disclosure errors or omissions by service providers. As a result, many commenters argued that the final regulation should be revised to include such relief for service providers in certain circumstances. Many commenters argued that inadvertent mistakes are inevitable, in spite of the best efforts of all involved, and that it would be inappropriate for a service provider to be subject to a prohibited transaction in these circumstances. These commenters believed that, under the proposal, a prohibited transaction would result if any error, no matter how small, existed in the detailed disclosures required by the rule. Commenters felt this risk was especially significant in the case of a package of services involving multiple service providers. These commenters asserted that, with required information coming from different, and in some cases unrelated, parties, the likelihood of “innocent” mistakes increases. Commenters were not comforted by the proposal's limitation that information must be provided “to the best of the service provider's knowledge,” because in some cases, such as a typographical error, the service provider may “know” that the information is inaccurate. Further, commenters argued that these errors would not be covered by the material change provision in the proposal, because many minor errors would not be material. Finally, commenters noted that the material

change provision focused on disclosing information when changes occur during the term of the contract and not on information that was incorrect at the time the contract was entered into. Commenters proposed various solutions, such as providing a cure period to allow for correction of minor or inadvertent errors or, alternatively, revising the rule to require only “reasonable” or “good faith” compliance with its disclosure obligations. Other commenters suggested that a correction mechanism could be permitted through the Department's Voluntary Fiduciary Correction (VFC) Program
13

or that relief could be provided through an expansion of the proposed class exemption.

13

See
Voluntary Fiduciary Correction Program Under the Employee Retirement Income Security Act of 1974, Adoption of Updated Program, 71 FR 20262 (April 19, 2006).

The Department was persuaded by commenters that relief should be provided so that certain inadvertent errors and omissions do not result in a prohibited transaction. Accordingly, paragraph (c)(1)(vii) of the final rule provides that no contract or arrangement will fail to be reasonable under the regulation solely because the covered service provider, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the information required by the regulation. However, the covered service provider must disclose the correct information as soon as practicable, but not later than 30 days from the date on which the covered service provider knows of such error or omission.

The Department notes that the class exemption, included as part of this regulation (paragraph (c)(1)(ix)), is meant to address situations in which a responsible plan fiduciary discovers an error or other deficiency in the disclosure. Paragraph (c)(1)(vii) is meant to provide the parties an opportunity to avoid a prohibited transaction by addressing errors up front. Once a prohibited transaction has occurred, the responsible plan fiduciary will need to rely on the relief provided by the class exemption, discussed below.

6. Definitions

Paragraph (c)(1)(viii) of the final rule defines the terms “affiliate,” “compensation,” “designated investment alternative,” “recordkeeping services,” “responsible plan fiduciary,” and “subcontractor.”

Specifically, paragraph (c)(1)(viii)(A) provides that a person's or entity's “affiliate” directly or indirectly (through one or more intermediaries) controls, is controlled by, or is under common control with such person or entity; or is an officer, director, or employee of, or partner in, such person or entity. The rule also provides that unless otherwise specified, an “affiliate” in paragraph (c)(1) refers to an affiliate of the covered service provider. This definition essentially is unchanged from the proposal, except that the definition no longer includes the concept of an “agent” of the covered service provider. The Department was persuaded by commenters that the notion of an “agent” of the covered service provider is unclear, overly broad, and not consistent with commonly understood “affiliate” arrangements. To the extent some commenters were concerned that this term might pull subcontractors of a covered service provider into affiliated status, the Department notes that the final rule specifically addresses the role of a covered service provider's subcontractors elsewhere.

Paragraph (c)(1)(viii)(B) defines “compensation” for purposes of the final rule as anything of monetary value (such as money, gifts, awards, and trips), but does not include non-monetary compensation valued at $250 or less, in the aggregate, during the term of the contract or arrangement. This is slightly different from the proposal, which did not include the $250 de minimis rule. The Department added this provision in response to suggestions from a number of comments concerning the cost and burden of tracking insignificant non-monetary gifts.

The definition of “compensation” includes descriptions of both “direct” and “indirect” compensation. Subparagraph (
1
) defines “direct” compensation as compensation received directly from the covered plan. Subparagraph (
2
) defines “indirect” compensation as compensation received from any source other than the covered plan, the plan sponsor, the covered service provider, an affiliate, or a subcontractor, if the subcontractor receives such compensation in connection with services performed under the subcontractor's contract or arrangement described in the definition of subcontractor contained in paragraph (c)(1)(viii)(F).

Subparagraph (
3
) provides that, for purposes of the regulation, a description or an estimate of compensation may be expressed as a monetary amount, formula, percentage of the covered plan's assets, or a per capita charge for each participant or beneficiary or, if the compensation cannot reasonably be expressed in such terms, by any other reasonable method.
14

In this regard, any description or estimate must contain sufficient information to permit evaluation of the reasonableness of the compensation. This provision is slightly modified from the proposal, because the final rule also provides that when compensation cannot reasonably be expressed in terms of amounts, formulae or percentages, any other reasonable method may be used (subject to the general requirement that the description of compensation must contain sufficient information to permit evaluation of the reasonableness of such compensation). This standard was modified in part in response to commenters' concern that some types of compensation could not necessarily be expressed in a monetary amount, formula, percentage of the plan's assets, or a per capita charge. The Department continues to prefer disclosure in terms of a monetary amount, formula, percentage of the plan's assets, or a per capita charge; however, the Department is persuaded that in situations when it is not feasible to disclose compensation in such terms, covered service providers should be able to use another reasonable method to do so.

14
Some commenters raised concerns with language in the preamble to the proposed regulation which seemed to imply that formulas, percentages, or per capita charges could be used only if it was not possible to disclose in terms of a monetary amount. The Department did not intend this interpretation; as stated in the final rule, there are alternatively acceptable formats for disclosing compensation to a responsible plan fiduciary, so long as the description sufficiently permits evaluation of the reasonableness of such compensation.

Paragraph (c)(1)(viii)(C) defines a “designated investment alternative” as any investment alternative designated by a fiduciary into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts. The term “designated investment alternative” does not include brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants and beneficiaries to select investments beyond those specifically designated. This definition is consistent with the definition used by the Department for purposes of defining “designated investment alternative” in its proposed participant-level fee disclosure regulation (see proposed § 2550.404a-5(h)(1), 73 FR 43041).

Paragraph (c)(1)(viii)(D) defines “recordkeeping services” as including services related to plan administration and monitoring of plan and participant and beneficiary transactions such as enrollment, payroll deductions and

contributions, offering designated investment alternatives and other covered plan investments, loans, withdrawals and distributions. It also provides that “recordkeeping services” includes the maintenance of covered plan and participant and beneficiary accounts, records, and statements. This broad definition of recordkeeping is intended to provide basic parameters to ensure that providers of recordkeeping services understand when they will be covered by paragraph (c)(1)(iii)(B) when they also make designated investment alternatives available to the covered plan.

Paragraph (c)(1)(viii)(E) defines a “responsible plan fiduciary” as a fiduciary with authority to cause the covered plan to enter into, or extend or renew, the contact or arrangement. This is consistent with use of the phrase “responsible plan fiduciary” in the Department's proposal, except that for ease of reference it has been separately included in the definitions section.

Paragraph (c)(1)(viii)(F) defines a “subcontractor” as any person or entity (or an affiliate of such person or entity) that is not an affiliate of the covered service provider and that, pursuant to a contract or arrangement with the covered service provider or an affiliate, reasonably expects to receive $1,000 or more in compensation for performing one or more services described in paragraph (c)(1)(iii)(A) through (C) of the regulation provided for by the contract or arrangement with the covered plan. The Department added this concept to the final rule in order to clarify that, in certain instances, a covered service provider will be required to report compensation received by a subcontractor to the covered service provider or an affiliate. For example, if a “covered service provider” that contracts with a plan to provide recordkeeping in turn subcontracts to outsource all or part of those services to another party, then that party is a “subcontractor,” because it is carrying out some or all of the covered service provider's obligations under the contract or arrangement with the covered plan. In certain cases, the covered service provider may have to disclose compensation received by this subcontractor.

C. Class Exemption

The class exemption from the restrictions of ERISA section 406(a)(1)(C) was proposed by the Department separately from the proposed regulation. It was intended to relieve a responsible plan fiduciary from engaging in a prohibited transaction under certain circumstances when the requirements of the regulation have not been met. The Department received five separate public comments in response to the invitation for comments contained in the notice of pendency relating to the proposed class exemption, in addition to comments that were made as part of information received from the public on the proposed regulation. This section discusses these comments and modifications that have been made to the final class exemption, which now is being granted and included as section (c)(1)(ix) of the final rule.

1. Comments on Proposed Class Exemption

A few commenters requested that the proposed class exemption be expanded to protect service providers from potential excise taxes under the Code. Specifically, these commenters wanted the class exemption to cover service providers that are responsible for making the rule's required disclosures in certain circumstances: For example, when disclosure is made on behalf of a third party, and the service provider, acting as a conduit, either does not receive the requested information from the third party, or it is later discovered that the information received from the third party was erroneous; when an inadvertent error is made in providing the responsible plan fiduciary with the detailed information required by the proposal, for example, some of the narrative information about conflicts of interest, commenters argued, was vaguely described or overly broad; or when a responsible plan fiduciary fails to execute a service contract or arrangement. The Department has determined not to extend specific prohibited transaction exemption relief from the prohibitions of section 406(a) to covered service providers in the same way that the final class exemption covers responsible plan fiduciaries who attempt to address a service provider's disclosure failure. However, the Department notes that the final rule clarifies that execution of a formal “contract” is not required, and gives covered service providers more opportunities to address disclosure failures, such as errors and omissions. The final rule also provides covered service providers with relief for “passing through” certain regulated disclosure materials that include information concerning plan-designated investment alternatives.

One commenter suggested that the proposed class exemption be expanded to cover prohibited transactions described under section 406(a)(1)(D) of ERISA. Section 406(a)(1)(D) prohibits the transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. The commenter stated that if the statutory exemption under section 408(b)(2) is temporarily unavailable for a particular service arrangement, but the covered service provider continues to be engaged by the plan to provide necessary services and receives payments, section 406(a)(1)(D) would be violated if plan assets are used to compensate the covered service provider during such time. The Department modified the operative language of the final class exemption to provide relief from section 406(a)(1)(D) to cover, among other things, situations when a responsible plan fiduciary decides to continue a service arrangement with a covered service provider, and to continue paying such covered service provider's fees, during periods when the parties are attempting to cure a disclosure failure by the covered service provider pursuant to the conditions of this exemption.

Other commenters observed that the proposed class exemption would apply if the responsible plan fiduciary unknowingly enters into a service contract that does not satisfy the disclosure obligations of the regulation, provided that certain conditions are met. The proposal required the responsible plan fiduciary to request the missing information, in writing, from the service provider, and the covered service provider would have been deemed to have failed to satisfy its disclosure obligations if it did not provide the information requested by the responsible plan fiduciary within 90 days. In this regard, the commenters requested that a satisfactory and timely service provider response to the 90-day request be deemed to satisfy the disclosure requirements and that the proposed class exemption be revised to provide relief in such instances. One commenter stated that a service provider should not be treated as failing to comply with a responsible plan fiduciary's request for information, for purposes of the exemption, merely because the covered service provider is unable to complete a response within 90 days of the request, despite good faith efforts on the part of the service provider to obtain such information.

The Department has determined that, under the exemption, a responsible plan fiduciary should not be permitted to give a covered service provider an unlimited amount of time to address a disclosure failure. Like the proposal, the final exemption requires that disclosure failures be addressed by the parties within specific timeframes. Under the final exemption, if the covered service

provider fails to comply with a responsible plan fiduciary's written request within 90 days of the date of that request, the fiduciary must notify the Department of the service provider's disclosure failure within a specified time period (
i.e.,
30 days). At such time, the responsible plan fiduciary will be covered by the exemption. The covered service provider will continue to be engaging in a non-exempt prohibited transaction until such time as the service arrangement is terminated or the disclosure failure is cured. Once a service provider's disclosure failure has been cured and the contract or arrangement complies with all of the other conditions of the Department's regulations at 29 CFR 2550.408b-2, or the contract or arrangement is terminated, it is the view of the Department that the prohibited transaction will cease. Thus, covered s

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2010-16768. Public record. Not legal advice.