Regulatory Compliance Association

PracticeEdge Session – ERISA

Andrew L. Oringer

Dechert LLP (Senior Fellow from Practice)

Peter E. Haller

Credit Suisse Securities (USA) LLC

Steven W. Rabitz

Stroock & Stroock & Lavan LLP

William E. Ryan III

Evercore Trust Company, N.A.

John W. Schuch

Bank of America Merrill Lynch

April 23, 2014

Context

• ERISA (Employee Retirement Income Security Act of 1974)

– Reactive, like employee benefits legislation generally

– Comprehensive and fully “reticulated” - provides a broad array of general fiduciary

standards and a series of prohibited transactions

– Law vs. “lore”

• Investors – Why are we talking about . . . ERISA?

– Plans as investors - “biggest lump of money”

• Investment vehicles by nature – no operating expenditures, generally

• Tax-exempt – substantially faster growth by comparison

– Evolution of the appetite for dealing with ERISA

– ERISA (e.g., corporate) and non-ERISA plans (governmental, non-U.S., etc.)

• Comparison and contrast

– At least two reasons to care

• The tax is often on the financial institution

• The institution may be a money manager directly subject to the rules

1

Plan Assets – In General

• ERISA applies to plans and “plan assets” – what is a “plan asset”?

– The “plan assets” inquiry can be surprisingly layered and complex

• A key concern is that, if a plan makes an equity investment in an entity, the

entity may service as a mechanism by which ERISA regulation of fiduciary

conduct can be avoided

– As a clear example, a plan may set up a subsidiary through which to invest its

assets. It would not generally be expected that such subsidiary should be free of

ERISA regulation merely because it is separately organized from the plan’s trust.

Rather, it would be expected that such an entity should be looked through, back to

the plan, for purposes of applying ERISA.

– As a converse example, it would appear equally likely that the mere purchase of

stock by a plan in a large, publicly traded operating company should not cause the

assets of the company to be deemed plan assets.

– What is the regulatory framework for the foregoing situations, and what is that

analysis for the vast number of entities that are on neither of these extremes?

• Many investment funds could never be acceptably structured to satisfy

ERISA

2

Plan Assets – In General (cont’d)

• “Plan Assets” Regulation (29 C.F.R. § 2510.3-101)

– An equity purchase in an entity results in a look-through unless an exception

applies

– If registration, publicly-offered and “operating company” exceptions do not apply,

the relevant exception is generally for “venture capital operating companies” or

under the 25% test

3

Plan Assets – In General (cont’d)

• “Plan Assets” Regulation (29 C.F.R. § 2510.3-101) (cont’d)

– Why care if a vehicle is a “plan assets” entity?

• May be trying to avoid ERISA coverage for one’s own fund or one’s other investment-

related activities

• May be running a fund subject to ERISA or otherwise managing ERISA money, and be

trying to avoid investment in a downstream vehicle subject to ERISA

44

“Significant Participation” (25%) Test

• Exception where “[e]quity participation in the entity by benefit plan investors

is not significant” under the “25% test”; “benefit plan investors” include

ERISA plans, “Keoghs” and IRAs

• Rule applies with respect to each “class” of “equity”

• Equity interests held by a person who has discretionary authority or control,

or any affiliate, are generally disregarded

5

“Significant Participation” (25%) Test (cont’d)

• Pension Protection Act of 2006 (the “PPA”) (adding ERISA § 3(42))

– “Benefit plan investors” – generally, non-ERISA plans are no longer taken into

account

– Proportional counting (downstream application)

– Practical ramifications

• Marketing to non-ERISA plans – unrestricted non-ERISA investment (subject to local rules

and custom); and possible increase in ability to market to ERISA plans

• Effect on acceptance of investment by commingled funds and other entities (including a

fund of funds)

• The PPA may be seen as making it easier to avoid plan-assets characterization, while at

the same time, making it easier (with the addition of the “service provider” exemption,

correction provisions, etc.) to comply with ERISA in the event of a willingness to accept

ERISA coverage

66

“Plan Assets” Funds

• Going forward as a “plan assets” fund?

– Fund of funds

– Hedge fund

– Private equity fund

– Other

• Note – convergence of various types of funds

7

Going Forward as a Plan Assets Fund

• Historical backdrop

– Increasing investment from plans

– PPA change to definition of “benefit plan investor” to exclude non-ERISA plans

– Collective investment

• In general

• Use of a fund of funds

• Possible application of ERISA at multiple levels

8

ERISA’s Fiduciary Rules – In General

• Prudence and diversification, and other general rules

– “Eye single” to the interests of participants and beneficiaries

– “Procedural” prudence; general deference to fiduciary decision-making

– Modern portfolio theory (investments not viewed in isolation)

– Plan documents

• Prohibited Transactions

– Per se

– Self-dealing

• Application – or non-application – to operating entities, investment vehicles,

etc.

9

Prohibited Transactions – In General

• Per se prohibited transactions

• Self-dealing

• Generally not cured by notice or waiver/consent (thus, potentially inflexible

results)

– Compare with rules under the securities laws

• IRAs are generally covered

• Parties may seek assurances (e.g., representations and warranties) from

their counterparties

– While the assurances may not eliminate applicable statutory liability, they may

serve to allocate risk between the parties, to the extent the contractual provisions

are valid and enforceable

– There is the possibility documentation could make regulators less likely to proceed

with enforcement actions, and could help with presenting a sympathetic case in

the context of litigation

10

Per Se Prohibited Transactions

• ERISA generally prohibits transactions between employee benefit plans and

“parties in interest” (known as “disqualified persons” under the tax laws)

• Expanding the common law, ERISA includes as parties in interest not only

employers, plan participants, fiduciaries and other insiders and affiliates, but

also mere service providers to the plan, including, for example, unrelated

brokers, custodians and other non-fiduciary plan advisers

– Especially with consolidation in the financial services industry, service-provider

relationships can be extensive

– Some (and maybe most) large, diversified financial institutions have generally

come to operate under the assumption that that they are parties in interest (and

disqualified persons) with respect to all plans

– Arguably, can effectively convert a related-party rule into a general rule

• There are significant taxes, penalties and rescission risks on the party in

interest, and make-whole and other risks on the fiduciary

11

Per Se Prohibited Transactions (cont’d)

• ERISA Violations = Large (Strict Liability) Penalties on Counterparties to Plan

Asset Funds. For purposes of the excise taxes described before, the DOL

takes the position that certain continuing transactions are deemed to be

entered into anew each year they remain outstanding. This means that,

according to IRS interpretations potentially, excise taxes can have a

cascading effect.

– Example: Assume a prohibited loan with a principal amount of $1,000.00 entered

into January 1, 2014 due December 31, 2019 with 10% interest per annum. With

an excise tax of 15% of the “amount involved” (the interest), the excise tax for

2011 (first year loan is outstanding) is $15.00 but look at what happens for just

one loan transaction:

12

2014 $15 $15

2015 $15 $15 $30

2016 $15 $15 $15 $45

2017 $15 $15 $15 $15 $60

2018 $15 $15 $15 $15 $15 $75

2019 $15 $15 $15 $15 $15 $15 $90

$315

Self-Dealing Prohibited Transactions

• Three basic types

– Use of plan assets for own account

– Representing both sides (e.g., cross-trading)

– Kickbacks (receipt of consideration from third party for own account)

• Issues for some fees and fee structures

• What are some of the risks?

– Taxes and penalties; disgorgement

– Issues for the underlying transaction

• Exemptions (or relative lack thereof)

13

Prohibited Transaction Exemptions –

In General

• Statutory

• Administrative

– Class

– Individual (general and “EXPRO”)

14

Prohibited Transaction Exemptions - Examples

• Investor-based

– QPAMs (PTCE 84-14), INHAMs (PTCE 96-23), bank collective investment funds (PTCE

91-38), insurance company pooled separate accounts (PTCE 90-1), insurance company

general accounts (PTCE 95-60), etc.

• Transaction-based

– Brokerage (PTCE 86-128), principal and agency transactions by U.S. broker-dealers in

securities (PTCE 75-1, Parts I and II), foreign exchange transactions (PTCE 94-20 and

ERISA § 408(b)(18)), securities lending (PTCE 2006-16), certain repurchase agreements

(PTCE 81-8), etc.

– No specific exemption for derivatives, swaps, etc.

• Note that transaction-specific exemptions are much narrower, and it is easy to

have a compliance-related foot-fault.

– For example, consider a plan asset fund’s purchase of a financial institution’s debt from

the financial institution’s U.S. registered broker-dealer - while the acquisition could be

exempt under PTCE 75-1, the ongoing extension of credit (i.e., loan) embedded in the

note might not

– Similarly, while PTCE 75-1 covers securities transactions, it does not cover commodities

or futures

15

Prohibited Transaction Exemptions – Examples

(cont’d)

• Certain rules that have changed the risk profile

– Exemption for transactions with mere service providers (ERISA § 408(b)(17),

added in 2006)

• Transaction for “adequate consideration” with a party in interest by virtue of being a

service provider or affiliate thereof is not prohibited, if the transaction is not with a

fiduciary with respect to the assets involved in the transaction or an affiliate thereof

• Issues with definitions (e.g., “adequate consideration,” “fiduciary” (particularly in the case

of directed trustees), “affiliate”), additional practical concerns (e.g., in the case of

continuing transactions) and lack of regulatory guidance or other authority

• Comfort levels vary in the market

– Use as a sword (planning)

– Use as a shield (defensive)

16

Prohibited Transaction Exemptions – Examples

(cont’d)

• Certain rules that have changed the risk profile (cont’d)

– Corrections for certain transactions involving securities or commodities (ERISA §

408(b)(20), added in 2006)

• 14-day correction period for certain prohibited transactions involving “securities” or

“commodities” that are discovered after they have occurred

• Definition of “securities” may be significantly broader than one might expect, thus

potentially increasing the utility of the exemption

• Potential practical effect in a broad range of circumstances

• Fundamentally not a planning tool, but rather a provision to address inadvertent mistakes

– But may provide general comfort as a practical matter

– And may be extremely important when actually needed

• Not available for transactions involving self-dealing

17

Exculpation, Indemnification and Insurance

• Exculpation

– General rule – no relief for liability for a breach

– Indemnification and insurance

1818

Trust Requirement

• Plan assets must generally be held in trust

• Relief for an entity holding plan assets where “the indicia of ownership of the

. . . interest in the entity are held in trust” (29 C.F.R. § 2550.403a-1(b)(3))

19

Custody

• Indicia of ownership of the assets of a plan must be subject to the

jurisdiction of the U.S. district courts, unless a regulatory exception applies

(ERISA § 404(b))

• Identification of the relevant “indicia” is not necessarily straightforward

– Applicable custody regulations were issued years ago

20

Custody (cont’d)

• Exceptions

– Generally only apply to certain non-U.S. securities and currency

– Exception for assets under the management and control of a qualified fiduciary (29

C.F.R. § 2550.404b-1(a)(2)(i))

• Similar, but not identical, to QPAM requirements

• Potential trap for the unwary – U.S.-based organization and principal place of business

– Exceptions for acceptable global-custody networks (29 C.F.R. § 2550.404b-

1(a)(2)(ii)(B), (C)) or certain other acceptable custody arrangements (29 C.F.R.

§ 2550.404b-1(a)(2)(ii)(A))

2121

Bonding

• Each person handling the assets of a Plan Assets Fund would need to be

bonded as required by Section 412 of ERISA

• Bond protects the plan against loss by reason of acts of fraud or dishonesty

on the part of persons required to be bonded

• In the case of a Plan Assets Fund, who procures the bond?

– The manager, or other fund affiliate?

– The investing plans?

22

Bonding (cont’d)

• Maximum bond is generally $500,000 per plan

– Issues may arise in connection with complying with the per-plan minimum in a

multi-investor fund

• Application of rules, which originated before collective investment was as commonplace,

can be unclear

– Bond amount can be $1,000,000 per plan if the plan is invested in employer

securities

• Purpose of the increased limitation is not entirely clear

• Application of the increased limit where the employer securities are elsewhere in the

plan’s portfolio is not entirely clear, raising the possibility that one might argue that

employer securities held somewhere in the plan’s portfolio could affect the manner in

which the bonding requirements to all managers of the plan

23

Bonding (cont’d)

• By statute, a U.S.-registered broker or dealer subject to a fidelity-bond

requirement of a self-regulatory organization does not need to be bonded

• Other exceptions for certain types of institutions are contained in regulations

2424

Reporting

• Form 5500 is the plan’s comprehensive annual information return

– Akin to a tax return, but the plan generally does not pay taxes

• Investors will need information regarding the investments of a Plan Assets

Fund

– Can provide detailed information to investors

– Or, if eligible, can file directly with the DOL as a DFE (direct filing entity)

25

Reporting (cont’d)

• Schedule C, and provision of compensation information

– Extensive requirements

– Rules apply to the plan administrator (not the Plan Assets Fund)

• But - reasons for cooperation

– Relationship issues

– “Wall of shame” and other DOL issues

– Contrast with prohibited transactions issues under Section 408(b)(2) of ERISA

2626

Reporting (cont’d)

• Hard-to-value assets

– Reporting issues, in general

– Possible effect on broader fiduciary duties

– General reporting requirements

• Gifts and entertainment

– Note seriousness of underlying substantive issues

27

Litigation Update

• Stock drop (including the pending Dudenhoeffer case)

• Indirect fees, "float“

• Allegedly ineligible (by virtue of the terms of an offering or otherwise by

contract) investments, and a recent settlement

• "Controlled group" liability – the Sun Capital Case

2828

Recent Developments Regarding the “QPAM”

Exemption• The anti-criminal rule under PTE 84-14 (the “QPAM” Exemption)

• Recent developments under Part I(g) of QPAM

– DOL Advisory Opinion 2013-05A (Nov. 1 2013)

– Deferred prosecution agreement (“DPA”) is not a “conviction”

• Prohibited Transaction Exemptions under Part I(g) of QPAM

– Examples of exemptions in the financial services industry

• UBS – 2013 (plea agreement between DOJ and UBS Securities

Japan)

• Citigroup – 2012 (Citibank Belgium SA sentenced in Belgian court)

• Riggs Bank – 2005 (plea agreement between DOJ and Riggs Bank)

• HSBC – 2002 (Republic New York Corporation entered guilty plea;

Republic New York Corporation acquired by HSBC)

• Bankers Trust Company - 1999

2929

Recent Developments Regarding the “QPAM”

Exemption (cont’d)

• QPAM I(g) Exemption Key Issues and observations

– Profound changes in the regulatory and enforcement environment for

financial service firms

– Impact of loss of QPAM exemption to asset management divisions

for global banks

– Timing issues (when to approach the DOL)

– Confidentiality concerns

– Use of other exemptions (service provider) if QPAM not available

• Not a complete solution

– Potential breach of Investment Management Agreements (where

firms represent that asset manager is and will continue to be a

QPAM)

– Conditions of the QPAM I(g) exemption as agreed by the filer

– Note transactional issues

30

DOL “Fiduciary Investment Advice” Developments

• General ERISA Definition (ERISA section 3(21)(A)): Person or entity that (a) has

discretionary management or control of a plan’s “assets”; (b) has discretionary

authority or control over a plan’s administration; or (c) provides “investment advice”

for a fee.

• Investment Advice -- Existing Regulation (DOL Regulation section 2510.3-21(c)):

Current regulations specify that investment advice is “fiduciary” under ERISA if it

satisfies all of the following 5 requirements (referred to as the “5-part test”). Advice is

fiduciary if:

• There is a “mutual agreement” between the parties giving/receiving the advice (need not be in

writing);

• Advice is a “primary basis” for the investment decisions;

• Advice is on a “regular basis” (not one time);

• Advice is for a “fee” (need not be a distinct non-transactional fee); and

• Advice is “tailored” to the needs of the plan/relates to specific property or securities.

• Investment Advice – DOL Proposed Regulations (Withdrawn September 2011)

– Reason for Proposal: Primary reason that the DOL proposed the change was not in

response to Dodd-Frank or specific Congressional directives, but because of DOL

enforcement issues (e.g., losing cases asserting fiduciary violations under the 5-part test).

– Application: All ERISA-covered accounts as well as IRAs (employer-sponsored and

personal).

31

DOL “Fiduciary Investment Advice” Developments (cont’d)

• Investment Advice – DOL Proposed Regulations (Withdrawn September 2011)

(cont'd)

– Structure: Fiduciary advice included: (i) makes recommendations related to the purchase,

holding or sale of securities or other property; (ii) provides advice, or an appraisal or

fairness opinion, concerning the value of securities or other property; or (iii) provides

advice or recommendations as to the “management” of securities (e.g. recommending

investment managers), for a fee.

• Presumed anyone “acknowledging” fiduciary status (orally or in writing), any investment adviser

(whether or not acting in that capacity) or valuation agent was fiduciary.

• 5-Part Test reworked to “2 ½ prongs” – if the advice or recommendation was provided (a) pursuant

to an agreement, arrangement or understanding, written or otherwise (no longer “mutual”

agreement – can be one-sided and after the fact), (b) will be individualized to the needs of the plan,

a plan fiduciary, or a participant or beneficiary; and (c) can be one-time (not regular).

• Exceptions:

– Fiduciary Disclaimer: Under the Proposed Regulation, a party can avoid ERISA fiduciary

status if the entity can demonstrate that the recipient of the advice knows, “or under the

circumstances reasonably should know,” that (a) the person providing the advice is acting in

its capacity as a purchaser or seller of a security or other property, or as an agent or

appraiser for a purchaser or seller, (b) the person’s interests are adverse to the interest of

the plan, and (c) the person is not undertaking to provide “impartial investment advice” (the

“Counterparty Exception”). Burden of proof is, again, on the financial institution or entity to

prove this (and appears that it can be orally modified, and where interests adverse only

– Valuations: Only where “required” for DOL filing/market based. All others fiduciary.

32

DOL “Fiduciary Investment Advice” Developments (cont’d)

• Investment Advice – DOL Proposed Regulations (Withdrawn September 2011) (cont'd)

– Problems with Proposed Regulation: (i) Inadequate Regulatory Harmonization (Had not

coordinated either with CFTC or SEC efforts under Dodd-Frank); (ii) Inadequate Impact

Analysis on Market Participants (Cost, Access to Products, etc.); (iii) Inadequate Cost-Benefit

Analysis: The DOL consistently indicated that it had inadequate cost estimates on

implementation (no estimate on IRA impact, for example.)

– Concerted public comments/Congressional complaints caused withdrawal in September 2011

• Current Status – New Proposal Expected in 2014/2015:

– DOL continues to “beat the drum” on the need to amend the regulation to protect against

“conflicted advice.” Congress continues to express concern about scope of proposal and

coordination with other regulatory efforts (e.g. SEC “uniform fiduciary” standard for retail

accounts under Dodd-Frank, FINRA issuance of Rollover Guidance).

– IRAs:

• IRAs, from being merely an afterthought in the original proposal, now seem to be one of the DOL’s

primary areas of concern.

• ‘Rollover” practices from 401(k) plans to IRAs focus of DOL. FINRA and GAO efforts – probably

deemed “fiduciary/”

– DOL intends to issue/revise existing exemptions for transactions – no real sense of progress

on that front.

33

Dodd-Frank Issues

• The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)

introduced a number of significant regulatory changes to the financial markets including

creating an entirely new regulatory regime for swaps trading

• Pension plans (including ERISA governed plans) and “plan asset” funds are frequent

end users of swaps and other financial instruments impacted by new Dodd Frank rules

• From an ERISA perspective, a key issue to consider is how requirements mandated by

Dodd Frank may implicate ERISA’s fiduciary and prohibited transaction requirements

• Business Conduct Standards

• Mandatory Swaps Clearing

• SEC Municipal Advisor Rule

34

Dodd-Frank Issues – Business Conduct

Standards

• Establish various requirements for swap dealers including disclosures (e.g., providing

daily marks, scenario analysis, etc.), conflict of interest and suitability obligations along

with additional rules for dealing with “Special Entities” in swaps (CFTC) and security

based swap (SEC) trading

• Special Entity Rules:

“Special Entity” includes ERISA governed plans (and governmental plans)

Prescribe requirements for when swap dealer is acting as (1) an advisor and (2)

mere counterparty to Special Entity

Swap dealer “acts as an advisor” when it recommends a swap tailored to the

particular needs of the Special Entity (subject compliance with various “safe

harbors”)

• CFTC business conduct rules finalized and were effective 2013. Resulted in need to

enter into/amend swap trading documentation generally done through ISDA Dodd-

Frank Protocol 1.0 or bilateral equivalent

35

Dodd-Frank Issues – Business Conduct

Standards (cont’d)

• Key ERISA issue is whether the duties and obligations imposed on swap dealer will

cause dealers to be deemed a fiduciary under ERISA

• DOL letter to CFTC concluding that final rules do not require swap dealers to engage

in activity that would make them fiduciaries under DOL’s current fiduciary definition

(and is committed to ensuring changes to definition do not result in unintended

consequences)

• SEC’s Business Conduct Rules still in proposed form

36

Dodd-Frank Issues – Mandatory Clearing

• Dodd-Frank mandates all swaps (determined by the CFTC) be submitted for clearing

• Phase in for mandatory swaps clearing began 2013 (for certain interest rate and credit

default swaps)

• Clearing Process: Swap Execution Submission to Clearinghouse If accepted:

original swap extinguished and replaced with two swaps between each

counterparty and the clearinghouse (with its clearing member as agent and

guarantor);

clearing member guarantee to clearinghouse of customer obligation; and

payment/margin obligation of each customer to its clearing member (who posts

to clearinghouse)

37

Dodd-Frank Issues – Mandatory Clearing

(cont’d)

• New Clearing Documentation: New swaps clearing related industry documentation

(OTC Addendum to Futures Agreement)

• Close Out Rights: Clearing members typically have various rights/options upon

customer default permitting the clearing member to liquidate the customer’s position

(by means of offsetting trades)

• DOL Advisory Opinion 2013-01A:

Margin held by clearing member or clearinghouse is not a plan asset for purposes

of Title I of ERISA

Clearing member would not be a plan fiduciary solely by reason of liquidating

swaps pursuant to close out rights resulting from negotiations with independent

plan fiduciary

QPAM Exemption (and INHAM Exemption) can provide relief for clearing services,

clearing member’s guarantee/extension of credit and close out transactions

Application to other exemptions?

38

Dodd-Frank Issues – SEC Municipal Advisor

Rule

• Dodd-Frank amended the Securities and Exchange Act of 1934 to require a “municipal

advisor” to register with the SEC and imposes a fiduciary duty to any municipal entity

for which it acts as municipal advisor

• “Municipal Advisor”: A person that provides advice to or on behalf of a municipal

entity or obligated person with respect to municipal financial products or the

issuance of municipal securities; or undertakes a solicitation of a municipal entity or

obligated person

• Municipal Entity: Includes any plan, program, or pool of assets sponsored or

established by any State, political subdivision of a State or municipal corporate

instrumentality (e.g., public pension funds)

• “Advice”: Defined broadly and depends on all the relevant facts and circumstances

(including whether a communication constitutes a tailored recommendation)

39

Dodd-Frank Issues – SEC Municipal Advisor

Rule (cont’d)

• “Municipal Financial Products”: Include “municipal derivatives, guaranteed investment

contracts, and investment strategies”

“Investment strategies” includes “plans or programs for the investment of

proceeds of municipal securities that are not municipal derivatives or guaranteed

investment contracts, and the recommendation of and brokerage of municipal

escrow investments.” The SEC notes that advice with respect to a single trade or

investment falls within “plan or program”

“Municipal Derivatives” mean any swap or securities-based swap to which either

a municipal entity is a counterparty or an obligated person, acting in such capacity,

is a counterparty

“Guaranteed Investment Contract” includes “any investment that has specified

withdrawal or reinvestment provisions and a specifically negotiated or bid interest

rate, and also includes any agreement to supply investments on two or more future

dates, such as a forward supply contract”

40

Dodd-Frank Issues – SEC Municipal Advisor

Rule (cont’d)

• Exclusions and Exemptions:

Serving as an underwriter

Registered investment adviser

Registered commodity trading advisor

Attorneys, Engineers, Accountants

Public officials and employees

Banks (providing specified types of advice)

Responses to RFPs

Swap dealers

Participation by an independent registered municipal advisor

41

“Fee Disclosure” - Overview

• Suite of disclosure requirements added by the

Department of Labor– First set of additional rules – Form 5500, Schedule C

– Rules under Section 408(b)(2) – prohibited transactions

– Rules under Section 404(c) and, eventually, under Section 404(a) –

participant-level disclosure under “404(c)” and other participant-

directed plans

• Market reaction, in general– Adapting to the new and evolving rules

• Plans

• Providers

– Costs

42

Disclosure Requirements Relating to Form 5500

• The Form 5500 disclosure requirements – in general

• To whom do the Form 5500 rules apply?

• Types of funds that give rise to Form 5500 issues:

– Plan assets” funds

– Funds that are not “plan assets” funds by virtue of satisfying the 25% test

• Note that “VCOCs” and “REOCs” generally not covered

– Contrast with the rules under Section 408(b)(2) and Section 404(a)(5), (c)

• What type of disclosure is required?

– Templates, market practice generally, etc.

• What are the legal issues involving compliance?

• What are the reputational, relationship, etc., issues involving compliance?

43

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements

• ERISA section 408(b)(2) – Plan Level Fee Disclosure

– Effective Date: July 1, 2012 (for existing clients); prior to client inception/fee payments

going forward.

– What Do We Have To Disclose and To Whom?: Must disclose to plan fiduciary engaging you

both “direct” compensation (fees paid directly by the plan to the service provider) and “indirect”

compensation (compensation earned from third parties in connection with plan transactions.

Examples of direct compensation can include agency brokerage commissions or investment

management fees paid by a plan client; indirect compensation can include payment for order flow,

float, or “soft dollar” amounts received by an investment manager in connection with plan

transactions. Not all revenue derived from plan transactions, however, needs to be disclosed

since it is not a “fee” for “service.” (e.g., principal transactions)

– Specific Points

• “Compensation” Definition: The Final Regulation clarifies that compensation can be disclosed by dollar

amounts, formula, percentages, or, provided that the compensation cannot reasonably be expressed in such

terms, through other "reasonable methods." There is now the ability to make a "reasonable and good faith

estimate" if the service provider cannot otherwise describe the cost, so long as the methods/assumptions for

the estimate are disclosed.

• “Ranges” of Compensation Now Allowed, Within Limits: In connection with the ability to make a reasonable

and good faith estimate, the DOL now specifically permits, in the preamble, the use of "ranges," stating that

"disclosure of expected compensation in the form of known ranges can be a “reasonable” method for

purposes of the final rule." The ability to use ranges, however, is not unlimited: First, ranges must be

"reasonable" under the circumstances. Second, the DOL clearly indicated that "more specific, rather than

less specific, compensation information is preferred whenever it can be furnished without undue burden."

44

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

– Specific 408(b)(2) Points (cont'd)

• Descriptions of "Indirect Compensation" Payments: In disclosing "indirect compensation" (payments

received from parties other than the plan), service provider must disclose (i) the source of the

compensation (i.e., the payer), (ii) a description of the arrangement between the payer and service

provider, and (iii) the services to which such compensation relates.

• "Designated Investment Alternatives" -- Additional Disclosure By Platform Providers: DOL tried to align

disclosure to plan sponsors to the participant 401(k) fee disclosures for "designated investment

alternatives" (fixed menu of investment options offered by record keepers), and required that additional

disclosure be provided.

• Initial Disclosure Timing Still Prior to Services/Fees: The Final Regulation still requires the initial

disclosure to be provided "reasonably in advance" of the services provided and compensation paid

without defining how far in advance it is required.

• Updates on Disclosure Within 60 Days of Change Still Generally Required: The Final Regulation still

provides that updates of non-investment fees must be disclosed within 60 days of such change.

However, the DOL did allow for certain changes to fees (a) in an ERISA-regulated plan asset fund or (b)

in connection with 401(k) recordkeeping platforms to be disclosed to clients annually, in lieu of the rolling

60-day requirement.

• Electronic Disclosure: The DOL confirmed that disclosure through electronic media (websites, e-mail) is

permissible provided the plan fiduciary has access to such media and is notified how to access the

information.

• Definition of "Covered Plans" Clarified: The DOL confirmed that only ERISA-covered plans are subject

to the disclosure requirements. This effectively excludes individual IRAs, municipal plans and

governmental plans.

45

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• ERISA Section 404(a)(5) “Participant Fee” Disclosure

– Summary: The DOL is now requiring plan administrators to provide in a clear format

information about plan and investment related fees and expenses, highlighting the fees

that the participant may indirectly to the investment providers) in operating the account.

– Covered Plans: “Participant-directed individual account” plans – Code section 401(k),

profit-sharing, “thrift” or similar plans; NOT (a) defined benefit retirement plans; (b)

defined contribution plans that do not allow for participant direction (c) employer-

sponsored, IRA-based retirement plans (e.g., SEPs, SIMPLE); (d) “Keogh” plans (e.g.,

owner or owner and spouse only plans) and (e) IRA accounts generally.

– Who Is Responsible for Providing the Disclosure?: The Plan administrator (as defined

in ERISA section 3(16)) has the responsibility under the regulations for providing the

disclosure, not service providers. However:

• The Plan administrator is not precluded from hiring vendors/service providers to make the

disclosures on its behalf or seeking/requiring that their service providers assist them in

providing such disclosures.

• The Plan administrator is not liable for the completeness and accuracy of information disclosed

when the Plan administrator reasonably and in good faith relies on information received from or

provided by a plan service provider or the issuer of a designated investment alternative ("DIA")

(e.g., a mutual fund).

46

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• ERISA Section 404(a)(5) “Participant Fee” Disclosure (cont'd)

– What Disclosure is Required? 4 general categories of plan related information that needs to be

disclosed to participants and beneficiaries: (a) “general operational and identification” information;

(b) “administrative” expenses; (c) “individual” expenses; and (d) investment-related information:

– "General operational and identification information": Examples include

• Identification of any DIAs offered under the plan with detailed fee disclosure (DOL Chart);

• Explanation of how participants and beneficiaries give investment instructions;

• Explanations of any limitations imposed by the plan to direct investments or transfer to/from DIAs

(e.g., plan blackout periods)

• Descriptions of any self-directed brokerage accounts or similar features where participants can

make investments in other than DIAs within their plan accounts.

– "Administrative" Expenses: Any non-investment fees/expenses for general plan administrative

services (e.g., legal, accounting, recordkeeping) which may be charged against individual

accounts, and the basis on which the charges are allocated (i.e., pro rata, per capita). Actual

amounts must be disclosed quarterly.

– “Individual” Expenses: Includes the disclosure of any expenses specifically charged against a

particular participant's or beneficiary's account (and can include some investment related

expenses). Examples include (a) qualified domestic relations order (“QDRO”) fees; (b) loan

processing fees; (c) front or back-end loads or sales charges; (d) redemption fees; and (e)

investment management fees. Actual charges also must be disclosed quarterly.

47

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• Some Current Challenges:

– Fee Updates: Updating of fee disclosures for both plan sponsors and participants under

408(b)(2)/404a-5

– DOL Enforcement : Activity in 408(b)(2) context focusing on what plan sponsors have

actually done with the disclosure (also routinely request copies of the disclosure for any

inquiry).

– DIAs and Self-Directed Brokerage Accounts: DOL has recently “flipped” on whether

plans need to have DIAs/whether brokerage accounts would require DIA-level

disclosure. needs to be disclosed here in Field Assistance Bulletin – 2012-02 v.

2012-02R

• 2012-02 – Q&A 30 (May 7, 2012): Created new “requirement” to offer DIA-level disclosure and

fiduciary oversight in brokerage accounts if non-DIA investment funds invested in such accounts

were selected by “significant” numbers of plan participants

– Implied not offering DIAs could be seen as “fiduciary breach” by plan sponsor.

– For sponsors with plans without DIAs, and offering more than 25 alternatives, the plan

sponsor had an obligation to identify at least 3 DIAs meeting ERISA section 404(c)’s

requirements, and would be required to provide the enhanced disclosure for those funds

for any investment option with at least 5 participants or, if a plan had more than 500

participants, those in which 1% or more of the participants were invested.

48

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• Some Current Challenges: (cont’d)

• 2012-02R – Revised Q&A 30/New Q&A 39 (Current):

– Were self-directed brokerage accounts DIAs? No

– Are plan sponsors required to provide a minimum number of DIAs? No

– Withdrew the original Q&A 30 imposing the requirements with respect to “significant”

numbers of investors or DIAs being created where brokerage accounts permitted

investments in 25 or more different products.

49

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• Proposal to require a summary under Section 408(b)(2)

– In March 2014, the DOL proposed an amendment to the existing

Section 408(b)(2) final regulations

• Under the proposal, a covered service provider would be required to

furnish a guide specifically identifying the document and page or other

sufficiently specific locator, such as a section, that would enable the

fiduciary to quickly and easily find the required information

• A guide would only be required if the service provider used different

documents or separate sources to satisfy disclosure obligations or if the

page length of the disclosure was excessive

– The DOL is seeking comments concerning the page length requirement

– Grandfathering or transition relief for existing disclosure is an open

question

50

ERISA Section 408(b)(2) and “404a-5” “Fee

Disclosure” Requirements (cont’d)

• Proposal to require a summary under Section 408(b)(2) (cont’d)

– If a guide is required, the service provider must direct the fiduciary to the place in

the disclosure documents where the fiduciary can find the following information:

• Description of the services provided

• Statement concerning services to be provided as a fiduciary and/or as a registered

investment advisor

• Description of all direct and indirect compensation, compensation paid to related parties,

compensation for contract termination, compensation for recordkeeping services; and

• Required investment disclosures for fiduciary services and recordkeeping and brokerage

services

– Guide to be provided in a stand-alone document

– Timing for disclosure of guide, from periodic - “reasonably in advance of the date a

contract is entered into, extended or renewed” - to an annual requirement.

– Proposal requires the guide to include the identity and contact information of a

person or office the fiduciary could contact concerning the disclosures

– Electronic disclosure

51