This is the fifth in a series of Technical Updates relating to the DOL’s July 2010 service provider fee disclosure regulations. Part IV in this series began the discussion of the initial disclosure requirements under the regulations. This Technical Update discusses compensation, and the disclosures which a covered service provider (CSP) must make to a responsible plan fiduciary of a covered plan with regard to compensation.
Q-1: What general principles apply to “compensation" under the service provider fee disclosure regulations?
“Compensation" is the general term the DOL uses to include compensation and/or fees. Compensation includes anything of monetary value, such as gifts, awards and trips. However, if the aggregate of non-monetary compensation is valued at $250 or less during the term of the contract then “compensation" does not include the non-monetary compensation.
Compensation includes all compensation the CSP or an affiliate or subcontractor reasonably expects to receive during the term of the contract. The regulations count all compensation related to the services which the CSP, an affiliate, or a subcontractor provide during the term of the contract. However, compensation does not include amounts received in connection with services, other than fiduciary services, rendered to an investment product in which the plan invests and which holds plan assets (such as a CCT or a PSA).
Example 1: Plan X enters into an arrangement with recordkeeper R to provide recordkeeping, brokerage, and trustee services with regard to designated investment alternatives in connection with an investment platform. Affiliates of R will provide the trustee and brokerage services. The term of the contract is 2 years. Compensation includes all amounts R or its affiliates reasonably expect to receive during those 2 years for providing services to plan X.
The regulations distinguish between four categories of compensation: (1) direct compensation, (2) indirect compensation, (3) related party compensation, and (4) contract termination compensation. This Technical Update will define each of these four types and will discuss the required disclosures.
Q-2: What is direct compensation?
Direct compensation is compensation the CSP, an affiliate, or a subcontractor receives directly from the covered plan. It does not include amounts received from an investment product, such as a CCT, which holds plan assets. See Q&A-6 for a discussion of payments from the plan sponsor.
Q-3: What are the required direct compensation disclosures under the regulations?
A CSP must describe all direct compensation. The description can be in the aggregate or itemized by service. (Note, however, that platform recordkeepers and brokers must itemize compensation related to those services. The next Technical Update will address this further.) Presumably the responsible plan fiduciary will determine the amount of detail the CSP must disclose in order to enable the fiduciary to compare services and costs and the reasonableness of the compensation.
Q-4: What is indirect compensation?
Indirect compensation means any compensation received from any source other than the plan, the plan sponsor, the CSP, an affiliate, or a subcontractor (if the subcontractor receives compensation in connection with the subcontractor’s services under the contract). Notice that the definition disregards compensation paid between or among the CSP, its affiliates, and its subcontractors. However, some such payments may be related party compensation. See Q&A-7, below.
Example 2: Assume pursuant to a contract between the CSP S and the plan, the plan will pay $1,000 per month to S’s subcontractor T for specified administration services, and T will pay $300 per month to S. S alsowill receive a payment of 0.2% of plan assets from a mutual fund house M. S, as the CSP, would disclose the $1,000 (to T) as a direct compensation and the 0.2% of plan assets (to S) as indirect compensation. The $300 payment from T to S is neither direct nor indirect compensation.
Q-5: What are the required indirect compensation disclosures under the regulations?
A CSP must describe all indirect compensation, identify the services for which indirect compensation is received, and identify the party paying the indirect compensation.
Example 2a: Continuing Example 2, S would disclose the fact that M is paying S 0.2% of plan assets as indirect compensation, and would identify the services S is performing for which M is paying it.
Q-6: Are payments directly from the plan sponsor either direct or indirect compensation?
No. They are neither direct nor indirect compensation. While a CSP certainly could provide written disclosures related to such payments, the regulations do not require it.
Example 2b: Assume the same facts as Example 2, except that the $1,000/month payments come from the plan sponsor rather than from the plan. S does not need to make any disclosures regarding those payments.
Q-7: What is related party compensation?
Related party compensation is compensation paid among the CSP, its affiliate, or its subcontractor if the compensation: (1) 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 (2) is charged directly against the covered plan’s investment and reflected in the net value of the investment (e.g., 12b-1 fees).
Q-8: What are the required disclosures for compensation paid among related parties?
In general, when a CSP is a “bundled" service provider and allocates compensation among related parties (i.e., the CSP, its affiliates and its subcontractors), the CSP need not disclose any allocation of payments among the related parties. Such payments are not indirect compensation. However, the CSP must disclose related party compensation. The disclosures must include identification of the service for which the CSP will receive the compensation and the payers and recipients of the compensation (including the status of the payer as affiliate or subcontractor).
Example 3: S agrees to provide trustee and administrative services for plan P for $3,000 per month, plus $75 for each distribution and $100 for each loan application processed. S engages T, a subcontractor, to process distributions and perform participant communications. S will pay T $65 per distribution plus $500 per month. (S will retain $10 of each distribution fee). S must disclose all of its services and all of the agreed charges. S need not describe the $500 per month it will pay to T, because that is not indirect or related party compensation. S must disclose the $65 per distribution transaction fee it will pay to T because that is related party compensation. The disclosure must describe the services involved in the $65 charge (distribution processing), identify S as the payer and T as the recipient, and specify that T is S’s subcontractor.
Q-9: Might the reporting of compensation among related parties result in double reporting of the same compensation?
Yes. The CSP must report compensation among related parties notwithstanding disclosure of these amounts as direct or indirect compensation or in connection with investment disclosures (to be discussed in the next Technical update). The DOL intends these related party disclosures to enable plan fiduciaries to better assess the reasonableness of the compensation paid for services and to assess actual or potential conflicts of interest that may impact the quality of services to the plan. The related party disclosure requirements replaced the much broader and potentially much more burdensome disclosure requirements under the proposed regulations regarding potential conflicts of interest.
Example 3a: In Example 3, S must disclose the $75 direct compensation to S for the distribution fee and the $65 related party payment from S to T.
Q-10: Do the related party disclosure rules require a CSP to report compensation the CSP pays to an employee?
No. The related party rules do not apply to compensation an employee receives from his/her employer on account of work performed by the employee. Additionally, such a payment would neither be direct nor indirect compensation.
Q-11: What is contract termination compensation?
Contract termination compensation means any compensation received in connection with termination of the contract or arrangement between the CSP and the plan. Note that newly renumbered DOL Reg. §2550.408b-2(c)(3) forbids payment of penalties to a service provide or lessor on contract termination. However, the contract can provide for reimbursement of actual expenses on early termination of a contract, although the contract must require the service provider or lessor to mitigate damages.
Q-12: What are the required disclosures relating to contract termination?
A CSP must disclose contract termination compensation and how the CSP will calculate and refund any prepaid amounts upon contract termination. Of course, a typical “pay-as-you-go" contract for services does not involve any prepayment, nor any penalty upon termination of the contract.
Q-13: Must a CSP describe compensation under the contract in terms of a dollar amount?
No. Although the DOL “prefers" disclosure in terms of a monetary amount, formula, percentage of plan assets or per capita charge, the regulations permit alternatives. The regulations provide that the CSP may express a description or an estimate of compensation as a monetary amount (e.g., $1,500 per month), a per capita charge for each participant, a formula (e.g., $X plus $Y per participant), or a percentage of plan assets (e.g., 10 basis points). If the CSP cannot reasonably express the compensation in such terms, the CSP may use any other reasonable method. However, any description or estimate must contain sufficient information to permit the responsible plan fiduciary to evaluate of the reasonableness of the compensation.
Q-14: How does compensation relate to the determination of whether a business is a CSP or a subcontractor?
Compensation is important in several ways in determining CSP status:
- A business is not a CSP if it does not reasonably expect that the service provider, its affiliates, and its subcontractors will receive at least $1,000 in total direct compensation and indirect compensation during the term of the contract.
- An “other" service provider (which is not a fiduciary, registered investment advisor, or a platform recordkeeper or broker), such as a TPA, investment consultant, auditor, or appraiser, is not a CSP unless the service provider, its affiliate, or its subcontractor reasonably expects to receive some indirect compensation or related party compensation.
- A business is not a subcontractor unless the business reasonably expects to receive at least $1,000 of compensation for covered services.
ERISA Workshop 2010 to Focus on New Service Provider Regulations
The focus of this year’s ERISA Workshop is indeed on ERISA, as the workshop will look in-depth at the new regulations mandating disclosure from service providers to plan administrators. We’ll show you how to know if you are subject to the new rules and what you must do to comply (and what happens if you don’t). We’ll also analyze the rules in terms of modern business practices and revenue models. Of course, this seminar will also keep you up-to-date on all other recent changes in tax rules, and important developments affecting qualified plans. With the new service provider regulations, this seminar is a “must attend" for all those servicing retirement plans. Registration is now open on our Web site.
Don’t miss our upcoming Web seminars on these timely topics:
A 401(k) Practitioner’s Guide to 457(b) Plans – Tuesday, September 14, 2010, 2:00 p.m. ET
Correcting Nonamenders: Restatement and Other Amendment Failures – An encore presentation, Tuesday, September 21, 2:00 p.m. ET
EFAST2: Amendments, Late Filing, and Short Plan Years – An encore presentation, Thursday, October 7, 2:00 p.m. ET
Visit our Web site to learn more and to register.
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