The Department of Labor has released a final regulation (“Final Regulation”) under Section 404(a) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), requiring fiduciaries of participant-directed individual account plans to disclose certain plan and investment-related information, including fee and expense information, to participants and beneficiaries. The DOL states that the required disclosures will allow workers to make informed investment decisions, and comparison shop among a plan’s investment options. The DOL has also issued a proposed regulation on special disclosure rules for target date and similar funds that are plan investment options.
Background
The Final Regulation is the third and final step in the DOL’s approach to increasing transparency of fees and expenses incurred by retirement plans and participants. The first step was the Form 5500 Schedule C disclosure requirements, which became effective in 2009. The second step was the enhanced disclosure requirements by service providers to plan sponsors, which were published as an interim final regulation on July 16, 2010. The DOL has recently extended the effective date of the service provider disclosure interim final regulation from July 16, 2011 until January 1, 2012.
Overview
The regulation provides that the investment of plan assets is a fiduciary act governed by the general fiduciary standards in ERISA sections 404(a)(1)(A) and (B), which require plan fiduciaries to act prudently and solely in the interest of participants and beneficiaries. To meet this standard, the Final Regulation requires fiduciaries of participant-directed individual account plans to provide participants with information about the investment options available under their plan, including fee and expense information, to enable them to make informed decisions about managing the investment of their accounts.
The preamble to the Final Regulation notes that, to some extent, disclosure of similar information is already required by plans that have elected to comply with the requirements of the DOL’s regulation under ERISA section 404(c). However, compliance with Section 404(c)’s disclosure requirements is voluntary, and does not extend to participants and beneficiaries in participant-directed plans that don’t intend to comply with Section 404(c). The DOL believes “that all participants and beneficiaries with the right to direct the investment of assets held in their individual plan accounts should have access to basic plan and investment information.” Accordingly, all participant-directed individual account plans are required to comply with the Final Regulation. This applies whether or not a participant-directed individual account plan seeks Section 404(c) status.
At the same time the DOL issued the Final Regulation under ERISA section 404(a), it also issued an amendment to the regulation under Section 404(c) making changes that incorporate the rules of the Final Regulation into the requirements for compliance with Section 404(c).
Duty of Prudence in Selection and Monitoring of Investment Options Is Made Explicit
The DOL expressly states in the Final Regulation that it does not “relieve a fiduciary from its duty to prudently select and monitor providers of services to the plan or designated investment alternatives offered under the plan.” This change gives the force of a DOL regulation to a long held view of the DOL that was previously expressed in a footnote to the preamble of the Section 404(c) regulation, and has been challenged in some recent court cases.
Applicability Date
The Final Regulation became effective on December 20, 2010. More important, however, is the applicability date, which is the required date of compliance. The applicability date is the first day of the plan year beginning on or after November 1, 2011. For calendar year plans, compliance will be required on January 1, 2012.
Covered Plans
The Final Regulation only applies to participant-directed individual account plans. Participant-directed individual account plans are defined in ERISA section 3(34) as plans that provide for:
- an individual account for each participant; and
- benefits based solely upon the amount contributed to the participant’s account, and any income, expenses, gains, losses, and forfeitures allocated to the account.
Participant-directed individual account plans include 401(k), 403(b) and other defined contribution plans that allow participants to make investment decisions. The Final Regulation applies to all participant-directed individual account plans regardless of the size of the plan. The Final Regulation does not cover individual retirement accounts or individual retirement annuities described in Internal Revenue Code section 408(k) (simplified employee pensions) or Section 408(p) (simple retirement accounts).
The focus of the Final Regulation is on disclosure of information about each “designated investment alternative” (“DIA”) of a plan. A DIA is defined in the Final Regulation as a plan investment into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their retirement account. A DIA does not include brokerage windows, self-directed brokerage accounts or similar arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan. The Final Regulation does require, however, the disclosure of certain basic information about brokerage windows if they are available under a plan.
Responsibility of Plan Administrator
The Final Regulation identifies the plan administrator as the fiduciary obligated to comply with the disclosure requirements. The Final Regulation provides some relief for plan administrators, in that it provides that they will not be liable for the completeness and accuracy of information in the disclosures 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 DIA.
Generally, the plan administrator is required to make two types of disclosures:
- plan-related information; and
- investment-related information.
The plan administrator is to make these disclosures in a manner calculated to be understood by the average plan participant. The disclosures must be provided to all employees eligible to participate in the plan, without regard to whether the employee has actually enrolled in the plan, and to beneficiaries who, under the terms of the plan, have the right to direct the investment of their account.
Disclosure of Plan-Related Information
The plan administrator must provide to each participant or beneficiary three categories of plan-related information:
- General plan information
- Administrative expenses
- Individual expenses
General Plan Information
The general plan disclosure consists of information about the structure and mechanics of the plan. This disclosure must include a description of:
- How participants and beneficiaries may give investment instructions
- Any limitations on such instructions, including any restrictions on transfer to or from a DIA
- Any plan provisions relating to the exercise of voting, tender and similar rights appurtenant to an investment in a DIA
- The DIAs offered under the plan
- Any designated investment managers
- Any brokerage windows, self-directed brokerage accounts, or similar arrangements that enable the selection of investments beyond those designated by the plan
Administrative Expenses
The plan administrator must disclose an explanation of any fees and expenses for general plan administrative services, such as legal, accounting and recordkeeping, that may be charged to or deducted from all individual accounts and are not reflected in the total annual operating expenses of any DIA. The plan administrator must also describe the basis on which such charges will be allocated (pro rata or per capita) to each individual account.
Individual Expenses
The plan administrator must provide an explanation of any fees and expenses that may be charged on an individual, rather than on a plan-wide, basis and which are not reflected in the total annual operating expenses of any DIA. Examples include fees for processing plan loans or qualified domestic relations orders, fees for investment advice, fees for brokerage windows, commissions, front-end or back-end loads or sales charges, redemption fees, transfer fees, and optional rider charges in annuity contracts.
Timing and Method of Disclosures
The disclosures of all three of the above information categories must be made on or before the date a participant or beneficiary can first direct his or her investments, and at least annually thereafter. The Final Regulation does provide a transitional rule that allows the initial disclosure to be furnished to existing participants and beneficiaries no later than 60 days after the applicability date.
Any changes in required plan-related information must be communicated at least 30 days, but not more than 90 days, before the effective date of the change. If the plan administrator is unable to provide this advance notice of a change due to unforeseeable events or uncontrollable circumstances, then notice of the change must be furnished as soon as reasonably practicable.
The requirement to provide disclosures on or prior to the date when the participant can first direct investments may be satisfied by furnishing the most recent annual disclosure, along with any updates issued pursuant to the requirement to disclose any changes.
Quarterly Statement of Actual Charges
In addition to furnishing the plan-related information up front and annually, the plan administrator must provide participants and beneficiaries, at least quarterly, a statement that includes the following information:
- The dollar amount of the plan-related fees and expenses (whether “administrative” or “individual”) actually charged to the participant’s account during the preceding quarter, whether by liquidating shares or deducting dollars
- A description of the services to which the charges relate
- If applicable, an explanation that some of the plan’s administrative expenses for the preceding quarter were paid from the total annual operating expenses of one or more of the plan’s DIAs, such as through revenue sharing arrangements, Rule 12b–1 fees, or sub-transfer agent fees (This information does not need to be expressed as a dollar amount.)
Disclosure of Investment-Related Information
The plan administrator must provide to each participant or beneficiary several categories of information about each DIA under the plan:
- Identifying information
- Performance data
- Benchmark information
- Fee and expense information
- Internet Web site address
- A glossary.
Identifying Information
The disclosure must include:
- the name of each DIA; and
- the type or category of the investment, such as money market fund, balanced fund, large-cap stock fund, employer stock fund or employer securities.
Performance Data
The plan administrator must provide specific information about the historical performance of each DIA. For a DIA that does not have a fixed rate of return (also termed under the Final Regulation as a “variable return”), the plan administrator must furnish the average annual total return for one-year, five-year and ten-year periods (or for the life of the investment, if shorter) ending on the date of the most recently completed calendar year. The plan administrator must also include a statement indicating that an investment’s past performance is not necessarily an indication of how the investment will perform in the future.
For a DIA that has a fixed or stated rate of return, the plan administrator must disclose both the annual rate of return and the term of the investment. If the issuer reserves the right to adjust the fixed or stated return prospectively during the investment term, the plan administrator must provide the current rate of return, the minimum rate guaranteed under the contract (if any), and a statement advising participants and beneficiaries that the issuer may adjust the rate of return prospectively and how to obtain the most recent rate of return (e.g., telephone or Web site).
Benchmark Information
For DIAs that do not have fixed rates of return, the plan administrator must provide the name and returns of an appropriate broad-based securities market index over the one-year, five-year and ten-year periods that are comparable to the performance data periods described above. The benchmark index must not be administered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter, unless the index is widely recognized and used.
The preamble to the Final Regulation states that for DIAs that have a mix of equity and fixed income components, such as balanced funds or target date funds, the plan administrator may blend and present the returns of more than one appropriate broad-based index. It is still required, however, that the returns of the single required benchmark index be presented.
Investment options with fixed rates of return are not subject to the benchmarking requirement.
Fee and Expense Information
For DIAs that do not have fixed rates of return, the plan administrator must disclose the following:
- The amount and a description of any shareholder-type fees (fees charged directly against a participant’s or beneficiary’s investment, such as commissions, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees, which are not included in the total annual operating expenses of any DIA)
- Any restrictions or limitations on a participant’s ability to purchase, transfer, or withdraw the investment
- The total annual operating expenses of the investment expressed both as a percentage (e.g., expense ratio) and as a dollar amount for a one-year period for each $1,000 invested
- A statement indicating that fees and expenses are only one of several factors that participants and beneficiaries should consider when making investment decisions
- A statement that the cumulative effect of fees and expenses can substantially reduce the growth of a participant’s or beneficiary’s retirement account and that participants can visit the DOL’s Employee Benefit Security Administration Web site for an example demonstrating the long-term effect of fees and expenses
For DIAs that have fixed rates of return, the plan administrator must disclose the following:
- The amount and a description of any shareholder-type fees
- Any restrictions or limitations on a participant’s ability to purchase, transfer, or withdraw the investment
Internet Web Site Address
The plan administrator must also provide an Internet Web site address that provides participants and beneficiaries access to additional information about a DIA. Such information must include the following:
- The name of the DIA’s issuer
- The DIA’s objectives or goals
- The DIA’s principal strategies (including a description of the types of assets held by the investment) and principal risks
- The DIA’s portfolio turnover rate
- The DIA’s performance data (as described above), updated at least quarterly
- The DIA’s fee and expense information (as described above)
Glossary
Lastly, the plan administrator must include a general glossary of terms to assist participants and beneficiaries in understanding the plan’s DIAs, or an Internet Web site address that is sufficiently specific to provide access to such a glossary. The DOL has indicated that it may develop or identify general investment glossaries that will meet the rule.
Timing and Method of Disclosures
As with plan-related information, disclosures of investment-related information must be made on or before the date a participant or beneficiary can first direct his or her investments, and at least annually thereafter. The Final Regulation’s transitional rule allows the initial disclosure
to be furnished to existing participants and beneficiaries no later than 60 days after the applicability date. The requirement to provide disclosures on or prior to date of the initial investment may be satisfied by furnishing the most recent annual disclosure.
Comparative Format
The plan administrator must furnish the investment-related information in a chart or similar format that is designed to facilitate a comparison of the information for each DIA available under the plan. The chart must prominently display the date and include the following:
- The name, address, and telephone number of the plan administrator (or its designee) to contact for requesting additional information
- A statement that additional investment-related information (including more current performance information) is available at the listed Web site address
- An explanation of how to request and obtain, free of charge, paper copies of the information provided on the Web site
The plan administrator may include additional information appropriate for such comparisons, provided that this information is not inaccurate or misleading.
The Final Regulation includes a “Model Comparative Chart” in the Appendix. The Model Comparative Chart includes four model tables — a variable return investments table, a fixed return investments table, a fee and expense table and an annuity options table. The model chart can be accessed online.
The Final Regulation provides that when a plan administrator uses and accurately completes the model, taking into account each DIA offered under the plan, the plan administrator will be deemed to have satisfied the comparative format requirement.
Disclosures of Additional Investment-Related Information
The Final Regulation requires the plan administrator to provide certain information subsequent to investment, and certain information upon request.
Information to be Provided Subsequent to Investment
Subsequent to an investment in a DIA, the plan administrator must furnish any materials the plan receives regarding the exercise of voting, tender and similar rights of a DIA, to the extent that such rights are passed through to the participant or beneficiary.
Information to be Provided upon Request
The plan administrator must furnish to each participant or beneficiary, upon request, the following information related to DIAs:
- Copies of prospectuses
- Copies of any financial statements or reports, including statements of additional information
- A statement of the value of a share or unit of each DIA, as well as the date of valuation
- A list of the assets comprising the portfolio of each DIA, but only to the extent that the assets are considered plan assets under DOL regulations, and the value of each such asset (or the proportion of the investment which it comprises)
Special Rules
The Final Regulation adds “special rules” for DIAs that consist of:
- qualifying employer securities;
- annuity options; or
- fixed-return investments.
Qualifying Employer Securities
In the case of DIAs designed to invest in, or primarily in, qualifying employer securities, the plan administrator must provide an explanation of the importance of a well-balanced and diversified portfolio.
The Final Regulation also exempts qualifying employer securities from certain requirements. For instance, the requirements to provide fee and expense information and total annual operating expenses do not apply to such DIAs, unless the DIA is a fund in which participants or beneficiaries acquire units of participation (i.e., a unitized fund), rather than actual shares.
Annuity Options
For a DIA that consists of a contract, fund or product that affords participants or beneficiaries the option to allocate contributions toward the current purchase of a stream of retirement income payments guaranteed by an insurance company, the plan administrator must provide the following information (in lieu of the investment-related information discussed above):
- The name of the contract, fund or product
- The option’s objectives or goals (e.g., to provide a stream of fixed retirement income payments for life)
- The benefits and factors that determine the price (e.g., age, interest rates or form of distribution) of the guaranteed income payments
- Any limitations on the ability to withdraw or transfer amounts allocated to the option, and any applicable fees or charges
- Any fees that will reduce the value of amounts allocated by participants or beneficiaries to the option (e.g., surrender charges, market value adjustments and administrative fees)
- A statement that insurance company guarantees are subject to the company’s long-term financial strength and claims-paying ability
- An Internet Web site address that contains additional information
Fixed-Return Investments
The Final Regulation also includes special Internet Web site rules for a DIA in which the return is fixed for the investment term. In lieu of complying with the Internet Web site requirements described above, the plan administrator must provide an Internet Web site address that includes the following information:
- The name of the investment’s issuer
- The objectives or goals (e.g., to provide stability of principal and guarantee a minimum rate of interest)
- Performance data updated on at least a quarterly basis
- Fee and expense information
Target Date or Similar Funds
The DOL reserved a subsection in the Final Regulation to provide special disclosure rules for target date, life-cycle or similar funds, with detailed guidance to be issued separately.
On November 30, 2010, the DOL issued that guidance as a proposed regulation that would amend the Final Regulation with respect to target date funds. The proposed regulation requires plan administrators to disclose certain information about the design and operation of target date funds, including the following:
- An explanation of the investment’s asset allocation
- An explanation of how that allocation will change over time (including a chart, table or other graphical illustration)
- The point in time when the investment will reach its most conservative asset allocation
For a target date fund that refers to a particular date (e.g., a target date, like the “Retirement 2050 Fund”), the disclosure must include an explanation of the age group for whom the target date fund is designed, the relevance of the date, and any assumptions about a participant’s or beneficiary’s contribution and withdrawal intentions on or after such date.
The proposed regulation also requires a statement that a participant or beneficiary may lose money by investing in a target date fund, including losses near and following retirement, and that there is no guarantee that the target date fund will provide adequate retirement income.
The proposed regulation requires these disclosures whether or not participants and beneficiaries are defaulted into a target date fund.
Electronic Notification
The DOL also reserved the section of the Final Regulation on the manner in which the disclosures must be furnished. The preamble to the Final Regulation states that the DOL is “further exploring whether, and possibly how, to expand or modify the standards applicable to the electronic distribution of required plan disclosures.” The DOL anticipates that this issue will be resolved in advance of the Final Regulation’s applicability date.
If you would like to discuss the disclosure requirements further, please feel free to contact us.
