Amid a background of 401(k) fee litigation brought by plan participants, and Congressional fee disclosure proposals, the Employee Benefits Security Administration of the Department of Labor (“DOL”) has released proposed regulations under ERISA section 404(a) (“proposed regulations”) that would require enhanced disclosure by plan fiduciaries of information concerning investment alternatives and fees to participants in participant directed individual account plans. The DOL has stated that fee disclosure is one of its highest priorities, and the new proposed regulations are the third regulatory step taken by the DOL to improve the reporting and disclosure of investment fees and related information. The DOL has previously released revisions to Schedule C of the Form 5500, increasing the reporting of direct and indirect fee information (see our July 2008 issue), and a proposed regulation under ERISA section 408(b)(2) that would require increased disclosure of fees and other compensation by plan service providers to plan fiduciaries (see our February 2008 issue).

Purpose of the Participant Disclosure Proposal

The DOL states in the proposed regulation that the fiduciary duties of prudence and loyalty under ERISA section 404(a) require the fiduciaries of participant directed individual account plans to ensure that plan participants and beneficiaries are aware of their rights and responsibilities concerning the investment of the assets in their plan accounts, and that the participants are provided with sufficient information about the plan and the designated investment alternatives to make informed decisions for the management of their accounts. This information, according to the proposed regulation, needs to be provided on a regular and periodic basis and must include both plan fees and expenses and fees and expenses relating to each of the designated investment alternatives.

The proposed regulation has been issued under the general fiduciary rules of ERISA section 404(a) and the new requirements, when adopted in final, will apply to all participant directed individual account plans and not just to those plans that intend to receive fiduciary protection through compliance with ERISA section 404(c). The DOL, however, also released a proposed amendment to the regulation under Section 404(c) that conforms the Section 404(c) regulation to the disclosure requirements of the proposed regulation under section 404(a). The DOL’s proposal specifically provides that it does not relieve plan fiduciaries from the duty to prudently select and monitor plan service providers or designated investment alternatives under the plan, and the proposed amendment to the Section 404(c) regulation includes this provision as well.

Proposed Disclosure Requirements

Under the proposed regulation, the required disclosures must be made to each participant or beneficiary that, pursuant to the terms of the plan, has the right to direct the investment of assets held in, or contributed to, his or her individual account. The disclosures must meet one set of requirements for plan related information, including administrative expenses, and a second set for investment related information. For purposes of investment related information the proposed regulation focuses on “designated investment alternatives,” which are defined as any investment alternatives designated by the plan into which participants and beneficiaries may direct the investment of assets of their individual accounts. The DOL clarifies that brokerage windows, self-directed brokerage accounts, or similar arrangements permitting participants to select investments beyond those designated by the plan, are not designated investment alternatives and the disclosure requirements under the proposed regulation do not apply to them.

The proposed regulation provides that a plan fiduciary, or a person designated by the fiduciary to act on its behalf, is to make the disclosures and that the disclosures are to be based on the latest information available to the plan. The required disclosures may be made by electronic means in accordance with the requirements of the DOL regulations on methods of disclosure. The information is to be written in a manner calculated to be understood by the average plan participant and, except with respect to administrative and individual expenses actually charged to participant accounts, fees and expenses may be expressed in terms of a monetary amount, formula, percentage of assets, or per capita charge. Under the proposed regulation, administrative and individual expenses actually charged to participant accounts may be disclosed to participants on the quarterly participant benefit statement that is required for self-directed individual account plans.

Plan Related Disclosures

Plan related disclosures required under the proposed regulation include:

• Information on general plan operation, to be provided on or before the date of plan eligibility and annually thereafter, that:
  • Explains the circumstances under which participants may give investment instructions
  • Explains any plan specified limitations on investment instructions, including instructions on transfers to or from a designated investment alternative
  • Describes plan provisions relating to the exercise of voting, tender and similar rights for designated investment alternatives and any restrictions on such rights
  • Identifies any designated investment alternatives offered under the plan
  • Identifies any designated investment managers
• A description of any material change in the above information within 30 days after the date of adoption of the change
• Information on administrative expenses:
  • On or before the date of plan eligibility, and annually thereafter, an explanation of any fees and expenses for plan administrative services, such as legal, accounting and recordkeeping, that are not otherwise included in investmentrelated fees and expenses and which may be charged to participant accounts, including the basis on which the charges will be allocated (e.g., pro rata or per capita).
  • At least quarterly, a statement that includes:
    • The dollar amount actually charged during the quarter to the participant’s account for administrative services
    • A description of the services provided to the participant or beneficiary for that amount
• Information on individual expenses:
  • On or before the date of plan eligibility and annually thereafter, an explanation of the expenses that may be charged against participant accounts for services provided on an individual participant basis, such as fees for plan loans, QDROs and investment advice
  • At least quarterly, a statement that includes:
    • The dollar amount actually charged during the quarter to the participant’s account for individual services
    • A description of the services provided to the participant for that amount

Investment Related Disclosures to be Provided Automatically

The proposed regulation identifies the following investment related disclosures that are required to be provided automatically:

• Information with respect to each designated investment alternative under the plan is to be provided to each participant on or before the date of plan eligibility and annually thereafter, that identifies:
  • The name of the designated investment alternative
  • A web site address that leads participants to supplemental information on the designated investment alternative including:
    • The name of the issuer or provider
    • The principal investment strategies and risks
    • The assets in the investment’s portfolio
    • The investment’s portfolio turnover
    • The investment’s performance
    • Fees and expenses of the investment
  • The type or category of the investment fund (e.g., money market, balanced or large-cap fund)
  • The type of investment management utilized (e.g., active or passive)
• Performance data:
  • For designated investment alternatives with respect to which the return is not fixed:
    • The average annual total percentage return for the 1–year, 5–year and 10–year periods, if available, calculated in the same manner as under Securities and Exchange Commission rules for mutual funds
    • A statement that an investment’s past performance is not necessarily an indication of how the investment will perform in the future
  • For designated investment alternatives with respect to which the return is fixed for the investment term, both the fixed rate of return and the term of the investment
• Benchmark information for designated investment alternatives with respect to which the return is not fixed:
  • The name and returns of an appropriate broad-based securities market index over comparable 1–year, 5–year and 10–year periods
    • The cited index may not be administered by an affiliate of the investment provider, an investment adviser or a principal underwriter unless the index is widely recognized and used
• Fee and expense information for designated investment alternatives with respect to which the return is not fixed:
  • The amount and description of each shareholdertype fee charged directly against a participant’s investment, such as sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, purchase fees, and mortality and expense fees
  • The total annual operating expenses of the investment expressed as a percentage (such as an expense ratio), including expenses such as investment management fees, distribution, and service and administrative expenses that reduce the rate of return on the investment, calculated in the same manner as under Securities and Exchange Commission rules for mutual funds
  • A statement indicating that fees and expenses are only one of several factors that participants and beneficiaries should consider when making investment decisions
• Fee and expense information for designated investment alternatives with respect to which the return is fixed:
  • the amount and description of any shareholdertype fees applicable to a purchase, transfer or withdrawal in whole or in part
• Materials provided to the plan relating to the exercise of voting, tender and similar rights with respect to a designated investment alternative in which the participant has an investment, to the extent that those rights are passed through to the participant under the terms of the plan

Investment Related Disclosures to be Provided upon Request

The proposed regulation also requires that the following additional disclosures relating to designated investment alternatives must be provided to a participant upon request:

• Copies of prospectuses or any approved summary prospectus for registered SEC registered entities, or similar documents for designated investment alternatives that are provided by entities not required to be registered
• Copies of any financial statements or reports, such as statements of additional information and shareholder reports, relating to the plan’s designated investment alternatives, to the extent they are provided to the plan
• A statement of the value of a share or unit of each designated investment alternative as well as the date of the valuation
• A list of the assets comprising the portfolio of each designated investment alternative which constitutes plan assets under the DOL plan asset regulations and the value of each asset or the proportion of the investment which it comprises.

DOL Provides Model for Required Chart of Investment Information

The investment related information required to be provided automatically to plan participants is to be furnished in a chart or similar format designed to facilitate a comparison of the information for each designated investment alternative available under the plan. The chart must also include:

• The contact information for the plan fiduciary or designated person to contact for any additional information that is required by the regulation to be provided upon participant request
• A statement that more current investment-related information may be available at the web site addresses disclosed to the participant as required under the regulation

The plan fiduciary may include additional information that it determines to be appropriate for the comparisons in the required chart, provided that the additional information is not inaccurate or misleading.

The proposed regulation includes a model of the required chart. The use and accurate completion of the model format will be deemed to satisfy the requirements of the regulation as to investment related information that is to be provided automatically.

Outlook for a Final Regulation

Comments on many aspects of the proposed regulation have been provided to the DOL by various industry groups, and the disclosure proposals have been met with criticism by some in Congress for not going far enough. Some of the practitioner comments focused on the difficulties inherent in the proposal’s requirement that the required information be provided to participants on or before the date of plan eligibility. The proposed regulation as issued provides that the effective date of the final regulation will be for plan years beginning on or after January 1, 2009. While the DOL has stated its intent to finalize the proposed regulation by the end of the year, many of the comments that were filed stress that the DOL needs to provide sufficient time for plan sponsors to come into compliance with the final version of the regulation, and request a delayed effective date for the final rules.