Table of Contents
This report was produced by the 2007 ERISA Advisory Council’s Working Group on Fiduciary Responsibilities and Revenue Sharing Practices. The ERISA Advisory Council was created by ERISA to provide advice to the U.S. Secretary of Labor. The contents of this report do not represent the position of the Department of Labor (DOL).
The 2007 ERISA Advisory Council formed the Working Group on Fiduciary Responsibilities and Revenue Sharing Practices (hereinafter referred to as the “Working Group”) to study numerous issues as to fiduciary responsibilities arising from the enactment of the Pension Protection Act (“PPA”), as well as to address issues relative to the practice of revenue sharing which has become a common practice used to offset plan expenses with respect to defined contribution 401(k) plans. The desired result of the Working Group was to discover and present matters that would enhance the ability of fiduciaries to fulfill their responsibilities under ERISA, to develop criteria in the area of disclosure to participants and otherwise to satisfy the objectives of ERISA.
Testimony to the Working Group was provided on July 11, 2007 and September 20, 2007, by seventeen (17) speakers representing the federal government, professionals that represent multiemployer plans, investment consultants, benefit plan administrators, benefit plan consultants, the actuarial industry, benefit plan trustees, plan sponsors, representatives of the investment industry, record keepers, and other individuals who provide services to benefit plans. After careful debate and analysis of the issues and transcripts, the Working Group submits the following recommendations to the Secretary of Labor for consideration:
Recommendation 1: The DOL should propose regulations that permit the payment from multiemployer plan assets for professional services rendered to the multiemployer plan trustees that would generally be deemed settlor functions – e.g., plan design, merger, amendment and termination, without requiring that such activities be artificially characterized as fiduciary functions, regardless of whether there is a perceived incidental benefit to plan settlors or the bargaining parties. While this recommendation is actuated by concerns arising under the Pension Protection Act of 2006 (“PPA”), the regulations should not be limited to actions taken to satisfy the PPA.
Recommendation 2: The DOL should issue guidance with respect to what procedures should be followed by trustees in the development of funding improvement or rehabilitation plans to provide some degree of protection or “safe harbor” from breach of fiduciary duty challenges, including litigation from groups that may be disadvantaged by such decisions.
Recommendation 3: The DOL should issue suggested best practices to assist multiemployer plan trustees and other multiemployer plan fiduciaries in considering the use and monitoring of various asset allocation strategies to meet the funding requirements of the PPA.
Recommendation 4: The DOL should develop definitions of revenue sharing-related terms designed to assist benefit plan sponsors, fiduciaries, service providers, and participants. The Working Group feels such an undertaking should take into account definitions/terminology followed by other agencies (e.g. Securities and Exchange Commission) and consider ongoing and anticipated changes in capital markets.
Recommendation 5: The DOL should issue guidance clarifying that revenue sharing is not a plan asset under ERISA unless and until it is credited to the plan in accordance with the documents governing the revenue sharing.
Recommendation 6: The DOL should issue guidance regarding the treatment of revenue sharing received by a plan. Specifically, there should be guidance patterned after Field Assistance Bulletins 2003-03 and 2006-01 regarding the allocation of revenue sharing received by a plan. Consistent with the approach taken in those FABs, such guidance would confirm that there is not a single permissible method of allocation because cost, efficiency and other factors may enter into the fiduciary’s allocation decision. Such guidance should be coordinated with the U.S. Department of Treasury in order to address any possible tax consequences.
Robert M. Archer, Chair
Randy DeFrehn, Vice Chair
Richard David Landsberg
Kathryn J. Kennedy
Willow J. Prall
Edward A. Schwartz
Edward S. Mollahan
Stephen W. McCaffrey
Richard J. Helmreich
James D. McCool, Ex Officio
William L. Scogland, Ex Officio
The Working Group undertook several issues for study. The balance of this report will address the scope of the Working Group, the questions for witnesses, the list of witnesses, the consensus consideration of the Working Group and a Summary of Testimony from the witnesses.
The Working Group made inquiry of two rather distinct areas. The first area of inquiry related to a fiduciary responsibilities update as to implications of the PPA. It was observed that the PPA had resulted in significant changes to the rules affecting both defined benefit ("DB") and defined contribution ("DC") plans, the most significant far reaching changes being made with respect to funding rules for single employer and multiemployer DB Plans. The Working Group focused on the area of multiemployer plans and that the fact that the PPA imposed new and broad obligations on the boards of trustees that sponsor collectively bargained multiemployer DB plans and on collective bargaining parties that were responsible for plan funding. It was recognized that the focus of inquiry must be on what changes, if any, directly affect the respective legal and fiduciary responsibilities of the Trustees vis-a-vis the responsibility to more closely engage the bargaining parties and the extent to which bargaining parties would be drawn more closely into the process of monitoring DB Plans. It was recognized that consideration of these issues would require input from professional advisors such as actuaries, accountants and attorneys, and that there was a need to more fully define the assembly of plan financial and actuarial information in the course of collective bargaining as a matter of plan fiduciary expense.
The Working Group sought to analyze the DOL's current protocols concerning expenditure for calculation of plan design features and the assembly of plan information and to revisit whether these expenses are fiduciary or settlor in nature. A concern in this area, as more fully set forth below, was that Field Assistance Bulletins and other protocol issued by the DOL did not provide sufficient guidance and the concern that judicial consideration of these issues resulted in conflicting precedents, thereby causing confusion to fiduciaries and their professional advisors. Furthermore, the Working Group was concerned that for groups that chose to follow the guidance in FAB 2002-02 in order to pay for the required calculations, the introduction of the statutorily mandated requirements for plan trustees to develop funding improvement and rehabilitation plans pursuant to the PPA would invite additional litigation by groups that are disadvantaged by the decisions made by plan fiduciaries; decisions that would otherwise not be subject to challenge because they are normally undertaken as settlor activities.
The Working Group understood that some guidance to fiduciaries in this process of disclosure might be forthcoming if, at the very least, to provide some degree of protection or "safe harbor" against litigation that might arise as a result of the selection of one alternative over another.
The Working Group also addressed the requirement of PPA for substantially more disclosure of a plan's financial situation and to evaluate whether such disclosure would invariably lead to challenges to decisions made by the boards of trustees.
The Working Group also noted another provision in PPA that had not received considerable attention; that is, the methodology that could be followed to increase a DB plan's investment funding to a certain level and the pressure on fiduciaries of multiemployer plans to enhance investment returns by a more aggressive strategy, which would necessarily lead to consideration of alternative investments such as hedge funds. It is understood that the 2006 Working Group on Prudent Investment Process had considered this issue and made appropriate recommendations; nevertheless, enactment of the PPA has placed even more emphasis on this issue.
From the standpoint of revenue sharing practices, the Working Group recognized that revenue sharing was a common and considerable practice used to offset plan expenses with respect to DC plans. The Working Group understood that there appears to be nothing in ERISA that prevents a plan fiduciary from negotiating with a service provider for the return to the plan of any revenue sharing payments that the provider may receive. The Working Group recognized the need to define revenue sharing with some specificity and to consider the potential role of the DOL and other administrative agencies in defining and assessing this issue. As the practice of revenue sharing has increased, the need for greater understanding of the practice and its parameters was to be considered. The Working Group further understood that with greater disclosure being provided to participants on costs and revenue sharing, plan sponsors are questioning how to allocate expense offset payments received by the plan. Against that backdrop, the Working Group sought to evaluate the following issues:
- Whether the DOL should issue guidance with respect to the acceptable and proper use of plan revenues generated by revenue sharing arrangements in an appropriate circumstance where there is excess revenue sharing (i.e., revenue sharing that exceeds record keeping/administration fees), and how should such excess revenue sharing be allocated to the participants;
- Survey current practices to determine the manner in which plan sponsor/fiduciaries currently ensure understanding of revenue sharing/fee arrangements;
- Determining what guidance the DOL should issue with respect to allocating monies to a participant's account;
- What a plan sponsor/fiduciary needs to know and plan provider should be required to provide when they enter into a revenue sharing or rebate arrangement.
Questions for Potential Witnesses
Fiduciary Responsibilities Update
Will the PPA complicate bargaining in connection with multiemployer plans because of the focus on plan funding, tougher funding standards and the perceived need to often alter plan design?
Define those expenses that can be paid with plan assets to meet PPA obligations, and whether there is need for further guidance in this area.
Will the PPA directly affect the respective legal responsibility of bargaining parties vis-à-vis trustees by drawing bargaining parties more closely into the process of monitoring plan funding/design issues?
What guidance can be provided to a plan sponsor with respect to simplifying disclosure of the plan’s financial situation, plan design, etc. to individual contributing employers, individual plan participants, and others?
Understanding the considerable pressure being placed on the trustees of many DB plans to meet PPA-mandated funding standards; what guidance, if any, would you provide as to appropriate investments to meet such funding obligations?
Revenue Sharing Practices
What are the current practices as to revenue-sharing arrangements, including the basis upon which the revenue-sharing is determined and the methods by which employers utilize the amounts shared?
What, if any, guidance should the DOL issue with respect to the obligations of plan sponsors, trustees and other fiduciaries regarding the allocation of revenue sharing payments received by plan from a service provider?
What guidance could the DOL offer with respect to what a plan sponsor needs to know and what a service provider should be required to provide when they consider a revenue-sharing arrangement?
Should the DOL develop a model prototype in this area?
Scope of the Working Group
The scope of inquiry for the Working Group and the intended questions were given to all the witnesses in advance of the testimony. The witnesses were advised that the questions were not intended to limit the parameters of testimony, but rather to generate thought and discussion of the scope of the Working Group. Specific emphasis was placed on developing through the expertise of these witnesses, potential recommendations for consideration by the Working Group and ultimately the DOL.
The Working Group solicited testimony of witnesses from a broad cross section of the employee-benefit community. Both through their written presentations and their testimony, the witnesses addressed the issues raised and provided a considerable source of developmental information for consideration by the Working Group. The witnesses and the dates of their testimony were as follows:
July 11, 2007
- Robert Doyle, Director of Regulations and Interpretations, Employee Benefits Security Agency, U.S. DOL
- Louis Campagna, Chief of the Division of Fiduciary Interpretations, Office of Regulations and Interpretations, Employee Benefits Security Agency, U.S. DOL
- Barry Slevin, Esq., Slevin & Hart
- Marc LeBlanc, Field Administrator and General Counsel, Sheet Metal Workers National Pension Fund
- Troy Saharic, Mercer Investment & Consulting, Inc.
- Judy Mazo, The Segal Company
- Mark Lotruglio, QuanVest Investment Consultants
September 20, 2007
- Joyce Mader, Esq., O'Donoghue & O'Donoghue
- Gene Kalwarski, Cheiron
- David Blitzstein, United Food & Commercial Workers Union
- Michael Malone, MJM-401(k)
- Laura Gough, Robert W. Baird & Co., Inc., on behalf of the Securities Industry & Financial Markets Assoc.
- Francis X. Lilly, Esq., Independent Fiduciary Services, Inc.
- Allison Klausner, Honeywell, on behalf of the American Benefits Council
- Frederick Reish, Esq., Reish, Luftman, Reicher & Cohen
- Sam Brkich, Newport Group, on behalf of the Council of Independent 401(k) Record Keepers
- Mary Podesta, Investment Company Institute
Consensus of Recommendations
Fiduciary Responsibilities Update
The Working Group recognizes and commends the Department on its sensitivity to the unique nature of multiemployer plans and the circumstances that distinguish such plans from single employer plans in the traditional application of rules governing settlor vs. fiduciary functions, including the questions of how the costs associated with what are traditionally settlor functions can be paid from plan assets. It is clear that the approach described in FAB 2002-02 was a creative attempt to resolve this dilemma within the Department’s then existing authority in a more expeditious and economical manner than would be the case if the issue were to be dealt with through the formal regulatory process. Unfortunately, the testimony provided by a variety of witnesses demonstrated that it is also clear that this approach was an imperfect solution to a complicated problem. Although they existed before the PPA, these imperfections have been amplified by its passage and the confusion experienced by plan fiduciaries, settlors and their professional advisors over their responsibilities has only increased and will increase further as they begin to address the requirements imposed on them as delineated in the PPA. Consequently, as one witness observed, design decisions that are required by law should not be recast as fiduciary simply to enable them to be paid for by plan assets. This reasoning was expanded on by another witness who cited a ruling by the Supreme Court in which it very clearly stated that “plan sponsors who alter the terms of ”(1)
In discussing the operational conflicts between the existing Departmental policy as expressed in FAB 2002-02 and the requirements to provide settlor type information to the bargaining parties under the PPA, the Working Group welcomed the Department’s general proposition that payment for any activity required by the statute would be an appropriate plan expense. However, for reasons stated by subsequent witnesses, the Working Group is concerned that such an extension of informal guidance will only compound the confusion experienced by plan trustees of inconsistent Departmental and, more broadly, judicial interpretation of such guidance especially as plans implement the benefit modification procedures required of Critical Status plans and groups that are adversely affected by these decisions challenge them in the courts.
It is for these reasons that the Working Group noted with optimism the Department’s willingness to consider moving beyond existing guidance to a more formal regulatory process if a compelling case for such action could be made. Indeed, it appears that such a compelling case has been made through the testimony received from a variety of expert practitioners.
First, and in particular, the Working Group notes the inconsistent treatment of the question of what may be settlor vs. fiduciary historically as applied by the Courts (not limited to the implementation of the PPA) as detailed in the testimony of one witness. Additionally, the specific reference to the Supreme Court’s decision in Heinz (Central Laborers' Pension Fund v. Heinz, et al., 541 U.S. 739 (2004)) which, while not specific to the settlor v. fiduciary issue, is particularly troublesome. Referenced by several witnesses, Heinz called into question the deference to be afforded by the Courts to informal agency guidance. After the Supreme Court overruled by a 9-0 vote a longstanding practice endorsed by the IRS for over thirty years and supported in oral argument by the US Solicitor General, it is difficult to envision that the courts would endorse an informal interpretation that a settlor function would be deemed to be a fiduciary function by the simple act of saying it is so. Additionally, the intent of the FAB appears to have been circumvented by the imposition of a statutory requirement for plans to adopt rehabilitation plans that, by definition, will require certain groups of participants be chosen over others for benefit reductions. Rather than finding a creative solution to a difficult problem, the continued application of FAB 2002-02 in the future will undoubtedly foster additional fiduciary breach litigation against trustees for doing what they are required to do under the PPA.
Second, administration of informal policy within the Department has been inconsistent and has been described by some as a “trickle down” approach to policy dissemination that leaves plans uncertain as to the rules simply because they may fall within the jurisdiction of one regional office rather than another.
Third, the Working Group was advised that the question of payment from plan assets for settlor expenses is not a settled issue and that the Department’s interpretation is inconsistent with a number of court decisions and may be inconsistent with its own determination regarding incidental benefits. Also called into question is the notion that payment for certain functions that are in the interests of plan participants and beneficiaries may be appropriate, even if there is an incidental benefit to employers.(2)
Finally, the additional requirements for the development of rehabilitation plans under PPA have inexorably altered (and some have contended, intentionally blurred) the roles of multiemployer plan trustees with respect to their roles in support of the collective bargaining process. As plan trustees develop new contribution / benefit design schedules consistent with their statutory mandates, the Working Group finds it difficult to conceive of a scenario wherein Congress would not have intended plan assets to be used by trustees to pay for the very calculations required to be developed by the trustees in order to meet the requirements under the PPA. To that end, it appears that informal guidance of the sort provided under FAB 2002-02 is no longer sufficient.
Therefore, it is the consensus of the Working Group that the Department should engage in the more formal regulation process through which input from the entire multiemployer plan universe can be solicited with respect to updating current informal guidance pertaining to the use of plan assets for plan design activities. Furthermore, based on witness testimony that the confusion over this issue preceded the enactment of the PPA, it is also the consensus of the Working Group that such a review not be limited to the new requirements of the PPA, but rather that the Department use this opportunity to develop comprehensive regulatory guidance, perhaps in the form of a narrowly crafted exemption from prohibited transactions, under which all multiemployer plans can distinguish when payment for design related issues may be made from plan assets.
The Working Group also reviewed the issue of how the new funding targets contained in the PPA will influence the asset allocation determinations of plans’ investment programs. Several witnesses commented on the fact that the new funding targets contained in the PPA will have an effect on the plans’ overall investment policies and will undoubtedly result in broader diversification into non-traditional asset classes. These asset classes contain investment alternatives which require a much greater depth of knowledge with respect to the advantages and potential pitfalls that may be encountered than do the more traditional asset classes. In reviewing their plans’ investment policies and in evaluating various non-traditional asset classes to determine whether such investments may meet the plans’ investment objectives, it will be necessary for trustees to expand their knowledge of the various proposed instruments in order to meet their due diligence requirements. As such, it would be quite useful for plans if the Department would provide additional informative guidance to plans regarding their obligations to understand the nature of such instruments and the conditions under which, and to what extent the inclusion of some alternatives may be appropriate for pension plan investments. Overall, the DOL should issue suggested best practices to assist multiemployer plan trustees and fiduciaries in considering the use and monitoring of various allocation strategies to meet the PPA funding standards.
In reaching this recommendation, it was the consensus of the Working Group that the Pension Protection Act will require the strengthening of the funding status of defined pension benefit plans. It was the general feeling of the Working Group that the guidance in this area has been inconsistent and that there may be an enormous amount of uncertainty as to the fiduciary responsibilities in addressing the funding status and plan design in making investment decisions. The Working Group understands that it is not the role of the DOL to determine the appropriateness of specific investment vehicles necessary to address this PPA issue. Likewise, it is not our role to determine the use of “alternative investments” generally. Rather, we suggest that there should be available a level of consistent information which can be relied upon by multiemployer trustees in understanding their fiduciary responsibilities. Finally, while the Working Group understands that a prior 2006 Working Group on prudent investment process evaluated this issue, the implementation of PPA warrants action on this issue.
Revenue Sharing Practices
The Working Group recognized that there was a considerable amount of consensus with respect to the concept of revenue sharing, how it can benefit plan sponsors and their participants. Some of the consensus thoughts include:
- Revenue sharing is an acceptable practice;
- There is a need for transparency in order to fulfill and execute the fiduciary responsibility of plan sponsors and their trustees;
- Bundled providers use “bundled” revenue sharing, which is not necessarily the practice with “unbundled” providers; and
- A plan sponsor needs to investigate and understand revenue share from vendor to consultant/broker.
The Working Group recognizes that revenue sharing in a broad sense allows the market "to develop efficiencies and innovations that have enhanced the quality of services of products available to DC and 401(k) plans." The witnesses generally testified, and the Working Group recognizes that revenue sharing supports a wide variety of distribution and shareholder servicing activities, including administrative record keeping and sub-transfer agent services that were traditionally viewed as investment fund responsibilities. As offered by one witness, as of year-end 2006, 401(k) plans held $2.7 trillion in assets, not counting assets that were rolled over into IRAs. In this connection, estimates suggest that one-half of $4.2 trillion in IRAs in 2006 came from 401(k) and other employer plans. The number of 401(k) plans grew from fewer than 30,000 in 1985 to approximately 450,000 in 2006. The Working Group therefore recognizes the essential role of such plans and the need for plan sponsors and fiduciaries to assure that workers can rely with confidence in these types of plans for retirement savings. Indeed, it appears that defined contribution plans and particularly participant directed plans, are the primary retirement vehicle for both employers and employees in this country.
The Working Group recognizes that in the DOL's view, revenue sharing does not involve any inherent ERISA violations. To the contrary, many of these arrangements may serve to reduce overall plan costs and provide plans with services and benefits not otherwise affordable to them.
The Working Group recognizes that fiduciaries, such as plan sponsors and trustees, must discharge their duties solely in the interest of participants and beneficiaries and for the sole purpose of providing benefits and defraying "reasonable" expenses of administering the plan. ERISA Section 404(a)(1)(A). Further, these fiduciaries must discharge their duties with the care, skill and prudence and diligence, under the circumstances, a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.
The Working Group recognizes that in order to discharge these duties, plan sponsors must understand all the plan fees and expenses to: 1) fulfill their responsibilities under ERISA; 2) evaluate the reasonableness of provider compensation; and 3) evaluate whether there are any prohibited transactions or other conflicts of interest. As discussed hereinafter, such fees and expenses generally include indirect payments such as revenue sharing, which may be 12 b-1 fees and sub transfer agency or sub TA fees.
According to DOL testimony, ERISA's prudence requirement applies to all fiduciary decisions including, but not limited to, the selection and monitoring of investments and the selection and monitoring of service providers such as third-party administrators, investment managers and advisors, record keepers and providers of investment information. A DOL witness referred to prior guidance it had issued concerning how fiduciaries might discharge its duties consistent with ERISA standards. For example, DOL Field Assistance Bulletin 2007-1 had been issued concerning selection and monitoring of investment managers. Several witnesses addressed that the DOL is currently working on two initiatives that are designed to help ensure that plan fiduciaries have the information they need concerning revenue sharing and similar agreements so that they can discharge their responsibilities in connection with the selection and monitoring of service providers in an informed and prudent manner.(3)
As its first recommendation, the Working Group believes that the DOL should compile appropriate terminology in connection with defining revenue sharing. The consensus of the Working Group is that there should be a definition of revenue sharing crafted in the manner to maintain flexibility in light of ongoing and anticipated changes in the market place. In this connection, the Working Group recognized the concern of several witnesses to define the most frequently used terminology in this area. As one witness stated, and the Working Group concurs, if the DOL does not define these terms, it is possible that conflicting Court decisions would create "a mine field" for plan sponsors, fiduciaries and fair and honest service providers.
As a general proposition, revenue sharing is a broad term that means many different things to different constituents. As one witness noted, there is an inconsistency between the use of the term "revenue sharing" in the securities industry and the way the term is used in the employee benefit plan community. This witness stated, with some concurrence from other witnesses, that in the employee benefit community, the term "revenue sharing" is used loosely to describe virtually any payment that a plan service provider receives from a party other than the plan.
Clearly from the testimony presented, there is a role for the DOL to "take the lead" in formally defining 401(k) terms. In the view of several witnesses, this would be a considerable step in reducing the confusion about the flows of revenues, fees and costs. It is therefore concluded that the need for the DOL to provide concise definitions in this area can only benefit the plan sponsors, fiduciaries and service providers in fulfilling their role to participants. Finally, any undertaking should be in coordination with other administrative agencies such as the Securities & Exchange Commission.
As a second recommendation, the Working Group believes that the DOL should consider issuing guidance with respect to the obligations of plan sponsors and trustees and other fiduciaries regarding allocation of revenue sharing payments received by the plan from a service provider. The Working Group heard considerable testimony on whether revenue sharing payments are "plan assets." As a result, it believes that there is a need for guidance on that issue. If, in fact, revenue sharing amounts were considered "plan assets", these amounts must be held for the "exclusive purpose of participants and beneficiaries and are subject to ERISA Section 406(b) prohibited transaction rules." Additionally, to the extent providers have control over the management and disposition of these payments, these providers may be considered fiduciaries.
Concern in this area is amplified in the considerable recent case law. For instance, a recent decision of the U.S. District Court for the District of Connecticut in Haddock v. Nationwide Financial Services, 419 F. Supp. 2d, 156 (D. Conn. 2007) held that fees, such as revenue sharing payments received from mutual funds and their affiliates by companies providing services to ERISA covered employee benefit plans, could be characterized as "plan assets" of those plans for purposes of the fiduciary responsibility requirements of ERISA. Other cases have held to the contrary. As one witness opined, the state of litigation and the "law in this arena remains uncertain at this time." Other witnesses suggested that the failure by the DOL to issue regulations or provide clear guidance might well result in conflicting Court decisions and inconsistent requirements for plan sponsors and service providers.
The Working Group understands the sense of the witnesses that this failure to act could have profound consequences in the 401(k) market place. It would appear that ERISA fiduciary status comes with a price to a benefit plan because "fiduciaries must be compensated for the cost of compliance and the risk of liability." After considerable consideration of this issue, it is the feeling of the Working Group that the DOL should issue guidance that clarifies that revenue sharing is not a Plan asset under ERISA unless and until it is credited to the Plan in accordance with the documents governing revenue sharing. For this reason, many of the concerns raised in the testimony may be avoided via alternative methods of evaluating and handling revenue sharing issues.
The Working Group would suggest that the DOL be mindful in interaction with other agencies having similar regulatory authority in developing any such guidance.
Third, the Working Group understands that ERISA does not specifically speak to methods by which revenue sharing proceeds might be allocated among the plan's participants and beneficiaries. The DOL suggests that in its testimony that in the absence of statutory guidance, allocation decisions must be made taking into account the terms of the plan and the obligations of plan fiduciaries to have prudently acted in the interests of the plan's participants and beneficiaries. It offers Field Assistance Bulletin 2003-3 pertaining to the allocation of expenses in a defined contribution plan and Field Assistance Bulletin 2006-1 pertaining to the distribution of settlement proceeds relating to late trading and market time as having applicability in the allocation of revenue sharing proceeds among plan participants.
The Working Group notes testimony that plan sponsors have considerable discretion to determine how revenue sharing proceeds will be allocated to and among the plan participants and beneficiaries. It also understands DOL's suggestion that the documents and instruments governing a plan therefore might specifically provide that revenue sharing could be used to reduce plan expenses generally or that such proceeds would be allocated among all participants on a pro rata or per capita basis or that such proceeds would be allocated to particular participants and beneficiaries whose accounts are responsible for generating the proceeds. The suggestion that prudence would require a process by which the fiduciary weighs the competing interests of the various classes of the plan's participants and the effects of various allocations on these interests supports a position of DOL intervention in this area. On this point, broad and strong testimony has been presented that suggests the need for such further guidance as to this issue of allocation of proceeds.
The Working Group therefore recommends that a Field Assistance Bulletin be issued regarding the treatment of revenue sharing and this Field Assistance Bulletin be patterned after Field Assistance Bulletins 2003-03 and 2006-01. Consistent with the approach taking in those FABs, such guidance would confirm that there is not a single permissible method of allocation because cost, efficiency, and other factors may enter into the fiduciary’s allocation decision. Some view was expressed that this guidance could be coordinated with the Department of Treasury to confirm that such allocations are treated as miscellaneous earnings or expense reimbursement to a participant’s account, rather than an addition for Internal Revenue Code Section 415 purposes. The Working Group makes this recommendation mindful of the fact that there is a potential for litigation in this area and it believes that guidance of this type will be beneficial to plan sponsors in assessing any allocation decision.
As an observation, the Working Group sees the need for plan sponsors to obtain all appropriate information necessary for dissemination to participants and to identify, negotiate and monitor fees and expenses that are not excessive and unreasonable. We are hopeful that the DOL should consider such factors in updating proposed revisions to regulations being considered with ERISA Section 408(b)(2). An extensive list of fee and expense data that plan sponsors could use effectively with their service provider was provided by the witnesses. In sum, the general thrust of these submissions was that a plan fiduciary should obtain information from service providers to the plan on items such as what services will be delivered; what will be charged for those services and how these expenses will be allocated between the sponsor and participants; and whether and to what extent the service provider receives compensation from other parties in connection with providing services to the plan.
The need for detailed information was supported by the testimony of one witness who stated that according to a recent survey developed by Hewitt Associates, 77% of employer plan sponsors surveyed were either very or somewhat likely to undertake a review of plan expenses, revenue sharing and disclosure of these to participants.
As to the issue of developing a prototype model, the sense of the Working Group is that if guidance is provided from a standpoint of the information required of a potential service provider, this would allow the plan sponsor to make an informed decision in this area.
Summaries of Witness Testimony
Summary of Testimony of Robert J. Doyle
ERISA and the Department of Labor have supplied significant guidance to Fiduciaries of both single employer and multiemployer plans relative to their utilization of Plan Assets to pay reasonable expenses in administering the Plan.
Expenses related to traditional trust law settlor type acts-plan formation issues i.e., plan design, plan amendment; plan termination can not be charged to the Plan. Acts relative to managing the plan and decision are fiduciary in nature and may be charged to the Plans.
FAB 2000-02 deals with Multiemployer plans allowing those expenditures which are typically Settlor to be fiduciary acts if the controlling documents provide those typical settlor functions to be Fiduciary. If the documents are silent, then the general rules applicable to settlor and fiduciary functions control. Traditional fiduciary functions can’t be varied by plan documents to make them Settlor, they remain fiduciary.
Where Trustees make plan design changes necessitated as a result of information received because of PPA compliance and the information was not developed solely to benefit the bargaining parties but, rather benefits the participants, it should be fiduciary and chargeable to the plan.
Mr. Doyle testified that he believes ERISA and DOL regulation pretty well define the obligations of fiduciaries with respect to the proper disposition of plan assets. The fiduciary must be prudent and act solely in the interest of participants and beneficiaries when using plan assets to pay expenses. He identified the basic rules that expenditures of Plan Assets can not benefit the plan sponsors/employers. He also stated the expenditures must be (i) reasonable, (ii) used to administer the plan or pay benefits and (iii) can’t be used to engage in prohibited transactions.
The issues before the Working Group arose because the DOL, the Fiduciaries and the plan sponsors are aware that expenses incurred, whether as a single employer or multi employer plan, fall outside the guidance, or might be expenses that directly or indirectly benefit the employer or a contributing employer in the multi employer context. Mr. Doyle elaborated on this statement by indicating that you have to determine who is benefiting from the expenditure, if it is the employer, it can’t be paid by the plan. He indicated that the DOL has tried to draw lines between what are settlor functions, which result when setting up a plan, and fiduciaries functions, which are attributable to the plan and its participants.
He further testified that he has looked at the definition of a fiduciary in ERISA Section 3(21) in a very broad manner, with a possibility that this definition might involve a lot of decisions made by a plan sponsor. He stated that the DOL has given guidance regarding a certain group of discretionary acts which DOL characterized as settlor, which could be engaged in without fiduciary implications. He viewed these as traditional trust law settlor type acts-plan formation issues i.e., plan design, plan amendment, plan termination. Additionally, he next described other acts relative to managing the plan and decision which he stated are fiduciary in nature. He indicated that this guidance resulted in a lot of inquiries seeking clarification or guidance regarding expenses attributable to each type of act. He provided that if they are settlor in nature, they do not implicate ERISA’s fiduciary responsibility provisions, and expenditure of plan assets for those activities is not appropriate. He testified that the DOL’s intent was to create a framework to provide certainty and flexibility on the part of employers in terms of designing their plan without requiring that they apply fiduciary standards for settlor expenditures. The DOL did this because it recognized that plan sponsors may have had different motives in terms of the establishment of the plan and what it was is trying to accomplish when it adopted the plans. He stated that in the late 1990 and early 2000, DOL investigations revealed that there was a lot of confusion regarding the proper use of plan assets. He further stated that there was yet more confusion when there was a multiple benefit to the plan and the sponsor and the question of the proper allocation of expenses to the plan and the sponsor. He stated that the DOL issued Advisory Opinion 2001-01A with the hope that parties would understand the distinction between settlor expenses and plan expenses even when a sponsor expends funds to maintain the qualified status of the plan. Their intent was to further clarify that the mere fact there was an incidental benefit to the employer would not be enough to characterize the expense as sponsor not payable by the plan.
Recognizing that this didn’t address all the questions with respect to Multiemployer plans, Mr. Doyle stated that the DOL issued Field Assistance Bulletin 2000-02 in an attempt to clarify the fiduciary/settlor issues relative to Multiemployer plans. He addressed a specific case where trustees were trying to allocate assets between two plans which the DOL concluded could result in a prohibited transaction as the trustees might be acting adversely to both sides of the transaction. The FAB provided that the documents which govern the plans, i.e., the trust documents, collective bargaining agreement and plan documents, control and dictate the expectations of the parties who created the plan as to the role of the trustee. He provided that if the plan documents confer fiduciary status upon the trustees with respect to what the DOL would normally view as settlor functions, then the DOL will honor that treatment and assume the fiduciary is acting prudently and is only taking into account the interest of participants and beneficiaries. He stated that if that is the case, the DOL will allow these expenditures to be charged against plans assets. If the documents are silent, then the general rules applicable to settlor and fiduciary functions control. Traditional fiduciary functions can’t be varied by plan documents to make them settlor, they remain fiduciary. He stated that the DOL believes that they gave significant amount of flexibility to trustees of multiemployer plans to charge expenses to plans.
He stated his belief that, prior to and after PPA, the trustees have been given a great deal of discretion with few constraints, in terms of the information about the plan that they are permitted to share with parties to the bargaining process. He stated his belief that the DOL believes that fiduciaries do have a lot of ability and a lot of discretion in terms of the information they share and how to develop the information to improve the bargaining process. He stated that when the trustees exercise this discretion, they must act prudently and solely in the interest of the participants.
In conclusion, he testified that the DOL welcomes this process to promote efficient effective plan administration to ultimately benefit participants and beneficiaries and testified that if there are impediments the DOL is receptive to reviewing such impediments in the interest of improving the current situation.
In response to questions regarding the FAB and any court cases concerning its use as precedent, Mr. Doyle stated that he believed that one court reached a similar conclusion but did not specifically give the FAB deference. He stated his belief that regulations would generally have greater value but it really is a matter for a court to decide if it makes sense as a matter of law. He stated his view that he thinks the FAB is sufficient, but if the public believes that the DOL needs to issue regulatory guidance on the issue of Settlor vs. Fiduciary expenses, the DOL might consider doing so, not just in the Multiemployer context but rather in a much broader context. He reiterated his earlier belief that the DOL has given a great degree of flexibility in this area which may be lost if regulations were promulgated.
Chairperson Archer stated that he has been involved in three situations where the DOL local offices challenged the use of plan assets incident to mergers and stated they were settlor. Mr. Archer indicated that it was resolved favorably as fiduciary issues. Mr. Archer asked for additional clarification on plan expense issues related to the PPA and existing DOL guidance where the parties make plan design change necessitated as a result of information received because of PPA compliance. Mr. Doyle stated his belief that if the information was not developed solely to benefit the bargaining parties but rather to benefit the trustees for participants, it should be fiduciary and chargeable to the plan. When asked about trustees having to provide additional benefit schedules which might result in a plan design issue yet also respond to the trustees’ PPA requirements, Mr. Doyle stated his belief that if the schedules were created in the interest of the plan then they are plan expenses.
Summary of Testimony of Louis Campagna
The DOL has been on record providing that fiduciaries have an obligation to discover revenue sharing arrangements that pay indirect compensation to service providers to get the total picture on the reasonableness of compensation paid by a plan and potential conflicts of interest related such providers.
DOL is in the process of amending the regulation to change that result and redefine the parameters of the exemption to specifically require service providers to make some disclosures. He stated that there would be an obligation to disclose the fees and any compensation that a service provider receives directly or indirectly as a result of services provided by the plan. This disclosure will be mandated on Schedule C to the Form 5500.
There is no inherent violation of ERISA involving revenue sharing except where a service provider takes the payment for itself. There is no requirement under ERISA to allocate these payments to participants.
In the absence of statutory guidance, allocation decision must be made taking into account the terms of the plan and the obligations of plan fiduciaries to act prudently and in the sole interest of the participants and beneficiaries. Plan sponsors have considerable discretion as a matter of plan design, how revenue sharing proceeds will be allocated to and among plan participants.
The principles set forth in two DOL FABs can be utilized by fiduciaries to lay the foundation for allocation of revenue sharing to participants. These FABs, taken together, could provide three options for prudent allocation of proceeds: (i) reduce overall expenses, (ii) allocate among all participants on a pro rata or per capita basis, or (iii) allocate to particular participants and beneficiaries accounts who generated the revenue sharing.
Mr. Campagna set the tone by indicating that his testimony will look at two topics, the first, what the fiduciary, both single employer and multiemployer need to know regarding revenue sharing and disclosure under ERISA. The second topic will be offsets of revenue sharing payments. He also would discuss what, if any, obligations the fiduciary has to allocate the proceeds of a revenue sharing arrangement to participants.
He testified that fiduciaries when engaging a service provider must understand the basic framework of ERISA and understand ERISA’s exclusive purpose and prudence requirements. He testified that ERISA’s prudence requirements apply to all fiduciary decisions including the selection and monitoring of all types of service providers as well as payment of expenses for such service providers. He believes that the DOL has provided various forms of guidance concerning how the fiduciary must discharge their selection and monitoring duties.
He stated that the DOL has gone on record over the years providing that it is a fiduciary’s obligation to identify revenue sharing arrangements that pay indirect compensation to service providers in order for the fiduciary to determine the reasonableness of the compensation that the plan pays. He further stated that the fiduciary must be aware of any other arrangements which arise because the service provider may have internal conflicts of interest and the fiduciary must be aware of any conflict situation in which the plan is involved when addressing compensation issues.
Mr. Campagna testified further regarding the obligation of the fiduciaries to determine if there are any conflicts of interest that the service providers have with their affiliates. He then discussed the work done with the SEC, which resulted in ten questions which should be answered when hiring a pension consultant. He identified the governing law concerning engagement of service providers as Section 408(b) (2). This Section provides the statutory exemption from the prohibited transaction rules. He described Section 408(b) (2) requirements for service provider and the rules related to a provision of service by a party in interest. He stated that the DOL regulation looks for compensation to be paid pursuant to a reasonable arrangement, and if that is achieved there really is not much to disclose. Currently, the regulation requires no disclosure by the service provider although it requires the fiduciary to obtain it.
Mr. Campagna stated that the DOL is in the process of amending the regulation to change that result and redefine the parameters of the exemption to specifically require service providers to make some disclosures. He stated that there would be an obligation to disclose the fees and anything that they receive as a result of services provided to the plan including indirect revenue sharing. If the service provider fails to disclose the required information they will be subject to excise taxes. He stated that the regulation as modified will require the service provider to disclose potential conflicts of interests, where any material financial interest could affect their judgment on some of the services they supply to the plans. This requirement will be placed on service providers, who are fiduciaries as well as non fiduciaries, which provide advice to plan fiduciaries.
He indicated that this regulation project will work in conjunction with the DOL project seeking to revise Schedule C to the Form 5500 in which DOL wants reported the indirect compensation that a service provider receives.
Mr. Campagna next addressed his second topic that of Revenue Sharing payments with offsets. He testified that there is no inherent violation of ERISA involving revenue sharing with one exception which he would discuss. Nor is there any requirement under ERISA to allocate these payments to participants.
He testified that the DOL view is that revenue sharing may be good, in that it reduces overall plan costs and provides the plans, especially small ones, with services and benefits which might not be affordable.
He then discussed the exception which could result in a violation. He described a situation where a plan fiduciary through its discretion causes payments to itself or an affiliate or other interested party. He testified that this transaction could result in an act of self dealing under the prohibited transaction rules unless the revenue sharing payments are given to the plan or used to offset the plan’s obligation to that advisor with any excess above that amount returned to the plan. He indicated that this offset could best be handled in the negotiation process with the service provider.
Mr. Campagna followed this testimony with a discussion of ERISA’s requirement to allocate revenue sharing payments back to participants. He stated that if revenue sharing payments are returned to the plan, they are plan assets subject to all of ERISA’s fiduciary and prohibited transaction rules. However, he further indicated that nothing in ERISA addresses the proper allocation of these payments to participants or describes the process by which such allocations are made. He stated that in the absence of statutory guidance, allocation decision must be made taking into account the terms of the plan and the obligations of [plan fiduciaries to act prudently and in the sole interest of the participants and beneficiaries. He stated that plan sponsors have considerable discretion as a matter of plan design how revenue sharing proceeds will be allocated to and among plan participants.
He discussed that the principles set forth in Field Assistance Bulletin 2003-03 and FAB 2006-01 can lay the foundation for a proper allocation among participants. He said the principles in these FABs provide the fiduciaries three options; they can (i) be used to reduce overall expenses, (ii) be allocated among all participants on a pro rata or per capita basis, or (iii) they can be allocated to particular participants and beneficiaries accounts who generated the revenue sharing. He further testified that when a plan is silent or ambiguous on how proceeds might be allocated, fiduciaries must be prudent in their selection of an allocation method. This means that the fiduciary using a rational basis must weigh the competing interests of the various classes of participants and the effects of the allocation method on each group. He also addressed a need to consider the cost and benefit to the plan and participants in implementing any allocation method.
He further stated that if an allocation method has no reasonable relationship to the revenues generated, it could be argued that a fiduciary breached his duty to act prudently, or, engaged in a prohibited transaction if not solely in the interest of participants. He stated that this might be the case, when an allocation benefits a plan sponsor, a party in interest or a fiduciary, who is also a plan participant, in more than an incidental manner.
Mr. Campagna and Mr. Doyle addressed various questions from the Council Members regarding various service provider scenarios which could arise and how they can be handled. Mr. Campagna addressed the proposed DOL guidance stating that it will specifically require service providers in a contract proposal or actual contract between the plan and the service providers to make certain disclosures regarding direct and indirect compensation, the services to be provided, indirect compensation and a provision that the service provider will disclose internal conflicts. It will be a prohibited transaction issue for the service provider and will allow for a contract action by the plan if the provider breaches the contractual provision. The DOL believes this is necessary because plan fiduciaries need to have this information in order to judge the reasonableness of compensation and the onus should not be on plan sponsors to go out and track this information down. Mr. Doyle stated that the DOL is charged with the responsibility to create a framework where the plan fiduciary has certainty that they are getting the requisite information and the service providers have some degree of certainty that they have satisfied the requirements for the exemption from a prohibited transaction.
They concluded their testimony by emphasizing that this is a very hard issue to address stating that the DOL has to review what is that the participants need to know.
In the case of an individual account plan, he further stated that the DOL wants to develop a public record in terms of suggestion and approaches because it is an extremely important issue. Mr. Doyle stated further that the DOL wants to come up with a framework that gives participant information they need but that the cost to obtain such information will not outweigh the ultimate benefit derived from information. Mr. Doyle indicated that the DOL’s obligation is to determine what it is that participants need to know to make an informed decision; at what cost to the individual; and how the DOL and SEC can identify types of disclosure that would serve to benefit participants and beneficiaries.
Summary Of Testimony Of Barry S. Slevin
Barry S. Slevin, a principal in the firm of Slevin & Hart, testified before the Working Group regarding fiduciary and settlor functions in the context of multiemployer plans. In presenting his testimony, Mr. Slevin indicated that he was presenting his own views and not necessarily the views of his clients or others in his firm. Mr. Slevin provided both oral and written testimony.
Mr. Slevin began his testimony by discussing the rules that apply when a plan sponsor of a single employer plan amends a plan. He indicated the fact that the plan sponsor in the context of a single employer plan can make a decision, put it in the plan document and make it immune from second guessing is an extremely important function and a way to reduce litigation risks and controversies. He noted that under ERISA, the plan sponsor of a multiemployer plan is defined as the board of trustees. He indicated that the question then becomes why the Board of Trustees of a multiemployer plan shouldn’t be able to amend the plan document and have the benefit of the same protection.
He then discussed the Department of Labor’s Field Assistance Bulletin 2002-2. He indicated that the Bulletin, in effect says, that the Board of Trustees can chose how it wants those functions defined, but that if it decides to be treated as a settlor, it may not use plan assets to make the decision. According to Mr. Slevin, this creates a conundrum for the Board of Trustees. Should they make the decisions as settlors in the dark and not ask their lawyers and their actuary for advice because they can’t pay their lawyer and actuary if they are acting as settlors? Or, should they give up the protection that the law gives the rest of the world that is a settlor decision and declare themselves to be fiduciaries and therefore use plan assets, the upside being they make better decisions? Mr. Slevin indicated that this is an impossible choice.
He next focused his testimony on the ability of multiemployer fiduciaries to provide information to collective bargaining parties. It is his view that multiemployer plans should be able to provide information to collective bargaining parties and not be worried that they are going to be subject to criticism by Department of Labor investigators. He thinks that this should apply to already existing information, as well as to the decision to develop information for the collective bargaining parties. He noted that the basic information the plan may develop for the Board of Trustees may not be the type of information the collective bargaining parties need.
According to Mr. Slevin, it is far from clear in terms of the Department’s enforcement perspective whether that development of information at plan expense and providing it to the collective bargaining parties would clearly be appropriate. He believes that specific guidance on this issue would be helpful. He indicated that he would be in favor of a field assistance bulletin confirming that a board of trustees can provide information to bargaining parties as long as they do so paying reasonable compensation.
Mr. Slevin then discussed the Pension Protection Act of 2006 (“PPA”). He noted that the PPA creates a required method of communication between the board of trustees and the collective bargaining parties when a plan is in endangered or critical status. He explained that the Board of Trustees is required to develop a funding solution to the plan’s financial problems called a rehabilitation plan for plans in critical status. The Board of Trustees is required to come up with a set of potential options to give to the collective bargaining parties and the collective bargaining parties are then required to decide and negotiate over those options. If the bargaining parties don’t agree, then one option that is the default plan will go into effect.
He indicated that this can be very contentious area. In Mr. Slevin’s opinion, whether the decision is settlor or fiduciary is important not only because of the question raised by Field Assistance Bulletin as to whether the fiduciaries can use plan assets to get advice, but also on the substantive question once they make the decision and if they are subject to criticism. If they don’t have settlor protection, he indicated that this can be an extremely contentious debate and subject to litigation for those participants who are unhappy with the schedules that have been adopted. It is Mr. Slevin’s view that troubled plans should not be saddled with more litigation in terms of defending these actions.
Mr. Slevin indicated that he doesn’t think that multiemployer plans should be required to make the choice that the Field Assistance Bulletin sets up. He believes that they should be able to make settlor decisions and use plan assets. In making settlor decisions, he believes that the trustees of a multiemployer plan should be able to get the same protection that a plan sponsor in a single employer context gets. He indicated that they should be able to use plan expenses to get good advice and that they shouldn’t be put in the ridiculous position of making the decision without advice. He indicated that he thinks that it makes a lot more sense to say that it’s a settlor decision and we are not going to question the substantive decision under fiduciary structures, but that the process is still going to be subject to fiduciary standards.
He noted that the fact that the Board of Trustees as settlors would be able to use plan assets to make these decisions to implement the PPA doesn’t mean that they are beyond regulation. In this regard, he stated that they would still be subject to the fiduciary responsibility provisions in terms of retaining professionals, paying them reasonably, and getting information that is only necessary to properly operate the fund.
Summary of Testimony of Marc LeBlanc
Marc LeBlanc, who is the Fund Administrator and General Counsel for the Sheet Metal Workers’ National Pension Fund (“National Pension Fund”), appeared before the Working Group and presented testimony regarding settlor and fiduciary functions in the context of multiemployer plans, the use of plan assets by multiemployer plans to pay for the performance of settlor type expenses, and the payment of expenses associated with complying with the requirements of the Pension Protection Act of 2006 (“PPA”). In presenting his testimony, Mr. LeBlanc indicated that the views he was expressing were his personal views and did not necessarily reflect the views of the National Pension Fund or its Board of Trustees. Mr. LeBlanc presented both oral and written remarks.
Mr. LeBlanc stated that it is appropriate for multiemployer plan assets to be used to pay for expenses that have traditionally been treated as settlor functions, even if the trust agreement specifically says that these functions are settlor functions. He noted that a plan may pay from plan assets the reasonable expenses of carrying out functions that are for purposes of providing benefits to participants and beneficiaries or defraying the reasonable expenses of administering the plan. He expressed the view that this should be so even though the relevant plan document makes it clear that the board of trustees does not act in a fiduciary capacity when it modifies the plan or makes decisions regarding the composition, design, form or structure.
Through law, regulation or some other form of guidance, Mr. LeBlanc believes that the issue should be clarified to permit multiemployer plans to cover the expenses incurred by trustees when they act analogously to settlors, subject to certain conditions and safeguards. These safeguards would include plan provisions that direct trustees to undertake certain due diligence both before and after they make a plan design decision.
He explained that ERISA does not describe fiduciaries simply as administrators, managers or advisors, but that the test is functional. A person is a fiduciary to the extent they have discretionary authority or responsibility in plan administration. He suggested that the premise that an act may be fiduciary or settlor in nature depending upon how the plan document characterizes it is without substantial support in trust law, ERISA, and several court rulings. He then proceeded to discuss applicable case law, including Hartline v. Sheet Metal Workers’ National Pension Fund.
With respect to the PPA, Mr. LeBlanc stated that the PPA gives Trustees new tools to avoid funding difficulties. Because these tools require settlor type decisions that will change benefits and contribution structures, he indicated that the plan must be able to pay to use these tools.
He noted that under the PPA, plans sponsors are required to provide the bargaining parties with a set of schedules for contribution increases or benefit cuts. He indicated that he doesn’t believe that it is realistic to pass these expenses back onto the bargaining parties and observed that the DOL has previously placed significance on the decision to make a payment out of plan assets on the lack of resources to pay for it.
According to Mr. LeBlanc, the costs of implementing the PPA requirements should be paid out of plan assets as expenses for the provision of benefits, as necessary administrative expenses, and as expenses in the best interests of participants. He stated that the expenses to develop a funding improvement plan or rehabilitation plan properly may be paid from plan assets because they are incurred for the purpose of providing benefits or administering the plan.
He indicated that the whole purpose of the PPA is to protect participants and beneficiaries and that compliance expenses should therefore be payable out of plan assets. He also believes that it is in the participant’s best interest to expect the trustees to obtain and oversee professional guidance and for the trustees to be authorized to pay those related expenses from plan assets.
He indicated that the plan sponsor of a multiemployer plan lacks the financial resources to pay these expenses to carry out settlor type functions. He also advised that the number of contributing employers and participating local unions in large multiemployer plans makes it impractical to obtain payment from the bargaining parties for these design related decisions.
He also expressed the view that increased disclosure obligations under the PPA will lead to second guessing of the trustees’ decisions. As an example, he indicated that a funding improvement plan may be required to reduce ongoing benefit accruals enough for the plan to meet its funding benchmarks. According to Mr. LeBlanc, participants will doubtless debate whether a cut is necessary.
Mr. LeBlanc indicated that the Department’s approach to these vital expenses disregards an important policy function served by the settlor doctrine. He advised that plan design choices are not easy, they’re not simple, and they’re not universally acceptable. The law, however, has long accepted that tough choices deserve deference. He believes that the position that Department takes is really unsupportable and that we should be encouraging people to seek guidance, rather than telling them they cannot. At a minimum, he would like to see the Department revisit the field assistance bulletin.
Summary of Testimony of Troy K. Saharic
Mr. Saharic is a Principal and West Zone Business Leader with Mercer Investment Consulting, Inc. in Seattle, and a member of the National Association of Government Defined Contribution Administrators. Mr. Saharic serves as the lead investment consultant to defined contribution (DC) plan sponsors with assets totaling over $30 billion. His testimony was focused primarily on the mid to large segment of the participant-directed DC market (defined as plans with assets greater than $500 million) and addressed the fee transparency issues facing plan fiduciaries seeking to understand total DC plan costs, and the desire for more transparent fee disclosures to participants.
Mr. Saharic began his testimony by providing some context – he shared that the US DC market is just over $4 trillion in size and expected to grow. He then pointed out that Americans are increasingly reliant on these plans for retirement readiness, and that it is ultimately the contributions to the plans and the net returns on these savings that will get them there. He testified that plan sponsors are looking for ways to enhance returns by adopting strategic investment structures, retaining high quality investment options and reducing investment / administrative costs borne by participants.
Mr. Saharic then described the service components required to offer a DC plan: Record keeping / Administration, Investment Management, and Custody/Trust Service. While these services were largely bundled (sold together) in the past, over the last 10-15 years there has been a migration towards unbundled DC plan management, particularly in the large ($1 billion+) segment of the market. The migration has occurred as these sponsors have been able to isolate and reduce costs of each service component. Mr. Saharic observed that in spite of this migration, bundled providers still manage 44% of DC assets in proprietary funds, representing 53% of DC plan accounts. Mr. Saharic commented that the bundled providers have maintained market share by providing services at what appears to be low cost – this apparent low cost achieved by economies of scale, growth in DC assets and the use of revenue sharing on arrangements with non-proprietary investment offerings.
Mr. Saharic indicated that revenue sharing has proliferated as a result of the increased offerings of non-propriety investment options, and is typically made available through (1) 12b-1 fees and / or sub-transfer agency fees paid from the assets of the mutual fund, or (2) revenue sharing arrangements negotiated between the investment manager and service provider. The negotiated arrangements, while better disclosed over the last few years, are not always transparent to the plan sponsor.
Mr. Saharic advised that plan sponsors need (1) to examine the economics of their 401(k) service provider arrangements, (2) understand the actual costs of each the service components being provided (e.g. administrative vs. investment management) and (3) determine whether overall fees are reasonable, can be reduced through utilization of lower cost investment vehicles/rebating to reduce investment expenses, or optimized by gaining additional services for the plan. In order to understand the level of cost and reasonability, Mr. Saharic demonstrated through example, that plan sponsors needs to seek to understand the various revenue sharing arrangements in place for each investment option.
Mr. Saharic testified that plan sponsors are supportive of promoting and providing transparent fee disclosures to participants but struggle with:
- Providing concise information on the complex and widely varying arrangements for revenue sharing in an format that can be easily understood, at a reasonable cost
- The lack of a simplified “best practice” fee disclosure in the market
- Competing priorities for DC participant communication (e.g. getting more eligible employees to participant, increasing savings, improving investment decisions)
In conclusion, Mr. Saharic stated that plan sponsors who have the appropriate tools, have been diligent in their efforts to fully evaluate the total costs of the DC plans that they offer and that these plan sponsors will continue to proactively look for ways to improve participants’ net returns by reducing all costs borne by their plans.
Next, he pointed out that revenue sharing arrangements are a reality of the DC industry. He encouraged the investment management community to continue to develop lower cost vehicles to use in DC plans.
Third, he asserted that fee disclosures can become transparent to participants if plan sponsors and advisors are diligent in gathering information. He acknowledged that some transparency issues still exist with respect to the revenues received and costs incurred by some record keepers / administrators that make understanding the fees a difficult task for some plan sponsors.
Finally, he stated that plan sponsors are fully supportive of providing transparent fee disclosure and plan expense to participants, however they are seeking direction for a more simplified consolidated fee disclosure.
Summary of the Testimony of Judy Mazo
Judy Mazo of The Segal Company agreed to testify before the Working Group on Fiduciary Responsibilities Update and Revenue Sharing. Specifically, Ms. Mazo directed her remarks to the ‘clash’ between settlor and fiduciary functions and the use of plan assets to pay for functions needed to run, operate and administer a multiemployer plan, particularly in light of the Pension Protection Act of 2006.
Ms. Mazo testified that there are four non-exclusive functions considered as ‘settlor’ functions. They are plan formation, plan design, plan amendment and plan termination. These four require expert, unbiased advice from attorneys, actuaries and accountants. The crux of the issue, she testified, is that plan assets may be used to pay for fiduciary functions but not for settlor functions. This is well-settled case law and regulatory interpretation. The conundrum for consideration is that the four settlor functions enumerated above are perceived by Labor as being so closely related to a fiduciary function as to require the use of plans assets in the retention of experts in order to properly discharge formation, design, amendment and termination exercises in the best interests of plan participants while Management views the very same functions as being non-fiduciary items for which plans assets cannot be used in the payment of fees. Ms. Mazo testified that plan participants view all of the money that goes into the plan as something that’s been negotiated and the employers view the money as all coming from their capital and their profitability. She stated that the ‘truth’ is probably somewhere in the middle.
Ms. Mazo discussed at length the Field Advisory Bulletin issued by the Labor Department in 2002. Up to that point, she stated, DOL had always couched its guidance as “for single employer plans” or “except for multiemployer plans.” The ’02 FAB stated that if plan assets were to be used for settlor functions then plan trustees would have to acknowledge that they were willing to be accountable on a fiduciary basis for those settlor decisions to use plan assets to engage experts in the matters of plan formation, design, amendment and termination. In essence, electing to heighten scrutiny and accountability to a fiduciary level for what had always been a plan management decision. The bottom line, Ms. Mazo stated was that to have trustees give up the liability shield in order to use plan assets for settlor functions. She testified that in the multiemployer world, nobody makes use of this particular FAB.
Ms. Mazo spent a great amount of time discussing the sensitive and political issues surrounding the use of plan assets and the need for a liability shield. First, she discussed with several examples that it isn’t really that hard to come up with a clear rationale that would allow multiemployer trustees acting as settlors to use plan assets to pay for the cost of doing their job correctly. She intimated that under Taft-Hartley, the charge to trustees is to administer the fund and its assets and that charge under most all trust agreements includes plan design to some degree. From a public policy perspective, Ms. Mazo laid out three reasons for allowing settlor functions to be paid for with plan assets. First, trustees must make sometimes controversial and always very sensitive decisions. Such decisions must be made without the threat of second-guessing. For instance the decision of increasing or decreasing benefits is always going to disturb one side or the other. Nevertheless, such a decision, she stated should be made without the threat of fiduciary litigation. Secondly, Ms. Mazo stated that the question of “what’s fair and unfair” is something inherent within the political process of the multiemployer pension plan world and is between the bargaining parties. The trustees should be able to mediate, she felt, and pay for expert guidance with plan assets. Third, and final, the point was raised as to the settlor v. fiduciary function and its effect upon fiduciary insurance. Carriers are pricing into the coverage the effects of electing fiduciary status per the FAB and also the effects of making settlor decisions without expert guidance. In any event, the premiums are being driven higher and higher.
In summary, Ms. Mazo stated that there were no clear answers. A problem exists. She stated that the Walling case was indicative of numerous court decisions holding that plan design is a settlor function. Likewise, Ms. Mazo alerted the Council to the fact that the Katarino case stated that the very same plan design function was a fiduciary function. The very essence of a solution must be found whereby DOL and Congress do not create an impregnable shield for trustees to do whatever they want in a self-interested way. The resolution lies in balancing risk, fairness and accountability.
Summary of Testimony by Mark Lotruglio
Mr. Lotruglio is vice president and principal with Quan-Vest Consultants, an investment management consulting firm that serves small to mid size multiemployer benefit plans.
He opened his remarks by noting that most decision makers of small to mid size defined benefit plans are not sophisticated regarding investment management. Such employers should hire experts to advise them.
Plan sponsor decision makers tend to be conservative. Historically, many have had strong preferences for domestic holdings, versus a strategic combination of domestic and foreign holdings. Such a preference has been especially prevalent with union organizations because of their pro-American stance. Low interest rates in recent years have forced plan sponsors into considering larger equity exposure, which has made many of them increasingly uncomfortable. He suggested that the use of additional asset classes, such as international stocks and real estate, has the desired impact of higher expectations of return and lower expectations of risk.
Mr. Lotruglio outlined three general ways to improve a given plan’s funding situation: improve returns, cut benefits or increase contributions. Improving return potential is difficult because of the likely corresponding increase in risk. Employers are seeking new investment ideas that can generate higher returns, while keeping risk in check. The accelerated funding requirements of PPA of 2006 have increased the challenges facing defined benefit plan decision makers. He feels that interaction between investment decision makers and plan actuaries is now even more critical than before PPA of 2006.
He recommends that the DOL issue guidance that specifies fiduciary responsibilities for plan sponsors, in light of movement within the defined benefit industry to more sophisticated investment vehicles. Many plan sponsors are now utilizing alternative investments which are often highly leveraged, non-transparent and complicated. Investment responsibility can be delegated to a third party by the plan sponsor, but only if acknowledged in writing by the service provider.
It is critical that plan sponsors be able to use plan assets to pay for investment management and investment consulting services, says Mr. Lotruglio. Otherwise, plan sponsors will not be able to manage their plans adequately, given the increased need that plans now have for higher returns, due to PPA of 2006.
He reiterated that the most important point of his testimony is that the increasing usage of alternative investments requires clarification and guidance from the DOL for plan sponsors. If the DOL does not issue such guidance, Mr. Lotruglio believes that the unfortunate consequence for employers will simply be higher contribution requirements.
Summary of Testimony of Joyce Mader
Joyce Mader, a partner with the firm of O’Donoghue & O’Donoghue, testified regarding settlor and fiduciary functions and the use of plan assets. Ms. Mader provided oral testimony, as well as written remarks.
Ms. Mader indicated that it has become much more difficult to advise trustees since the Department of Labor began issuing guidance in this area. She indicated that multiemployer trustees have a choice now, it appears, between acting as fiduciaries or acting as settlors. When they ask what’s the best way to go, she indicated that the answer is, “Well, that depends.” Ms. Mader indicated that is very frustrating and unsettling to trustees, particularly when they ask questions about whether they are protected, covered by insurance and whether they can use plan assets.
Ms. Mader indicated that up until the time of Field Assistance Bulletin 2002-2, there hadn’t been any real specific issues addressed to multiemployer plans. Instead, she advised that there seemed to be an effort to say that these are the rules except for multiemployer plans, and it was never very clear what the rules for multiemployer plans were.
She then provided a brief overview of the differing case law in this area. For example, she indicated that in one batch of cases, the courts said that multiemployer plans amending plans are not doing so as fiduciaries. In another batch of cases, she indicated that courts found that multiemployer plans amending the plan were doing this as fiduciaries.
She also discussed guidance provided by the Department of Labor regarding settlor and fiduciary functions, including the Erlenborn letter dated March 13, 1986 and the Maldonado letter issued March 2, 1987, wherein the Department reviewed the kinds of activities that would be considered settlor functions for which plan assets could not be properly expended. When discussing the Maldonado letter, she noted that there was no discussion of multiemployer plans. She also indicated that it is not clear how this characterization of these functions as settlor because they relate to the business activities of an employer relate to the functions of a multiemployer board making specific decisions on plan design.
She stated that she has been mystified that the Department would characterize a plan amendment to increase benefits as something benefiting the employer. She advised that her experience has been that usually it is the employer fighting to avoid the increase and the union and/or trustees fighting to get it. And yet she indicated that the analysis as to why this is a settlor function versus a fiduciary function is because it benefits the employer.
She then discussed Advisory Opinion 97-03A. She indicated that it became apparent in this advisory opinion that the Department viewed expenditures for a function that it classified as a settlor function as “inuring to the benefit of an employer” and that the Department believes the reason it is a settlor function is because the function benefits the employer, in violation of Sections 403(c)(1) and 404 of ERISA. She noted that the language, "except in the case of multiemployer plans,” was in the opinion.
She testified that she doesn’t believe that the Department’s analysis is really supported by the language of ERISA. She indicated that Section 403(c)(1) of ERISA provides that the assets of the plan must be held for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying the reasonable administrative expenses of the plan and that Section 404(a)(1)(A) of ERISA requires that fiduciaries discharge their duties for the same exclusive purpose. She advised that for a number of years prior to the 1997 Advisory Opinion, both courts and the Department of Labor had recognized that fiduciaries could, in fact, incidentally benefit the employer through the incidental benefit rule. As an example, she cited Interpretative Bulletin 94-1 regarding economically targeted investments.
When responding to a question regarding what the rule should be, she indicated, in part, that court cases would not have to be overturned to find that something is not a settlor function because the language of Sections 403 and 404 of ERISA says that plans assets may be expended for the purpose of paying benefits and doesn’t say it has to be a fiduciary function. She testified that a straight-on reading of the language says that plan assets may be expended for the purpose of paying benefits and for defraying the reasonable expenses of plan administration.
She then discussed Field Assistance Bulletin 2002-2. She described the Bulletin as allowing multiemployer plans pick. She indicated that they can either decide that they are going to function as a fiduciary and then can spend plan assets or they can decide that they are not functioning as a fiduciary and then can’t spend plan assets.
In her written testimony, Ms. Mader concluded that it is not clear to her why multiemployer trustees should not be able to expend plan assets for settlor functions. She indicated that such an expenditure is not prohibited by ERISA which permits expenditures for the purpose of providing benefits as well as for the reasonable expenses of plan administration.
Summary of Testimony of Gene Kalwarski
Gene Kalwarski, who is the CEO and a consulting actuary with Cheiron, appeared before the Working Group and presented testimony regarding the Pension Protection Act (“PPA”).
He indicated that about two thirds of about 75 Taft-Hartley plans that are his clients are going to be facing critical or endangered status from the get-go and that for the balance, it takes only a single year of a bad investment return to send them into endangered or critical status. He is concerned that there is so much responsibility on the actuary to guide these funds though rehabilitation plans and funding improvement plans that actuaries are going to be overwhelmed and there is going to be a greater fear of liability exposure.
As an example, he indicated that they are being asked to classify for a pension fund by March 30, 2008 , whether a plan is critical or in danger. However, he indicated that there are ambiguities in the law and that they have no guidance. He advised that the IRS has told them that guidance probably isn’t coming until the first quarter. He indicated that actuaries have to go in there and be certifying whether a plan is in red, yellow or green without having answers for how to project an ‘07 evaluation to ‘08. According to Mr. Kalwarski, there are different techniques and if they do it one way and another actuary does it another way, there is going to be fear down the road that there will be lawsuits.
He stated that asking the actuary to do projections is the best part of the PPA. However, he indicated that in the 1980s, there was a situation where one of the largest insurance companies nearly toppled and the actuaries were performing projections all the time. He advised that one of the problems was that actuaries were making best-estimate assumptions, whether it be 9 percent, 6 percent or 5 percent.
He advised that a straight-line assumption is useful, but it doesn’t indicate any level of risk and the reality is markets go up and down. He indicated that what happened in that industry since the 1980s was the creation of a technique called dynamic financial analysis, which forces the life insurance actuaries not only to do projections based on straight-line assumptions, but to also do projections based on up-and-down markets. He indicated that this is something that is desperately needed in the pension area.
Summary of Testimony of David Blitzstein
David Blitzstein, who is a Special Assistant for the Multiemployer Funds Collective Bargaining Department of the United Food & Commercial Workers International Union, testified before the Working Group regarding the fiduciary/settlor distinction in the context of multiemployer plans. Mr. Blitzstein provided both oral and written comments.
Mr. Blitzstein is a multiemployer trustee who currently serves on five pension plans and advises an additional multiemployer pension plan. He indicated that he has also acted as a negotiator of employee benefits on behalf of two international unions.
Since the issuance of Field Assistance Bulletin 2002-2, he indicated that he has become less comfortable with the definitions of fiduciary and settlor. He indicated that he is concerned about the confusion over the issue of whether a multiemployer plan trustee is a fiduciary or settlor when making decisions that in a single employer context are clearly settlor in nature.
He indicated that the Field Assistance Bulletin and some subsequent actions by the Department of Labor seem to confirm his belief that the Department does not completely appreciate the delicate and complex relationship between multiemployer plans and collective bargaining parties. As an example, he advised that the Department issued a letter to a multiemployer pension plan taking the position that it had violated ERISA in paying its actuarial consultant fees related to costing benefits which was used in collective bargaining. He indicated that this made no sense to him and that it sent a chill through the multiemployer plans and collective bargaining parties who knew about it.
He indicated that he believes that the passage of the Pension Protection Act (“PPA”) blurs and fundamentally changes the pre-PPA fiduciary/settlor distinctions. According to Mr. Blitzstein, the funding rules and procedures established by the PPA anticipated a closer consultative relationship between plan trustees and bargaining parties. However, he indicated that based on the Department of Labor’s current position, if a Board of Trustees took the position that trustee decisions were settlor-type decisions, that would mean that the trustees could not use plan assets to pay fund professionals to assist the trustees in fulfilling their statutory responsibilities under the PPA. Mr. Blitzstein indicated that does not make sense and is not in the best interest of plan participants.
He also expressed the view that shifting the responsibility and cost of calculating benefit design and contribution levels to the collective bargaining parties is dangerous public policy. He indicated that consultants retained by collective bargaining parties have no ethical or professional commitment to the pension plan or its participants and may offer short-term, risky solutions that are not necessarily in the best interest of participants.
He proposed that a decision made by fiduciaries under the PPA that is a plan design decision, including decisions regarding which classes of participants’ benefits should be adjusted, would not be subject to fiduciary standards, as this is classically the type of decision that settlors have been given flexibility to make without having to justify it on fiduciary grounds. He stated that the fact that the PPA directs the trustees to make these decisions means that plan assets may be used to do so. He indicated that this proposal also anticipates that the normal fiduciary standards would apply to the expenditure of plan assets, including the principles of reasonable compensation and the provision of necessary services.
He next addressed investment issues related to the PPA’s mandated funding standards, including what may be appropriate alternative investments to meet those funding requirements. He indicated that the PPA’s funding standards will require boards of trustees to reduce risk and decrease return volatility in their plans. According to Mr. Blitzstein, this is a difficult challenge that can’t be accomplished with the traditional 60/40 equity/bond asset allocation.
Even before that passage of the PPA, he advised that some plans had started using risk-budgeting tools to measure their market exposures in risk in an effort to avoid the risk of shortfall funding. He indicated that this drove some boards of trustees to invest or consider investing in alternative assets that are non-correlated with stocks and bonds, such as real estate, private equity, global inflation-linked bonds, commodities, hedge funds, and infrastructure.
He indicated that his biggest fear is that boards of trustees will hesitate to make these fundamental decisions to more aggressively diversify their asset portfolio because they may be viewed as an outlier in the pension community, raising the risk of fiduciary liability. He urged the Working Group to address that concern and give boards of trustees the confidence that prudent diversification investment strategies are encouraged by the Department of Labor and protected under fiduciary standards.
Finally, he proposed that a U.S. Government task force, including the Department of Labor, Department of the Treasury, Pension Benefit Guaranty Corporation, and the Federal Reserve Bank, address market failures and dislocations that potentially threaten the retirement security of tens of millions of Americans. He indicated that the task force could consider ways to better manage asset bubbles and severe market volatility, promote market transparency, and encourage the development of investment products in the private sector that would assist pension trustees in managing inflation risks, interest rate risks, and mortality risks.
Summary of Testimony of Michael Malone
Mr. Malone is the founder of MJM401k, which is a consulting firm and a Registered Investment Advisor that specializes in serving middle market 401(k) plans. In his experiences, he has seen revenue sharing used both appropriately and inappropriately. The concept is abused at times by some providers and advisors.
In a majority of cases, the employer is “unconscious” about revenue sharing that is taking place because the employer has not been a party to the discussion or decision making as to how it is applied. However, the employer is the entity that is ultimately responsible and has the greatest fiduciary liability exposure.
Mr. Malone explained a “solving for x” culture whereby the goal of advisors and plan providers may be the development of a plan that has no “billable” expenses. Thus, a given plan sponsor may view the plan as “free” because the sponsor is unaware of total plan costs. Inappropriateness occurs when the plan sponsor is not engaged in decisions which affect plan participants. Mutual fund share class selection is an example of an area where plan sponsors are often not involved in the selection process, but should be. Different share classes of the same mutual fund can vary by as much as 100 basis points in total annual cost. Share class selection has fiduciary consequences.
He emphasized that revenue sharing can be a very useful tool with significant benefits for participants. The DOL should issue written guidance that demands strict disclosure of all revenue sharing agreements between 401(k) service providers. Plan fiduciaries should be put on notice by the DOL that they are legally responsible for controlling all expenses paid by 401(k) plan participants. Mr. Malone feels that such guidance should explicitly state that a plan sponsor has a fiduciary responsibility to understand any revenue sharing within a plan, and sponsors must determine whether compensation paid to service providers is reasonable.
Guidance from the DOL should specify required disclosure of all plan expenses, including compensation to service providers, on both the IRS Form 5500 and the SAR. Service providers should be required to disclose all available share classes of recommended funds, and the breakdown of how fees would be allocated or shared, depending on which share classes are selected. Service providers should disclose to plan fiduciaries any and all compensation that they receive. Analyzing the profitability or efficiency of a given provider is not necessary. Instead, plan sponsor fiduciaries should have a full understanding of all costs and all compensation, and determine whether the resulting costs to the plan and participants are reasonable.
Mr. Malone’s experience has been that most service providers will, when asked, provide specific and complete information regarding revenue sharing. One exception he noted involves the use of guaranteed investment contracts and “fixed accounts” which are often used by insurance company plan providers.
The DOL needs to provide education to plan sponsors to help them better understand 401(k) plan pricing and the role of revenue sharing in such pricing. Such educational material should address: 1.) full explanation of investment vehicle expense ratios, 2.) potential unreasonable compensation to plan service providers, 3.) multiple share classes, 4.) expense ratios which often pay for more than just investment cost, 5.) “wrap fees” which are often undesirable because they are usually disclosed to participants, whereas revenue sharing arrangements usually are not, and 6.) selection of funds based only on the lowest expense ratios or the greatest revenue sharing, which can be detrimental to participants. Mr. Malone feels that if too much attention is focused on plan expenses and revenue sharing, important issues such as quality and value returned for cost can be lost.
While time did not permit for Mr. Malone to complete his testimony before the Council, his written remarks indicate a strong opinion that the DOL should develop a model prototype for the disclosure of revenue sharing payments. He further noted that participant level disclosure of revenue sharing would be either “unread at best” or “misunderstood at worst.” As such, Mr. Malone believes the burden of understanding revenue sharing, and making sound decisions accordingly, falls upon the shoulders of plan sponsor fiduciaries, not plan participants.
Summary of Testimony of Francis X. Lilly
Mr. Lilly is the chairman and CEO of Independent Fiduciary Services, Inc., a Washington D.C.-based investment consulting firm providing investment consulting advice to institutional investors. Mr. Lilly previously served as Solicitor of the Department of Labor from 1983-1985. Mr. Lilly presented testimony to the Working Group on Fiduciary Responsibilities and Revenue Sharing regarding revenue sharing practices and disclosure of plan fees and expenses in connection with defined contribution plan investment management expenses.
Mr. Lilly summarized the current judicial and regulatory environment regarding defined contribution plan fee disclosures. He noted that recent legal actions filed concerning plan fees have been of two types: (1) those filed against plan sponsors alleging failure to disclose and/or monitor fees and expenses; and (2) those filed against plan service providers alleging that the service providers did not disclose revenue sharing arrangements and that the proceeds of such arrangements should have been used for the benefit of plan participants. In the face of many pending court cases challenging fee disclosure or fee reasonability, Mr. Lilly cautions that the lack of specific defined contribution plan fee disclosure requirements from the Department of Labor could lead to conflicting and inconsistent requirements dictated by the courts. Mr. Lilly also summarized the current disclosure requirements on Form 5500 Schedule C and the current requirements of ERISA Section 408(b)(2) regarding reasonability of compensation paid to parties in interest for services necessary for plan operation. Proposed revisions to these requirements would presumably provide for greater compensation reporting by plan service providers of amounts paid by the plans and by parties other than plans, such as investment managers, consultants, brokers or trustees.
In addition, Mr. Lilly highlighted the confusion that surrounds use of the term “revenue sharing” in the defined contribution plan context, and the lack of a clear understanding of all fees paid by defined contribution plans or earned by and between service providers for these plans. Mr. Lilly offered a generally accepted definition of revenue sharing – an arrangement by which a portion of the internal fees associated with an investment product is paid to an entity that either provides services to the defined contribution plan in which the investment product is included or distributes the investment product. Revenue sharing, so defined, is thus separate and distinct from any payments made directly to a defined contribution plan by the plan’s bundled service provider. Such payments to the plan are considered rebates in the investment community’s vernacular. Mr. Lilly further offered generally-accepted definitions of several common elements of fees, costs and revenues that are paid and/or earned by defined contribution plans, their service providers and mutual funds/investment companies – including expense ratios, management fees, 12b-1 fees and their components, sub-transfer agent fees, and shareholder servicing fees. Mr. Lilly asserted that it is imperative that the Department of Labor take the lead in formally defining these and other fee terms in the defined contribution plan context in order to improve recognition of the full panoply of such fees and to avoid potential confusion of conflicting court decisions regarding their meaning.
Inherent in the Department’s effort to fully understand the cost structure of defined contribution plan programs, and in the industry’s efforts to serve such plans in a profitable manner, is the key question in Mr. Lilly’s opinion – what are the real costs of plan administration and mutual fund investment management in the defined contribution environment and what is the most efficient and effective way to disclose those costs? The answer to this question is complicated by several factors, such as the implications of rebates to plans, the layers of fee categories and sub-categories among providers and the degree to which stated fees are fixed and non-negotiable. As to the last factor, Mr. Lilly notes that fees are not generally fixed and non-negotiable because defined contribution plan providers share fees with investment managers in a variety of ways. Fee application and disclosure is further complicated by market forces – large plans may simply have more options than small or mid-sized plans with regard to fee arrangements because of their relative negotiating positions. One prevailing issue is that there are a number of ways that a provider can raise revenue. The challenge is to determine how plan fiduciaries can best determine that all the fees imposed are for the cost of real and necessary services to the plan.
Mr. Lilly acknowledged that fees must, at least in part, be driven by the market economy. Improvements in services for defined contribution plan services and technology must be reflected in the prices of those services to plans. Mr. Lilly asserted that service providers should not be required to disclose the profit margin in their pricing models. However, Mr. Lilly recognized that plan fiduciaries have a right and a responsibility to understand the actual cost of specific services provided to the plan.
Mr. Lilly noted that although defined contribution plan fiduciaries must meet the ERISA fiduciary standard of care, many lack sufficient information regarding fees to adequately meet this standard. To remedy this situation, Mr. Lilly recommended standardization of the terminology used in the defined contribution fee context. Mr. Lilly stated that his clients would welcome direction and guidance from the Department in this area to establish an industry-wide standard for disclosure of fee information. Mr. Lilly also recommended that the Department lead the defined contribution plan service industry toward greater clarification of costs and services, requiring service providers to state the specific cost for certain plan services. This would, in Mr. Lilly’s opinion, contribute to greater transparency regarding plan fees. Such transparency would enable plan fiduciaries to make informed decisions by comparing providers on a level playing field and would enable plan fiduciaries to better carry out their responsibilities.
Summary of Testimony of Allison Klausner
Allison Klausner is the Assistant General Counsel Benefits at Honeywell International, Incorporated, responsible for legal matters, including litigation, compliance and corporate transactions related to employee benefits. She testified representing the American Benefits Council, and was accompanied by Lynn Dudley of the American Benefits Council. The American Benefits Council is a public policy organization that represents principally Fortune 500 companies and other organizations that assist employees of all sizes in providing benefits. Collectively, the Council’s members either sponsor or provide services to more than 100 million Americans.
Ms. Klausner addressed 401(k) fees, with a focus on two areas – (1.) the dialogue between plan sponsors and participants, and (2.) the dialogue between providers and plan sponsors.
Ms. Klausner noted that communication with participants is broader than fees, and that communication is key to achieving sufficient levels of participant savings in plans. She warned that participants need to understand fees within the context of services received, and that fees are just one factor to consider when choosing an investment fund. Fees should not be elevated to the extent that other factors, like potential returns, time horizon, risk tolerance, etc., are ignored. She testified that granular disclosures of fees could increase cost to the plan/complexity to the participant, and could, at worst, mislead or dissuade participants from trying to understand the plan or available funds. As a large plan sponsor, she recommended that disclosure should be focused on investment objectives, risk level, fees and historical returns of investment options.
Ms. Klausner also recommended that the rules regarding electronic communications need to be reformed to enable more efficient forms of communication, including internet and intranet postings. She also observed that participant level disclosure rules should apply to participant directed plans. She added that the information should be disclosed in a manner in which fees are charged, rather than artificial divisions of a single fee into multiple parts. Where disclosures of the exact dollar amounts would be costly, uses of estimates should be allowed.
With respect to provider-to-plan sponsor disclosures, Ms. Klausner noted that plan fiduciaries are already taking extensive steps to ensure that fee levels are fair and reasonable for participants. She cited a Hewitt survey where 77 percent of plan sponsors surveyed were either “very” or “somewhat likely” to undertake a review of fund expenses, revenue sharing and disclosure to participants. She related this to her specific experience at Honeywell where the due diligence process includes interviews with providers to gain insights on how processes are completed and where there are opportunities to be more cost effective. She discouraged plan sponsors using “check lists” to determine whether fees are reasonable due to the wide variance among plans.
Ms. Klausner noted that when assessing fee levels, a best practice for large plan sponsors is to negotiate with each provider of services, to best understand the fee for each portion of plan service. This also enables the sponsor to measure performance against the fees being charged for the various services (record keeping, investments, etc.) Effectively, the model moves away from bundling and revenue sharing. For the smaller sized market, bundling of services has resulted from desires to get economies of scales, sometimes among a group of service providers. In this case, it can be more difficult for the sponsor to asses exactly which piece of service a specific fee is for – and in that case it makes sense for the sponsor to assess the total fee for the menu of services that is required for the plan.
Summary of Testimony of Sam Brkich
Sam Brkich is Vice President at The Newport Group and a member of the Board of the Coalition of Independent 401(k) Record keepers (CIKR). His testimony on revenue sharing made the following points.
Revenue sharing is a common practice and is paid by many, but not all, mutual funds. However, disclosure to clients varies widely. There is nothing inherently “wrong” with revenue sharing, but it should be transparent. Generally, there is nothing in contracts regarding revenue sharing unless revenue sharing is part of the fee. It is not uncommon for there to be excess revenue sharing, although the amount is normally small. It can be expected if the average account balance of the plan exceeds $40,000. CIKR understands that a number of non-fiduciary service providers do not offset fees by revenue sharing, although CIKR members agree that excess revenue sharing should be returned to plan participants. A fiduciary is required to disclose revenue sharing and apply it to the benefit of the plan. However, this requirement does not apply to a non-fiduciary. But it is not clear whether it would be violation of regulations if a non-fiduciary retains revenue sharing that has not been disclosed. The question is whether amounts received by the provider are amounts paid by the plan. In Opinion Letters 97-15A and 97-16A the DOL appeared to take the position that revenue generated by a plan’s investment in a mutual fund that are paid to a service provider are amounts being paid to the plan indirectly. In any case, it would seem that amounts received indirectly through revenue sharing would need to be disclosed to the fiduciary in order for the statutory exemption for reasonable service arrangements to be available. There are limitations on a provider’s ability to identify and allocate revenue sharing, particularly in some investment types, e.g., stable value funds. Some CIKR members are working on a model to identify revenue sharing payments. Securities law creates some issues with revenue sharing being a plan asset.
CIKR would like clarification and guidance from the Department of Labor to address (1) whether providers can or must use excess revenue sharing to benefit plans, (2) whether excess needs to be held in trust, and (3) if so, how quickly, and (4) whether the receipt of revenue sharing needs to be disclosed in the Plan’s 5500. Further, a ruling from the IRS on the effect of a rebate on the tax-qualified status of the plan would be helpful. The existing rulings from the DOL do not address whether revenue sharing might violate the regulations because the DOL considers it be a factual question. CIKR believes the guidance should provide that:
- Service providers may agree to rebate excess revenue sharing, and the time and manner of crediting should be part of the fiduciary’s determination that the services arrangement is reasonable.
- If revenue sharing is not rebated, the determination of reasonableness should be based on provider disclosed estimates of expected revenue sharing, and the provider should have a contractual obligation to provided updates.
- Payment of revenue sharing should not be a prohibited transaction, and should become a plan asset when it is required to be paid to the plan under the terms of the service agreement.
- Plans should be permitted to allocate excess revenue sharing among participants on a reasonable basis.
- DOL should facilitate the IRS providing guidance or regulations on the character in the plan of revenue sharing payments.
Summary of Testimony of Mary Podesta
Ms. Podesta is the Senior Counsel for Pension Regulation with the Investment Company Institute (ICI), a national trade association representing mutual funds, unit investment trusts, and closed-end funds.
Ms. Podesta began her testimony by noting that the 401(k) plan has been a great success over the past 25 years and that research done by ICI and the Employee Benefits Research Institute shows that 401(k) participants make very sensible choices in allocating their assets (Ms. Podesta cited a recent ICI survey that found that, on an asset-weighted basis, 401(k) investors in stock mutual funds incur an expense ratio of 74 basis points versus 88 basis points for retail stock fund investors). Ms. Podesta noted that employer plan sponsors have played a critical role in this success and according to a 2006 survey by Deloitte and others, 75% of plan sponsors have chosen to use a full-service, or “bundled”, arrangement to obtain investment products and administrative services for their 401(k) plan.
Ms. Podesta focused much of her testimony on the reasons why employers choose to use bundled arrangements and why asset-based fees paid to record keepers in the form of revenue sharing are consistent with ERISA and can serve to reduce overall plan costs.
Ms. Podesta testified that in the plan context, asset-based fees mean that new participants and those with lower wages and lower account balances can participate in plans without the cost of plan administration falling disproportionately on their shoulders as a percentage of their account balance. Ms. Podesta also noted that asset-based fees are a way for a plan to spread out the payment of start-up expenses of a new plan or transition expenses when a plan moves from one record keeper to another, with these payments spread over time as assets grow.
Ms. Podesta noted that as with any service arrangement, plan fiduciaries need to monitor the arrangement to make sure that it remains reasonable over time. In this regard, Ms. Podesta stated that a plan and a service provider have the following options if growth of plan assets supports a revision of the service arrangement: (1) reduce costs by selecting lower-cost investment options or share classes, (2) require additional services that may not have been affordable originally, (3) negotiate with the record keeper to receive a share of the record keeper’s revenue and use the refunded revenue in a manner consistent with ERISA, or (4) put the arrangement out to bid to see if other service providers would offer comparable services at a lower cost.
Ms. Podesta testified that the ICI supports the Department of Labor’s initiative to revise its 408(b)(2) regulations to clarify what information plan fiduciaries need to make sure that a service arrangement is reasonable. In that regard, ICI’s view is that the DOL should require that plans receive information from their service provider on the services that will be delivered, the fees that will be charged, and whether and to what extent the service provider receives compensation from other parties in connection with the plan servicing. Ms. Podesta further noted that a plan need not look at the cost to the service provider since the plan fiduciaries are not required under ERISA to assess a service provider’s profitability.
Ms. Podesta next testified that a service provider that offers a number of services in a package should not be required to assign fees to the components of the package. In response to a question regarding a plan sponsor’s desire to know the component costs in order to be able to make comparisons to other service providers, Ms. Podesta responded that if the services are offered in a package then what the plan sponsor needs to know is the total cost of the package.
With regard to revenue sharing, Ms. Podesta testified that a service provider should disclose compensation that it receives from an unaffiliated party because that will allow the plan sponsor to understand the service provider’s total compensation and to appreciate any conflicts of interest. With regard to services provided by affiliates of the service provider, Ms. Podesta noted that plan sponsor should understand all of the services and the aggregate compensation paid, but the sponsor need not look at how those payments may be allocated among those affiliates since such an allocation is artificial given that affiliate transactions are not market-based transactions.
In response to a question regarding potential future changes to the rules governing rule 12b-1 fees, Ms. Podesta pointed out that at a recent Securities and Exchange Commission roundtable on 12b-1 fees, there was general consensus that modest changes may be needed but not radical reform. In response to another question around what might be the effect if a draconian rule were imposed to eliminate the practice of revenue sharing, Ms. Podesta pointed out that such a drastic rule change is not needed, especially given the fact that the 401(k) marketplace is very competitive and dynamic marketplace that has encouraged positive innovation over the year.
Summary of Testimony of Fred Reish
Revenue Sharing is prevalent and generally most participants pay revenue sharing in some form through their investments.
Currently, Service providers, that include revenue sharing expense in their costs, are knowledgeable plan people, who have no obligation or incentive to share their knowledge with the fiduciaries, although the fiduciary must disclose revenue sharing and possibly include such funds as plan assets when reimbursed.
When Plan fiduciaries receive better fee disclosure; they are better educated and can better assess the Service Providers and their Revenue Sharing expenses, which should benefit plan participants.
Regardless of whether the provider is a bundled or unbundled record keeper, there should be full disclosure of cost and fees because it is participant’s money. There should be full disclosure of the services and benefits attributable to the fees charged. This disclosure will permit fiduciaries to determine the reasonableness of the fees and compare these fees with those of other providers.
With respect to fee rebates, in current practice, the allocation on a pro rata basis is proper, but in the future, the best practice will be to allocate the funds back to the participant’s accounts, which actually generated the fees.
The Chairman read into the record, Mr. Reish’s background and requested that Mr. Reish focus on the problem of compliance with respect to Revenue Sharing fees. He sought Mr. Reish’s perspective on when these funds constitute Plan Assets. Mr. Reish stated that “Revenue Sharing is prevalent. Of the 401(k) and 403(b) plans that I am the general ERISA attorney for, every one of them pays revenue sharing.” This results in most participants paying Revenue Sharing in some form through their investments. In addition, he testified that of the providers he represents, all of them receive some form of Revenue Sharing. However, he stated that most fiduciaries do not realize or recognize that the plans they are responsible for have Revenue Sharing expense. He indicated that he believes that the plan asset advisers and providers are aware and do not disclose it to the fiduciaries. The law has clearly placed the obligation on the wrong party. However, that process is changing and the responsibility to disclose Revenue Sharing expense is shifting from the fiduciary to the provider to disclose it to the fiduciary.
This shift will start with the new rules for schedule C of 5500 and will also change because of the 408(b) (2) regulations when they are issued. Although the burden will shift to disclose, the fiduciary is still charged with the responsibility to determine if a fee is reasonable. DOL is now bifurcating the responsibility for fees and expenses, especially for indirect expenses. He did identify one issue with respect to his belief on the revised Schedule C requirements. Currently, because Schedule C must only be filed by employers with 100 or more employees, the requirement will only capture 20 percent of the plans. He believes it should be extended to all plans. He also raised a question regarding the proper disclosure of information by providers, whether bundled or unbundled and, requested that the DOL apply one consistent standard regardless of the business model employed by such provider. He testified that there are two principles that fiduciaries must address regarding expenses; (i) whether or not they are reasonable as they are allocated out and (ii) whether or not there are conflicts of interest of the Service Provider, they need to consider in their decision making as to the reasonableness. He also indicated that by receiving this information annually, they will be better educated to operate the plan and this information will educate them on the cost and expenses relative to the asset growth in the plan which might generate additional fees. This knowledge will enable the fiduciaries to negotiate better and provide for a comparison of each provider and the revenue sharing attributable to
He next described the various forms of revenue sharing fees and their impact on various size plans, i.e., (i) 12b-1 fees, (ii) sub-transfer agency fees and (iii) payments derived from investment management fees.
He testified that in large plans you almost never see broker-dealers operating as brokers so there are no 12b-1 fees for that purpose but the 12b-1 fees may be used to offset plan fees and expenses. He stated that you will see sub-transfer agency fees, which pay for transfer agent and shareholder services and may also subsidize record keeping services depending upon the share classes. He said this is an area ripe for investigation because the lawsuits raised this issue. He stated that fiduciaries must be better educated on the reasons for different share classes and associated fees.
He testified that in middle market plans you get a mix of the types of fees, but they are generally the sub-transfer agency fees or the investment management service type. If there is a broker, there may be 12b-1 fees, all of which increase the cost to the participant. He stated that with the small plans, you get a combination of sub-transfer agency fees and 12b-1 fees, especially where you have an annuity product with offsets and then after the offset amount is obtained a brokers charge is added back as a contract charge. This result may still be okay because there are usually much more services needed by a small plan.
Mr. Reish next engaged in a lively debate with several members of the Council regarding the need for full disclosure concerning bundled and unbundled providers’ fees and what type of disclosure must be made Mr. Reish indicated that it was his perspective that all cards should be placed on the table explaining the cost of the services provided to the fiduciaries so they could properly compare the various potential provider of services to the Plan. He indicated that full disclosure should not include the provider’s profitability but if there are any incentive payments made or crediting fees to an affiliate which might be a conflict of interest, they must be disclosed. He testified that there should be full disclosure as it is participant’s money. He stated that there should also be full disclosure of the services and benefits attributable to the fees charged so fiduciaries can test their reasonableness for the expense of these services against other providers. He testified that the burden should be shifted to the providers, the ones who can best supply the information. He testified that transparency should be the rule regardless of a plan’s size.
The final area addressed by Mr. Reish related to the when and how to utilize unallocated reimbursements received by a plan. He stated that one area of concern is that the IRS and DOL each have their own set of rules and they need more coordination. He believes that the DOL rules are much more realistic in their approach to the allocation issue. He stated that there is a need for additional guidance maybe in the form of a Field Assistance Bulletin to walk people through the issue. He recommends that in current practice, the allocation on a pro rata basis is proper, but in the future, the best practice will be to allocate rebates back to the participant’s accounts that actually paid them. He thinks under a cost benefit approach allocation on a per account basis is proper. However, he testified if a record keeper's systems become sophisticated and capable of analyzing such fees, then the rebates generated must be directed to the specific accounts which generated the cost in the first place.
Summary of Testimony of Laura Gough
“Revenue Sharing” has different meanings for different agencies, i.e. SEC, DOL and FINRA and it is important that you recognize the proper meaning when you are addressing DOL issues and not SEC issues.
The term, “Revenue Sharing” in an employee benefit context encompasses anything that a plan might receive from a third party, other than the employer or plan sponsor, i.e., revenue from 12b-1 fees, servicing fees or sub-transfer agency fees.
The DOL must make sure in its guidance that its guidance recognizes the unique distinction in the definition between its guidance and other bodies so confusion does not result. The DOL must delineate what types of payments it is talking about when it issues its guidance.
The DOL initiative must clearly state for providers what information is required by the fiduciaries with respect to Revenue Sharing and ensure that the guidance is in line with the guidance from other regulatory bodies that govern investments that are made in retirement plans.
Ms Gough was testifying on behalf of the Securities Industry and Financial Markets Association. Ms Gough testified that she wanted to clarify what exactly is “Revenue Sharing” because different people and different agencies use the term but it does not have the exact
It is her belief that revenue sharing arrangements and the services they have supported have created greater flexibility within the marketplace. Revenue Sharing has enabled many plans, even small plans, a great amount of flexibility to choose from a multitude of different investment options. It allows all plans to select from outside of the proprietary investment options previously required by bundled providers. Revenue Sharing provides a more democratic manner to allocate expenses with larger shareholders accepting the larger burden of expenses. Revenue Sharing has also enabled a number of smaller third party administrators to be able to maintain a competitive position in the marketplace
When the SEC and FINRA use the term Revenue Sharing, it has a very specific meaning and it is a payment from a fund adviser or a fund distributor and it comes from such person’s net revenues or profits and such payment is made to a broker-dealer for overall marketing services, training services, educational services and is not attributable to one particular client(s). The term Revenue Sharing, in an employee benefit context, encompasses anything that a plan might receive from a third party other than the employer or plan sponsor, i.e., revenue from 12b-1 fees, servicing fees or sub-transfer agency fees. In the securities sense, there can any number of different types of revenue that could result i.e., float, loaning of securities, or any types of payments that could be attributable to any one customer payable out of the fund adviser’s net profit. In the plan sense, it is any fees that are part of the net asset value, part of the expense ratio of the plan or fund not paid directly out of the plan assets.
Consequently, the DOL must make sure in its guidance that it is specific and recognizes the distinction in the various agencies’ applications of the term so that confusion does not result and the DOL must be careful to delineate what types of payments it is addressing when it uses the term Revenue Sharing.
Ms. Gough next addressed the area of the proper use and allocation of revenue sharing for an ERISA plan. In a plan context, revenue sharing is paid or servicing payments are paid to a plan provider, and then such servicing payments are then used to offset legitimate plan expenses. Generally, the provider will set up an expense account to receive in payments and then the provider deducts the plan expenses out of that expense account. Any additional excess expenses are paid either by the provider, the plan sponsor, or allocated in a prudent manner and paid by the participants. If there is excess revenue or an excess credit, then there may be issue because if revenue sharing is not a plan asset, how do you reallocate it to participant’s accounts. Another issue arises because the Office of the Comptroller of the Currency, the IRS and state insurance laws, each have rules which provide that if you have a share class in a mutual fund, you can not treat different shareholders in different ways with respect to payments. Each shareholder in a share class must receive funds in the same manner. The Internal Revenue Service might also inquire whether a preferred dividend was paid if one group was treated differently than another group with the possible result that all dividends paid to the mutual fund would be taxed.
In response to a question, Ms. Gough indicated that she has seen these credits either, (i) reallocated back to participants, (ii) reallocated to offset expenses and then used to reduce fund expense or (iii) some plans state that these are not plan assets and will not allocate back to the participants. Ms. Gough responded to another question if there has been any regulatory action concerning the preferential dividends by stating that this could an IRS issue and SEC issue. She testifies to her knowledge only the SEC has issued a no action letter which allows 12b-1 fees to b e rebated back to certain client accounts.
Ms. Gough then testified regarding share classes stating that it is up to the Plan Sponsor to negotiate the fees and terms of the various share classes by asking the right questions; do we qualify; what are the elements of the servicing payments, what is the most appropriate share class for my participants and how much revenue can be used to offset expenses. The provider must determine what its systems can do to reallocate excess revenue to participants and at what cost working with the Sponsor. She testified that it is up to the Plan sponsor to negotiate all the terms up front, in order to determine; what is the most appropriate share class for the plan and how the Plan might achieve different levels of the share class. She also agreed with a question stating it is a fiduciary duty to determine and negotiate the reasonable expenses of an investment fund before participation in a particular share class.
- Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 434-444 (1999) as cited in the testimony of Marc LeBlanc.
- See September 20, 2007 testimony of Joyce A. Mader, page 19
- The first initiative involves the revision of Schedule C (service provider information) to form 5500 annual return/report. The second initiative involves an amendment of the regulations under the statutory exemption for services provided in Section 408(b)(2) of ERISA.