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The Final 408(b)(2) Regulation: Impact on Broker-Dealers

This is the third in our series of bulletins on the impact of the Department of Labor (DOL) Final Regulation on service provider disclosures under ERISA Section 408(b)(2).  In our Alert released on February 3, 2012 [http://www.drinkerbiddle.com/DOLreleasesfinal-408b2regulation], we described the major changes between the Final Regulation and the Interim Final Regulation issued in July 2010.  In our bulletin released on May 10, 2012 [http://www.drinkerbiddle.com/final408b2impactoninvestmentmanagers], we described the impact of the changes on investment managers.  In this bulletin, we discuss the impact of those changes on broker-dealers.  (For background purposes, you can refer to our Alert describing the impact of the Interim Final Regulation on broker-dealers which is available at http://www.drinkerbiddle.com/interimfinal408b2impactonbrokerdealers.)

Key Considerations for Broker-Dealers:

  • The compliance date is extended from April 1, 2012, to July 1, 2012.
  • The indirect compensation disclosure must include a description of the “arrangement” pursuant to which the broker-dealer (or an affiliate or subcontractor) will receive indirect compensation.
  • The preamble provides for simplified compensation disclosures for Broker-Dealers as long as the responsible plan fiduciary has sufficient information to determine the reasonableness of the brokerdealer’s compensation.  Broker-dealers may also use estimates and/or a reasonable range to disclose compensation.
  • “Trailing” payments received after the completion of services are still received “in connection with” those services, thus requiring disclosures.
  • The DOL clarified that insurance brokers and agents selling pension plan arrangements are covered service providers if they receive indirect compensation.

1. Effective Date.  The DOL extended the compliance effective date of the Final Regulation from April 1 to July 1, 2012.  This extension may be particularly useful to broker-dealers who are still working on an effective disclosure strategy and need the additional time to comply.

2. Indirect Compensation.  Under the Interim Final Regulation, broker-dealers have been struggling with how to disclose their indirect compensation (as well as the services, payer and calculation for such compensation).  The new requirement to describe the “arrangement” with the payer that gives rise to the indirect compensation will create an additional hurdle for broker-dealers.  Some arrangements, such as the receipt of 12b-1 fees, may be relatively easy to describe.  However, there are many different arrangements pursuant to which broker-dealers receive compensation that may prove more difficult.  In the preamble, the DOL described a scenario in which financial institutions subsidizing the cost of attendance at a conference must be disclosed as an arrangement pursuant to which the service provider receives indirect compensation.  In the example, the subsidy related to the provider’s clients and hence was compensatory.  While not addressed in the preamble, if the subsidy does not relate to the provider’s clients, it is arguably not compensatory and not indirect compensation.  Broker-dealers will need to carefully examine these types of arrangements to determine whether disclosure is necessary.

3. Simplified Compensation Disclosures.  While parts of the final regulation (such as the requirement to describe indirect compensation arrangements) have added complication for broker-dealers, the DOL has provided some relief to these firms.  In the preamble, for example, the DOL noted that broker-dealers may not be able to identify the payer of indirect compensation in advance of the arrangement because the investments have not been purchased.  This is frequently the case with stock brokerage accounts.  To address this issue, the DOL noted that indirect compensation descriptions “may be expressed in general terms” and if information is unknown when disclosures are made, “the description need not identify the specific payer in advance of the service arrangement.”  While this is helpful to broker-dealers struggling with disclosures, it is limited by DOL caveats - although general terms may be used, the disclosure must still be “sufficient to permit a responsible plan fiduciary to evaluate the reasonableness of such compensation in advance of the service arrangement.”  Based on the DOL’s discussions in the preamble, we are helping broker-dealers navigate how to make disclosures in general terms (e.g., provide a schedule of transactions and a list of who pays revenue sharing to the broker-dealer), while still providing sufficient information for responsible plan fiduciaries to evaluate reasonableness of the total compensation.

Further, the simplification of what must be provided in advance of an arrangement when the broker-dealer does not know what will be purchased raises a question as to whether a change notice will be required.  The DOL addresses only the initial notice, leaving open whether the broker-dealer must provide a change notice when the plan actually purchases an investment.  This raises a critical issue for broker-dealers that requires guidance from the DOL.  We have commented on this issue to the DOL and hope it will be addressed when the DOL issues the additional guidance that has been promised.

The DOL also provided relief to broker-dealers in the form of addressing compensation ranges.  In the preamble, the DOL noted that disclosing “known” and “reasonable” ranges under the circumstances could be a reasonable form of disclosure.  We caution broker-dealers to think carefully about what range to disclose.  Disclosing compensation in the range of 0 to 100 basis points strikes us as not being reasonable – it is unlikely that a broker-dealer is providing services for 0 basis points.  Additionally, if the range is too broad, it may be difficult for a responsible plan fiduciary to evaluate the broker-dealer’s compensation.  Finally, the DOL refers to “known” ranges, indicating that each end of the range must be a real amount the broker-dealer may receive.

In addressing whether information can be provided electronically, the DOL noted that this can be done (e.g., on a website), but noted that the information must be “readily accessible” and that fiduciaries must be given “clear notification on how to gain such access.”  Thus, broker-dealers making disclosures on websites will want to make sure they are clearly informing fiduciaries that information is available electronically and how to access the information.  

Thus, while the DOL has softened the disclosure requirements for broker-dealers somewhat, they must be careful they do not take the DOL’s leniency too far and fail to provide sufficient information.  It is a fine line that broker-dealers should discuss with legal counsel.

4. Stock Brokerage Accounts.  In addition to presenting compensation disclosure issues, self directed brokerage accounts present questions for broker-dealers with respect to the recipient of the disclosures.  When plan fiduciaries decide to offer a brokerage account through a specific broker-dealer, the plan fiduciaries are “responsible” for the selection and should receive the disclosures.  However, when a participant decides to use the broker-dealer, then the participant becomes the decision-maker about whether and how to use the stock brokerage account.  This raises a question as to whether the plan fiduciaries or the participant or both are the “responsible plan fiduciaries.”  This is another critical issue that remains unanswered and on which we have commented to the DOL.  

The DOL’s recently issued Field Assistance Bulletin with FAQs on issues related to the participant disclosure requirements also contains information about brokerage accounts.  For further information, see the article in our ERISA Newsletter for Retirement Service Providers (which will be distributed shortly after this bulletin).

5. Trailing Payments.  In a footnote to the preamble, the DOL discussed how to determine whether the $1,000 threshold for a covered service provider is satisfied, noting that the question is whether the compensation is received “in connection with” the contracted services rather than when the compensation is received.  Specifically, the DOL noted that “[s]ome compensation, for example, trailing commissions, may be received after the services have been furnished, but still be ‘in connection with’ those services.”  This may raise an issue for broker-dealers in determining to whom disclosures should be made.  For example, often a broker-dealer will have so called “orphan accounts” with respect to which the firm receives trailing payments after the plan’s representative has gone elsewhere.  Broker-dealers are struggling with making disclosures to the fiduciaries of these plans.  Further, as the $1,000 threshold is measured over the life of the arrangement, counting such ongoing payments makes it more likely that a broker-dealer will reach that threshold and will be a covered service provider.  Broker-dealers will need to carefully review all of their arrangements so plans with these trail payments do not slip through the cracks.

6. Insurance Brokerage.  In a footnote to the preamble, the DOL addressed a comment regarding insurance brokerage services provided to qualified plans.  When these insurance brokers receive indirect compensation (which most do), they fall into the “catch-all” category of covered service providers.  (While the footnote refers to insurance brokerage services, in the past the DOL has combined insurance brokers and agents, and we assume they intend to do so here.)  Our understanding is that many insurance companies have not contemplated that agents may be covered service providers.  Those insurance companies will need to move quickly to make the necessary disclosures.

7. Asset Allocation Models.  As described in our bulletin [http://www.drinkerbiddle.com/final408b2impactonrias] regarding registered investment advisers, the preamble’s discussion of, and the DOL’s informal position regarding, designated investment alternatives may complicate matters for broker-dealers.  If an asset allocation model is a designated investment alternative, broker-dealers (and recordkeepers) must provide responsible plan fiduciaries with expense information as well as information the broker-dealer has, or can reasonably attain, that is necessary for the participant disclosures.  In recent guidance regarding participant disclosures, the DOL addressed when asset allocation models will be considered designated investment alternatives.  Specifically, the DOL clarified that if the model is just a vehicle for allocating among a plan’s designated investment alternatives (and satisfies other conditions), the model is not itself a designated investment alternative.  On the other hand, if the model is an entity in which participants invest that then invests in the other designated investment alternatives offered by the plan, then the model itself is also a designated investment alternative.  While this guidance will help broker-dealers determine what models require the additional disclosure information, brokerdealers are still struggling with actually gathering the information and many will be relying upon recordkeepers for making such disclosures.

8. Timing for Initial Disclosures.  The Regulation requires that disclosures be provided to the responsible plan fiduciary “reasonably in advance of the date the contract or arrangement is entered into, and extended or renewed.”  The Department elected not to provide clarification as to when a contract or arrangement begins.  This is of particular concern for broker-dealers because broker-dealers are often gathering information and presenting options to plan fiduciaries before a formal agreement is executed.  Clearly the information should be disclosed before the plan is obligated to pay any compensation to the broker-dealer.  However, it is due before the arrangement is entered into, which suggests it may be due before the responsible plan fiduciary selects an investment.  Broker-dealers must carefully consider when an arrangement begins and educate representatives so they understand the importance of providing disclosures in advance of the arrangement.

9. Guide.  The Regulation provides a sample guide that can be used by covered service providers to facilitate the disclosure process.  While the guide is not required at this time, the DOL will be issuing proposed regulations addressing a guide requirement in the future.  For broker-dealers who will be making disclosures by cross-referencing multiple documents, the guide requirement will likely be prospective and only require adjustments to future disclosures sometime after the July 1, 2012, effective date.

10. Additional Guidance.  As mentioned above, the DOL recently issued guidance regarding the participant disclosure requirements in the form of frequently asked questions and answers.  We expect that the DOL will publish answers to frequently asked 408b-2 questions in the next few weeks.  

The Final Regulation provides some relief for broker-dealers in the form of relaxing the compensation disclosures to permit estimates, general descriptions, and ranges.  Nevertheless, the relief is limited by the notion that the disclosures must still be sufficient for responsible plan fiduciaries to evaluate the broker-dealer.  Preparing the compensation disclosures for broker-dealers will require significant time and effort.  Thus, we recommend that broker-dealers who have not started the process of preparing disclosures do so quickly.

Additional Articles in this series:

The Final 408(b)(2) Regulation: Impact on RIAs

Finally the Final … 408(b)(2) Regulation

© 2023 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume II, Number 153

About this Author

Fred Reis Faegre Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

(310) 203-4047
Bruce Ashton, Drinker Biddle Law Firm Los Angeles, Employment Benefits Attorney

Bruce L. Ashton has more than 35 years of experience handling employee benefits matters. His practice concentrates on representing plan service providers (including RIAs, independent record-keepers, third-party administrators, broker-dealers and insurance companies) in fulfilling their obligations under ERISA. His experience includes representing public and private sector plans and their sponsors, negotiating the resolution of plan qualification issues under IRS remedial correction programs, advising and defending fiduciaries on their obligations and...

Summer Conley, Employee Benefits Attorney Drinker Biddle

Summer Conley assists clients in a variety of employee benefit areas, including qualified plan work, executive compensation, and health and welfare issues such as HIPAA, COBRA, Section 125 and health care reform. She has assisted many companies in their compliance with the HIPAA privacy and health care reform rules. Summer has experience drafting all types of plan documents, summary plan descriptions and employee communications as well as advising clients regarding establishing, changing and terminating benefit programs and entering into benefits service...