October 24, 2021

Volume XI, Number 297


October 22, 2021

Subscribe to Latest Legal News and Analysis

October 21, 2021

Subscribe to Latest Legal News and Analysis

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

This is the first in our series of bulletins on the impact of the Department of Labor’s (DOL) Final Regulation on service provider disclosure under ERISA Section 408(b)(2).  In our bulletin released February 3, http://www.drinkerbiddle.com/files/ftpupload/PDF/FinallytheFinal.pdf, we described the major changes between the Final Regulation and the Interim Final Regulation issued in July 2010. In this bulletin, we discuss the impact of those changes on Registered Investment Advisers (RIAs). (For background purposes, you can refer to our alert describing the impact of the Interim Final Regulation, which is available at http://www.drinkerbiddle.com/files/ftpupload/PDF/408(b)(2)ImpactonRegisteredInvestmentAdvisers.pdf on the firm website.)

(Note: The disclosures under the Final Regulation must be made to the “responsible plan fiduciary,” defined as a fiduciary with the authority to cause a covered plan to enter into a service arrangement.  For ease of reference, we have used the term “plan sponsor” to refer to the responsible plan fiduciary.) 

1.   Effective DateThe compliance effective date of the Final Regulation was extended from April 1 to July 1, 2012.  We believe this extension will have minimal impact on most RIAs that provide investment services to covered plans, such as participant-directed 401(k) and ERISA-covered 403(b) plans, since most would have been able to meet the original compliance date.  However, for others, such as the following, the delay may provide a significant benefit:

a.   RIAs that do not consider themselves to be part of the retirement plan community and have not closely followed the development of the new disclosure requirements because they have few retirement plan clients;

b.   Those that actively manage the investments for pooled plans, such as defined benefit and profit sharing plans that are not participant-directed - As with the first group, many of these RIAs may have failed to recognize that they are covered service providers under the new rule;

c.    Managers of investments that plans may invest in, such as hedge funds in which the underlying assets are “plan assets”, which makes the manager a fiduciary under ERISA. These investment managers may not have taken steps to comply because they may not recognize that they are covered service providers;

d.   RIAs that refer investment managers to clients – RIAs should be aware that the DOL has taken the position that the referral of investment managers is similar to the recommendation of investments and may result in ERISA fiduciary status, thus causing them to be covered service providers under the new rule.

2.   Summary and RoadmapThe Final Regulation does not impose a requirement that the covered service provider give responsible plan fiduciaries a summary or “guide” to its disclosures, although the DOL has indicated that it intends to propose such a rule in the future. For the moment, the DOL has provided a non-mandatory sample guide. Given the pace at which the regulatory process moves, it is unlikely that a new guide requirement will be in place by the July 1 compliance date, though it could be in effect by year-end.  Also, we believe that any requirement for a guide will be prospective and, as a result, RIAs will not need to “re-disclose” the summary or guide to pre-existing plan clients. 

For RIAs that have relatively straightforward service agreements, such a requirement would not appear to be particularly onerous – or, for that matter, particularly necessary – but if a guide does become a requirement later on, RIAs may provide the guide at the beginning of their agreements or as a separate, standalone piece to accompany the agreement.

3.   Designated Investment Alternatives (DIAs).The Preamble to the Final Regulation states that a “’designated investment alternative’ is any investment alternative designated by the covered plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts.”  While not explicitly stated in the regulation, DOL officials have said informally that this would include asset allocation models (AAMs) in which a participant may invest directly, e.g., where the AAM is listed on the recordkeeper’s website as an investment (as opposed to an “education” model which shows the participant an allocation that he can construct for himself). 

The impact of that interpretation may be significant.  This is because (i) under the 408(b)(2) regulation, the recordkeeper has an obligation to disclose information about each designated investment alternative, including expense ratios and other expenses, and (ii) because the participant disclosure regulation (404a-5) requires that plan fiduciaries provide extensive information to participants about DIAs, including expense ratios, performance history and portfolio turnover. Since the information about the model’s performance, expenses, etc., is not usually available, recordkeepers will presumably turn to RIAs to provide the information.  And if an RIA is unable to do so, the recordkeeper may decline to include the model on its platform.  We are working with several RIA firms on compliant alternatives. .

4.   Indirect Compensation.  The Final Regulation requires disclosure of the “arrangement” with the payer under which indirect compensation is paid.  This is new and will take time for service providers that receive indirect compensation, such as recordkeepers or broker-dealers, to comply with.  It does not appear, however, to have much impact on RIAs, since they tend not to receive indirect compensation.  (It should be noted that because RIAs generally serve as fiduciaries to plans under ERISA, they need to offset any indirect compensation against their stated advisory compensation to avoid engaging in a prohibited transaction.  This is a separate requirement from the obligation to disclose.)

It is noteworthy that the DOL has indicated in the preamble that it “intends the concept of compensation to be received by a covered service provider, or its affiliates or subcontractors, ‘in connection with’ a particular contract or arrangement for services [to] be construed broadly.” It goes on to say that, to the extent compensation relates to the service contract or arrangement, the compensation received will be considered to be “in connection with” the contract or arrangement.  In other words, if the service provider is receiving compensation as a result of its arrangement with a plan, even if the service would not be considered a covered service, it must disclose the compensation. 

The preamble provides the example of a conference offered to plan clients in which the clients pay a small fee for attendance and a financial institution pays the RIA a larger “subsidy fee” to defray a portion of the cost of the conference.  The DOL states that, if the RIA is providing investment consulting services to covered plans and receives subsidies “or other remuneration” from financial institutions as to which the RIA may be making recommendations, “such subsidies or remuneration would be compensation received ‘in connection with’ the service provider’s contract or arrangement with the covered plan.”  Thus, both the amount (on a plan-by-plan basis) and the “arrangement” with the payer would need to be disclosed.  This arrangement may also present prohibited transaction issues.

5.  Responsible Plan Fiduciary Exception.   Under ERISA’s prohibited transaction rules, the responsible fiduciary for a plan (e.g., the plan sponsor or a committee) is prohibited from permitting a plan to enter into an arrangement with a service provider unless the arrangement is “reasonable,” which means that the responsible plan fiduciary has received the required disclosures. The regulation provides an exemption for responsible plan fiduciaries where a service provider fails to provide the required information, so long as a number of conditions are satisfied. Among these are the requirements that the responsible plan fiduciary request the information in writing as soon as it learns of the failure to disclose and that it identify the service provider to the DOL if the service provider fails to provide the information within 90 days of the written request.   

The Interim Final Regulation also required the fiduciary to evaluate whether it should terminate or continue the arrangement if the service provider failed or refused to provide the requested information.  In other words, termination was permissive and at the discretion of the fiduciary.  This concept is retained in the final rule, but a new requirement has been added.  The rule now states that, “If the requested information relates to future services (i.e., services that will be performed after the end of the 90-day period)  and is not disclosed promptly after the end of the 90-day period, then the responsible plan fiduciary shall terminate the contract or arrangement as expeditiously as possible, consistent with such duty of prudence.”  [Emphasis added] 

As a result, in the Final Regulation, the fiduciary is now required to terminate the contract where there is a failure to disclose.  While we have no reason to believe that many RIAs will be impacted by this requirement—because we anticipate that they will comply with their disclosure obligations in the first place—this is significant for their plan sponsor clients, since a failure to terminate the contract will expose the plan fiduciaries to both fiduciary breach and prohibited transaction exposure.

6.   Disclosure of Changes.  The Final Regulation continues to require that the RIA disclose changes in information related to its services, status as a fiduciary and an RIA, and compensation within 60 days after the RIA is informed of the change.  

Related to this matter, we recommend that RIAs include an “Aetna provision” in their service agreements to facilitate making changes to their arrangements with their clients.

7.   Disclosures for Reporting and Disclosure PurposesThe Interim Final Regulation required that information needed by the plan administrator of a covered plan to comply with its reporting and disclosure obligations under ERISA had to be provided within 60 days of a written request.  The final rule modifies this to specify that the information must be provided “reasonably in advance” of the date the plan administrator states in its written request that it must comply with its reporting and disclosure requirement.  For example, the plan administrator must state when it expects to file its Form 5500, and the RIA must provide the information “reasonably in advance” of that date. This presupposes that the plan administrator has made its written request in time for the RIA to do so. 

The Final Regulation should have limited impact on RIAs; however, it will almost certainly require modification of their service agreements. In addition, we strongly recommend that RIAs review their other service-related documents, such as investment policy statements, to insure they are consistent with the service agreement disclosures.

>>The compliance date is extended from April 1, 2012, to July 1, 2012. (Also, the due date for the initial participant disclosures of plan and investment information (for calendar year plans) is extended to August 30, 2012.)

>>The definition of designated investment alternatives (DIAs) under the Final Regulation may result in asset allocation models being classified as such.  This would require that the RIA offering such models disclose expense information and could result in shifting to the RIA the responsibility for assembling the participant-level (404a-5) disclosure information for such models. 

>>Based on an example in the Final Regulation, the definition of “indirect compensation” may have been expanded and could capture arrangements not otherwise identified by the RIA as sources of indirect compensation payments.

>>A new provision requires that arrangements with third party payers that result in indirect compensation payments to the RIA be described.

The changes in the Final Regulation are equally important for plan sponsors to understand, since they will be receiving disclosures from their investment advisers between now and July 1 and are required to evaluate those disclosures to fulfill their fiduciary obligations. 

>>Plan sponsors should identify whether the RIA will be providing services as an ERISA fiduciary and should verify that the disclosure properly identifies the RIA’s status as a fiduciary and an investment adviser registered under the Investment Advisers Act of 1940 or state law.

>>Plan sponsors have a fiduciary duty to carefully review the RIA disclosures in order to assess the services to be provided, the reasonableness of the fees and the potential conflicts of interest that might affect the quality of services.

>>Plan sponsors are required to terminate contracts with an RIA if the RIA fails to provide the disclosures, even after a written request by the plan sponsor.

>>If a plan sponsor requires certain disclosure information from an RIA in advance of a reporting or disclosure obligation, such as the Form 5500, it can make a written request to the RIA and the RIA is required to furnish the information reasonably in advance of the due date.

© 2021 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume II, Number 53

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...

Joan M. Neri, Counsel, Drinker Biddle, Employee Benefits, Executive Compensation

Her practice focuses on all aspects of employee benefits counseling.  Joan represents plan service providers (including registered investment advisers, third party administrators, and recordkeepers) in fulfilling their obligations under ERISA.  Joan also represents plan sponsor clients on the design of qualified retirement plans (including ESOPs), nonqualified executive compensation plans and welfare benefit plans, day-to-day plan administrative issues and transactional planning involving benefit plan acquisitions, plan mergers and plan terminations.  Joan has represented major publicly-...