With so much focus on the disclosure of fees charged to plans, it’s easy to miss that new Department of Labor (DOL) rules, effective July 1, 2012, specify several other requirements for a contract or arrangement with a retirement plan service provider to be reasonable. We’ve long advised employers they should have a reasonable written contract with all of their benefit plan service providers. Why does this deserve attention now?
The new DOL rules, coupled with a recent surge in participant lawsuits against employers for failing to monitor plan service providers, raise and further highlight the risks of not having a reasonable contract. It is essential to have a contract that complies with the new rules and protects the interests of the plan and employer.
What the Law Requires
All contracts or arrangements between benefit plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) and those providing services to the plans for compensation are required by ERISA to be reasonable. Employers are generally the plan fiduciaries responsible for ensuring this requirement is met. Although the latest DOL disclosure rules are inapplicable to health and welfare plans (primarily because their fee structures are so different), the DOL has reserved a section to issue rules for these plans in the future.
A contract or arrangement for services will no longer be reasonable unless a retirement plan’s covered service providers make certain disclosures reasonably in advance of its effective date (or extension or renewal date) and update the disclosures for changes or to correct errors in a timely manner. These providers generally include ERISA fiduciaries, recordkeepers, brokers and others who expect to receive at least $1,000 of direct or indirect compensation in connection with providing certain services to the plan. A more detailed explanation of covered service providers and the disclosure rules can be found in the article
by George Whitfield in the February 2012 edition of this newsletter or at www.wnj.com/publications
It’s not just the amount of compensation that must be disclosed reasonably in advance. Other items that now must be disclosed include a description of the services that will be provided, the status of the provider (e.g., under what law an investment adviser is registered), the cost of recordkeeping services and the manner in which compensation will be paid (e.g., deducted from accounts or investment returns). As required before, the contract also must allow for the provider’s services to be terminated on reasonably short notice.
Even though service providers have the obligation to disclose, employers must ensure the disclosures occur because the consequences of non-compliance impact the employer. The employer is required to request the disclosures if they are not forthcoming and report any service provider who does not comply to the DOL. Failure to comply with the new requirements can result in penalties and taxes and jeopardize the plan’s tax qualification. It also exposes the employer to fines and potential litigation. In such litigation, courts will focus on whether the required disclosures occurred and whether the terms of the contract or arrangement are reasonable.
The determination of reasonableness turns on more than just meeting the requirements discussed above. Following are some best practices to observe to ensure a contract or arrangement is reasonable. Note that these also may be relevant for health and welfare plans because they are subject to ERISA’s reasonable contract or arrangement requirement even though the latest DOL disclosure rules are inapplicable.