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A Better Partnership


Jun 2012
June 18, 2012

Service Provider Contracts Deserve and Require Employers’ Attention

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

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.

Best Practices
  1. Get the terms in a written contract. Without a written document there is no reliable way to demonstrate what the terms are and whether they are compliant.
  2. Understand the terms. For example, many employers are unaware of whether they have hired (and the plan is paying for) a provider who is an ERISA 3(21) fiduciary investment advisor or 3(38) fiduciary investment manager. There’s a big difference and the employer should know.
  3. Compare the terms. It’s important to know how the terms compare with those of similar plans including, but not limited to, the compensation being paid.
  4. Negotiate for the best terms possible. Unless negotiation occurs from the beginning, the first agreement you receive rarely reflects the best terms you can get and, thus, is rarely appropriate to sign without negotiation. Things you may want to negotiate include the standard of care the provider will observe, the method and venue for resolving disputes, which state’s laws apply and the terms (if any) on which the parties will indemnify each other.
  5. Regularly reevaluate the terms of the contract and its reasonableness. It isn’t a defense to say the terms were reasonable three years ago if they are not still reasonable.
  6. Document the process followed to arrange, renew or extend the contract. Even if the terms of a contract are found to be unreasonable in some way, you may be protected if you followed a reasonable process when entering into it.
  7. Obtain expert review from unbiased counsel to ensure the contract is compliant and protects you. Courts and the DOL haven’t shown much sympathy for employers who have failed to understand the contract details or hire someone who does. Further, service providers draft these agreements and cannot give unbiased legal advice on them, so it’s important to seek assistance from an independent expert.

Any service contract that hasn’t been reviewed for compliance with the new DOL rules, or entered into in accordance with the best practices outlined above, should receive review now. If you have any questions, please contact Heidi Lyon or any other member of our Employee Benefits Practice Group.

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