401k Fee Disclosure Roberta J Ufford Groom Law

401(k) Fee Disclosure Roberta J. Ufford Groom Law Group, Chartered April 7, 2008 1

l Developing Litigation l Form 5500 Schedule C l Proposed 408(b)(2) Regulation l Proposed Legislation 2

Developing Litigation Claims by Plan Participants l Class actions by plan participants allege plan sponsor fiduciaries imprudently allowed providers to receive “revenue -sharing. ” Plaintiffs allege plan fiduciaries – ¡ Caused plans to enter arrangements in which participants paid unreasonable, hidden and excessive fees. ¡ Did not understand/recognize revenue sharing arrangements. Did not disclose to participants in “proper detail and clarity” the transactions, fees and expenses. l E. g. , Loomis v. Exelon Corp. , Case No. 1: 06 -cv-04900 (filed Sept. 11, 2006 N. D. III). NOTE: Court dismissed claims for investment issues; claims for excessive fees may proceed. (N. D. III. 2007). 3

Developing Litigation Claims by Plan Participants l Class actions by plan participants also may include allegations that plan sponsor fiduciaries – ¡ Should have selected lower cost separate accounts rather than mutual funds. ¡ Should have selected lower cost index funds. ¡ Failed to capture for the plan’s benefit all sources of revenue, such as float and securities lending income. ¡ Improperly used “unitized administration” for company stock, resulting in dilution of return and excessive fees. 4

Developing Litigation Claims by Plan Participants l Some actions by participants against sponsors include claims against service providers. Complaints allege: ¡ ¡ ¡ Directed trustee/provider is a fiduciary based on (i) trustee and/or investment manager status, and/or (ii) limits placed on investments the plan may offer to participants (primarily proprietary funds). Provider (and sponsor) did not disclose actual plan costs to participants, including revenue sharing, and allowed participants to pay excessive fees. Revenue sharing is “plan assets, ” which should be credited to participants; provider’s receipt of revenue-sharing is a prohibited transaction. l E. g. , Hecker v. Deere & Co. v. Fidelity Management Trust Company, et al. , Case No. 06 -C-0719 -S (filed Dec. 8, 2006, D. Wisc. ) 5

Developing Litigation Preliminary Court Decisions l Initial decisions are mixed: ¡ Hecker v. Deere & Co. - District court dismissed all claims against plan sponsor, trustee and recordkeeper. Plaintiffs have appealed. l ¡ See 2007 WL 1874367 (W. D. Wisc. 2007). Tussey v. ABB, Inc. – District court held ABB was not required to disclose revenue sharing to participants, but denied motion to dismiss other claims. Court held that Fidelity could be a plan fiduciary because of its role in selecting plan investment options. l See 2008 WL 379666 (W. D. Mo. 2008). 6

Developing Litigation Claims by Sponsors Against Providers l Class actions brought by plan sponsors/trustees allege, first, that providers are “fiduciaries” because providers – ¡ Determine what investments to offer on their platform and/or retain discretion to add/delete fund options. ¡ Encourage sponsors to rely on providers’ investment expertise. For example, a provider may: l Hold out as a financial expert; advertise “complete” plan investment and administrative services. l Offer asset allocation materials to participants. ¡ E. g. , Ruppert v. Principal Life Ins. Co. , Civ. No. 06 -903 -DRH (S. D. III); Phones Plus, Inc. v. The Hartford Financial Services, Inc. , Civ. No. 01835 -AVC (D. Conn). 7

Developing Litigation Claims by Sponsors Against Providers l Additional New Cases: ¡ Columbia Air Services, Inc. v. Fidelity Management Trust Co. (D. Mass. ) l Lawsuit alleges that Fidelity obtained revenue sharing payments in addition to amount expressly agreed as compensation without providing any additional services. ¡ Zang v. Paychex, Inc. (E. D. Mich. ) l Lawsuit alleges that Paychex obtained revenue sharing payments in addition to amount expressly agreed as compensation. Lawsuit also challenges the float that Paychex allegedly received from the custodian, JP Morgan. 8

Developing Litigation Preliminary Court Decisions Charters v. John Hancock Life Ins. Co. (D. Mass. ) - Court denied Hancock’s motion to dismiss, stating that a trier of fact could reasonably determine that Hancock’s power of fund substitution gives it discretionary control. l Hartford v. Phones, Plus, Inc. - Court allowed claims against insurance company provider to proceed based on insurer authority to substitute funds. See 2007 WL 3124733 (D. Conn. ). ¡ See also Haddock v. Nationwide, 419 F. Supp. 2 d 156 (D. Conn. 2006). l 9

Developing Regulation l DOL has three regulatory projects aimed at increasing the disclosure of fees and service provider conflicts. ¡ Final amendment of Form 5500 Schedule C requires more disclosure to government, sponsors and participants. ¡ Proposed amendment of ERISA section 408(b)(2) regulation will increase disclosure to plan sponsors. ¡ Proposed to amendments to DOL regulations governing disclosure to participants are expected. 10

Form 5500 Plan’s Annual Report l Significant new Form 5500 package published November 16, 2007 ¡ Generally effective for 2009 plan year filing. ¡ Significant changes to Schedule C. ¡ Affects both pension and welfare plans. l 72 Fed. Reg. 64710 and 64731 (Nov. 16, 2007). 11

Schedule C Service Provider Compensation Schedule C identifies the plan’s service providers and the compensation they receive. l For years, Schedule C instructions have required reporting of “ indirect” compensation received by plan service providers, such as “finder’s fees” received in connection with plan transactions. l But, these fees have typically not been reported and DOL has not enforced this reporting rule. l DOL’s explicit goal in revamping Schedule C is to expand clarify the reporting of indirect compensation. l 12

Schedule C: Indirect Compensation l Indirect compensation means payments from sources other than the plan or plan sponsor that are “in connection with services to the plan or the person’s position with the plan. ” ¡ Include compensation received if the person’s eligibility for the payment or the amount of the payment is based, in whole or in part, on services rendered to the plan or transaction(s) with the plan. ¡ Don’t include compensation that would have been received had the service not been provided or the transaction had not taken place and that cannot be allocated to services. 13

Schedule C: Indirect Compensation l Examples provided by Schedule C: ¡ Finder’s fees, float, brokerage commissions, soft dollars and “other transaction-based fees” received in connection with transactions or services involving the plan. ¡ Amount charged to the plan’s investments and reflected in unit value. 14

Schedule C: Indirect Compensation l Examples of Indirect Compensation – 401(k) Plans ¡ Advisory fees paid by mutual funds to mutual fund advisors. ¡ Investment management fees paid from a bank collective fund to managers and sub-advisors. ¡ Commissions paid to a broker from a mutual fund, bank collective fund, separate account. ¡ 12 b-1 distribution fees paid from a mutual fund to the plan’s recordkeeper. 15

Schedule C: Indirect Compensation The definition of indirect compensation may include meals and entertainment of plan service providers. l The Schedule C instructions provide that a plan administrator need not report "insubstantial" nonmonetary compensation (e. g. , "gifts and meals of insubstantial value") if: l (1) the compensation is tax deductible to the payor and excluded from taxable income for the recipient, and (2) the gift is valued at under $50 and total gifts to the recipient from the same source during the year do not exceed $100. 16

Schedule C: Alternative Reporting n If a Service Provider receives “Eligible Indirect Compensation” (EIC) and no other compensation in connection with the plan, plan reporting is limited. n If Service Provider receives other compensation (direct or ineligible indirect), this other compensation is reported, but amount of the EIC need not be reported. 17

Schedule C: Eligible Indirect Compensation Includes: l Fees charged against investment funds, or l Finder’s fees, float, brokerage commissions, soft dollars, and other transaction-based fees paid for transaction or services involving the plan. Service Provider must disclose: l The existence of indirect compensation, and services provided or other purpose of payment. l The amount of, or an estimate, or the formula to calculate, the fee, and l The identity of the parties paying and receiving the fee. 18

Schedule C: Bundled Arrangements A “bundled arrangement” ¡ A service arrangement where the plan hires one company to provide a range of services either directly or indirectly from the company, through affiliates or subcontractors, or through a combination, which are priced to the plan as a single package rather than on a service-by-service basis. l Plan reports only its direct payments to the bundled provider. l 19

Schedule C: Bundled Arrangements l Generally, a plan need not separately report how plan payments are allocated among the bundled provider’s affiliates or subcontractors, unless these amounts are – ¡ Set on a per transaction basis (e. g. , brokerage), ¡ Fees charged against the value of the plan’s investments (e. g. , management fees), or ¡ Finder’s fees, float, soft dollars, and non-monetary compensation earned by certain providers (fiduciary, investment manager or adviser, consultant, recordkeeper, broker). 20

Schedule C: Allocating Compensation Service providers must be reported on Schedule C if they earn $5, 000 or more in direct and/or indirect compensation in connection with services to the plan. l In figuring the total amount of reportable compensation on Schedule C, service providers may allocate any compensation received in connection with several plans, following reasonable allocation methods disclosed to the plan administrator. l 21

Schedule C: Service Provider Duties Plan administrators, not service providers, are obligated to complete Form 5500. l But, a new line on Schedule C requires the plan administrator to report service providers who refuse to provide necessary information following a request. l Illustrates DOL’s intention to use to Form 5500 as an enforcement tool. l 22

Schedule C: Additional Guidance DOL is currently accepting questions on Schedule C and other Form 5500 reporting issues. l May provide more guidance before new Form 5500 requirements come into effect. l 23

Proposed 408(b)(2) Regulation ERISA § 406(a)(1)(C) prohibits service arrangements between a plan and a party in interest. l ERISA § 408(b)(2) exempts arrangements for plan services if: ¡ arrangements are reasonable; ¡ services are necessary for the establishment or operation of the plan; and ¡ the plan pays no more than reasonable compensation. l Most service providers rely on the § 408(b)(2) exemption. l 24

Proposed 408(b)(2) Regulation l On December 13, 2007 the DOL published: ¡ Proposed revisions to the ERISA § 408(b)(2) regulations l ¡ A proposed prohibited transaction class exemption l l 72 Fed. Reg. 70988 72 Fed. Reg. 70893 As expected, the proposed 408(b)(2) regulations and related class exemption closely track the finalized Form 5500 Schedule C instructions. 25

Proposed 408(b)(2) Regulation Proposed new regulation would: l Revise the “reasonable arrangement” standard by adding new service provider disclosure and other requirements. l Require all service agreements to be in writing. l Impose new service provider disclosure obligations, before or at the time the plan enters a service arrangement. ¡ In comparison, Schedule C disclosure is required after services are performed. 26

Proposed 408(b)(2) Regulation l Would apply to 3 categories of service providers: ¡ Service providers who are fiduciaries (under ERISA § 3(21) or under the Investment Advisers Act of 1940). ¡ Service providers who provide or may provide banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping, securities or other investment brokerage or other third party administration services. ¡ Service providers who receive or may receive indirect compensation in connection with providing accounting, actuarial, appraisal, auditing, legal or valuation services to a plan pursuant to a contract. 27

Proposed 408(b)(2) Regulation l Compensation defined as: ¡ l “money or any other thing of monetary value (for example, gifts, awards and trips) received, or to be received, directly from the plan or plan sponsor or indirectly (i. e. from any source other than the plan, the plan sponsor, or the service provider) by the service provider or its affiliate in connection with the services to be provided pursuant to the contract or arrangement or because of the service provider’s or affiliate’s position with the plan. ” Compare to Form 5500 “reportable compensation: ” ¡ “For Schedule C purposes, reportable compensation includes money and other thing of value (for example, gifts, awards, trips) received by a person, directly or indirectly, from the plan (including fees charged as a percentage of assets and deducted from investment returns) in connection with services rendered to the plan, or the person’s position with the plan. ” 28

Proposed 408(b)(2) Regulation l Compensation related disclosure: the proposed regulations would require that service providers disclose (before the parties enter an agreement for services): ¡ All services to be provided under the arrangement. ¡ The “compensation or fees” to be received by the service provider with respect to each service. ¡ The manner of receipt of compensation or fees. 29

Proposed 408(b)(2) Regulation Bundled Services In a bundled services arrangement, the service provider offering the bundle of services must disclose all the services and the aggregate compensation or fees to be received directly or indirectly by the service provider, any affiliate or subcontractor, and any other person in connection with the arrangement. l The service provider must disclose the allocation of the aggregate compensation with respect to: ¡ Compensation or fees that are a separate charge directly against the plan’s investment reflected in the net value of the investment; or ¡ Fees that are set on a transaction basis (such as finder’s fees, brokerage commissions, and soft dollars). l 30

Proposed 408(b)(2) Regulation Conflicts Disclosure l The proposed regulations also would require providers to disclose (before the parties enter into a service agreement): ¡ Whether the service provider will provide services as a fiduciary. ¡ Any participation or interest the service provider may have in plan transactions. ¡ Any material financial, referral or other relationship that creates or may create a conflict of interest for the service provider. ¡ Whether the service provider will be able to affect its own compensation without prior approval of the plan fiduciary. ¡ Its policies or procedures to address potential conflicts of interest. 31

Proposed 408(b)(2) Regulation Contract Requirements l In addition to the required disclosures, the written contract must include: ¡ Terms requiring the service provider to disclose any material change to the disclosed information within 30 days of the date the service provider acquires knowledge of the material change; and ¡ Terms requiring that the service provider disclose all information requested by the plan fiduciary or plan administrator in order to comply with reporting requirements (e. g. , Form 5500). 32

Proposed Class Exemption According to DOL, if a service provider does not comply with the proposed 408(b)(2) regulation, the services arrangement will involve a prohibited transaction and the service provider will be required to correct and pay excise taxes. l Plan fiduciaries also could be liable for a prohibited transaction, even if unaware that the service provider did not comply. l A proposed class exemption would relieve a plan fiduciary from liability for a prohibited transaction caused by a service provider’s failure to disclose. l ¡ No relief provided to a service provider. 33

Proposed Class Exemption l Conditions of the proposed exemption: ¡ The plan fiduciary entered into the arrangement with a reasonable belief that the service provider met disclosure requirements. ¡ The fiduciary did not know, and did not have a reason to know, of the failure to disclose. ¡ Upon discovery that a service provider failed to disclose, the fiduciary must: l Request the missing information in writing. l Evaluate whether to terminate or continue the arrangement with the service provider. l Report to the DOL if the service provider does not comply with the disclosure request. 34

Proposed 408(b)(2) Regulation Comments on Proposed Regulation were due Feb 11, 2008. Hundreds of comments were submitted. DOL has scheduled hearings on March 20, 2008. l Issues ¡ What “services” and “service providers” are covered? ¡ Application to IRAs ¡ Technical considerations: disclosure formats, timing of disclosure ¡ Transition issues l 35

Proposed Legislation l The 401(k) Fair Disclosure For Retirement Security Act of 2007, H. R. 3185 (The “Miller Bill”) ¡ Would amend ERISA to impose new requirements addressing disclosure of fees that plans pay for services and other new standards for participant directed plans. ¡ New requirements would generally apply to qualifiedcash or deferred arrangements (i. e. , 401(k) plans). 36

Proposed Legislation l “Miller Bill” - Service Provider Disclosure ¡ ¡ ¡ would require that a Plan Administrator receive service provider disclosure before entering any contract for services for $1, 000 or more. Identification of all parties that would be performing services under the contract. Description of services and total cost. Itemized list of services and expenses (i. e. , sales commissions, expenses for investment advice). Disclosure of any conflicts of interest. If applicable, disclosure of impact of share classes and certain free, discounted or rebated services. 37

Proposed Legislation l “Miller Bill” (continued) ¡ Notice of Investment Options: Require Plan Administrators to provide participants with notice of investment options, including: l l l ¡ Detailed information about each investment option (i. e. , investment objectives, level of risk, historical returns). A “Fee Menu” for all plan options, disclosing potential service fees that could be assessed against participant accounts. Disclosure of potential conflicts of interest. Participant Annual Benefit Statement: Require Plan Administrators to provide participant-specific benefit statements within 90 days of plan year close. l Statement would disclose subcategories of fees assessed from each participant’s account for each option selected. 38

Proposed Legislation l Additional “Miller Bill” Requirements ¡ Minimum Investment Option: Participant-directed plan menu must include at least one nationally-recognized index fund likely to meet retirement income needs at adequate levels of contribution. ¡ Enforcement: Direct to DOL to enforce new requirements and create statutory penalties for failure to comply. l l l Establish an Advisory Committee. Create a penalty structure authorizing the DOL to assess a penalty against Plan Administrators of up to $100 per day for a failure. Authorize DOL to publicly identify noncompliant providers. 39

What Are Plan Sponsors Doing? l l l Reviewing Plan Arrangements: ¡ Identifying Providers’ direct/indirect compensation; negotiating for a share. ¡ Better benchmarking on fees and performance. ¡ Evaluating share class, separate accounts and collective trust alternatives. ¡ Considering alternatives to paying recordkeeper with asset based revenue sharing payments. Reviewing fiduciary process for legal sufficiency ¡ Adequate due diligence? ¡ Documentation? Reviewing governance/fiduciary structure. Reviewing disclosure to participants about how plan fees are paid. Reviewing allocation of recordkeeping fees. 40

What Are Service Providers Doing? Improved disclosure to plan sponsors of direct/indirect compensation, including range of fees and type of payment by option. l Considering disclosures to participants. l Reviewing contractual authority and procedures for making changes to “ 401(k) fund platform”. l Reviewing contracts, marketing materials and marketing practices to determine fiduciary status in fund selection. l 41