401k Plan Fee Disclosure and 5500 Reporting 2009

401(k) Plan Fee Disclosure and 5500 Reporting 2009 FIRMA National Risk Management Training Conference April 29, 2009 Jennifer E. Eller jee@groom. com 1

n n Service Provider Fee Disclosure Participant Fee Disclosure Legislation Litigation 2

Service Provider Disclosure - Background n n Retirement system shift to participant-directed defined contribution plans Development of fee structures relying on “indirect” and “hidden” direct compensation (retirement and welfare plans) New class action litigation against plan sponsors and plan service providers Media attention and legislative pressure to improve disclosure 3

Service Provider Disclosure n Two DOL regulatory projects address disclosure of fees and service provider conflicts. ¨ Disclosure of Fees Paid in a Plan Year - Amendment of Form 5500 Schedule C requires more disclosure of compensation paid directly and indirectly for plan services. ¨ “Point of Sale” Disclosure - Proposed amendment of ERISA section 408(b)(2) regulation (services exemption) will require disclosure by “covered” service providers. 4

Service Provider Disclosure n n Amendments to the Form 5500 are final and effective for 2009 plan years. Proposed Amendments to ERISA section 408(b)(2) regulations were not finalized before January 20, 2009. ¨ Obama Administration may propose or issue similar rules. ¨ Congress may act. 5

Service Provider Disclosure Some “Themes” n n n Disclosure burden shifts to non-fiduciary service providers, with enforcement mechanisms For service providers – complex new requirements to interpret and implement ¨ disclosure of “indirect compensation” ¨ reporting relief for “bundled” arrangements ¨ coordination with other service providers For plan sponsors – more information 6

Service Provider Disclosure Form 5500 - Schedule C n Report service providers receiving $5000 or more direct or indirect compensation paid by the plan ¨ Applies if plan has more than 100 participants. n DOL’s goal in revamping Schedule C was to expand reporting of indirect compensation. n Key changes ¨ New definitions - “indirect” compensation, bundle, investment fund ¨ Report “source” of “indirect compensation” ¨ Reporting relief for “eligible indirect compensation” and “bundled arrangements” 8

Service Provider Disclosure Schedule C – Indirect Compensation n 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 transactions 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. 9

Service Provider Disclosure Schedule C – Indirect Compensation n n 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. ¨ Amounts charged to the plan’s investments and reflected in unit value, e. g. , investment management fees, 12 b-1 fees. Not included – “investment fund” operating expenses, e. g. , portfolio brokerage expenses. 10

Service Provider Disclosure Schedule C – Alternative Reporting n n If a Service Provider receives “Eligible Indirect Compensation” (EIC) and no other compensation in connection with the plan, plan reporting is limited. ¨ Plan administrator still receives detailed information. ¨ Schedule C identifies person who provided information. Even if other compensation received by a Service Provider (direct or ineligible direct) is reported, amount of EIC need not be reported. ¨ Line 3 “source” reporting not required for EIC. 12

Service Provider Disclosure Schedule C – Bundled Arrangements n A “bundled arrangement” ¨ A service arrangement where the plan hires one company to provide a range or 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. ¨ An investment transaction in which the plan receives a range of services either directly from the investment provider, through affiliates or subcontractors, or through a combination. 14

Service Provider Disclosure Schedule C – Bundled Arrangements n Payments received by the bundled provider’s affiliates or subcontractors are not reported 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). 15

Service Provider Disclosure Form 5500 – Schedule C Implementation Issues n Scope of covered “indirect compensation” n EIC definition; disclosure formats n Defining a “bundle” n Service provider disclosure obligations ¨ Disclosing fees received ¨ Disclosing fees paid to other persons in connection with plan services ¨ Duties of service providers responsible for Form 5500 preparation 16

Meals, Gifts and Entertainment Form 5500 – Schedule C n n n Direct and indirect compensation may include some compensation received by employees of plan sponsors and service providers. Not reported – compensation, e. g. , salary, received by a plan sponsor or service provider employee, from his or her employer. Reportable – “other” compensation, including nonmonetary compensation, received by a plan sponsor or service provider employee from a third party. 18

Meals, Gifts and Entertainment Form 5500 – Schedule C n n Indirect compensation may include meals and entertainment received by employees of sponsors and service providers. But, “insubstantial” non-monetary compensation (e. g. , “gifts and meals of insubstantial value”) need not be reported if: 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. 19

Service Provider Disclosure 408(b)(2) Amendment Proposed amendment to ERISA’s services exemption regulation would: ¨ require written service agreements. ¨ require detailed disclosure by service providers, before or at the time the plan enters a service arrangement and upon material changes in fees. ¨ apply to non-fiduciary service providers. Fed. Reg. 70988 (Dec. 13, 2007). Final Rule was “withdrawn” from OMB on Jan 26, 2009 ¨ 72 20

Meals, Gifts and Entertainment 408(b)(2) Regulations n n n Key providers must provide advance disclosure of compensation (amount, estimate) ¨ sufficient info for fiduciary to evaluate reasonableness “Compensation” – includes "gifts, awards and trips for employees" received directly or indirectly either (1) in connection with services to be provided to the plan or (2) because of the provider's "position with the plan. " Issues/Challenges ¨ Meals trigger heightened disclosure for a non-key provider? ¨ How to disclose in advance? 27

Participant Disclosure Proposed Regulations n n Proposed rules would enhance disclosures provided to participants in participant-directed individual account plans. 73 Fed. Reg. 43014 (July 23, 2008). Only would apply to individual account pension plans; would not apply to welfare plans or DB plans. Unlike existing 404(c) regulations, proposed rules would be mandatory. Proposed effective date of Jan. 1, 2009; but the rules must be finalized in order to be effective. 29

Participant Disclosure Proposed Regulations n n Proposed regulations issued under ERISA section 404(a); with conforming changes to 404(c) regulations. Incorporates DOL view that plan fiduciaries are responsible to prudently select and monitor service providers and investment options. Would identify a fiduciary duty under section 404(a) to provide sufficient information regarding the plan, its expenses, and investment options to allow participants to make informed investment decisions. Proposed regulations describe four categories of information, to be provided on a “regular and periodic basis. ” 30

Participant Disclosure Proposed Regulations 1. Plan Information: At eligibility and annually thereafter: n Circumstances where participants may give investment instructions and limitations or restrictions on these rights n Plan rules regarding proxy voting rights n Identification of designated investment options and investment manager. Can provide via SPD. 31

Participant Disclosure Proposed Regulations 2. Plan Administrative Expenses: At eligibility and annually thereafter: ¨ Explanation of administrative fees that will be charged to the plan and the basis on which the fees will be allocated to or affect participant account balances (pro rata or per capita). Note: Excludes expenses that are paid through expense ratio of investment options. Can provide via SPD. 32

Participant Disclosure Proposed Regulations 3. Individual Participant Expenses At eligibility and annually thereafter: ¨ Explanation of any fees that will be charged against the individual account of a participant (i. e, loan processing, QDRO expenses, investment advice fees). Can provide via SPD. 33

Participant Disclosure Proposed Regulations Quarterly disclosure of: ¨ The actual dollar amount of administrative expenses and individual service charges assessed against the participant’s account during the preceding quarter ¨ A description of the services provided for such fees. Can provide in quarterly benefits statement. 34

Participant Disclosure Proposed Regulations 4. Investment Information A. Automatic Disclosures (provide in comparative form): n Name of designated investment option n Internet web address for further information n Type of investment (e. g. money market fund) n Type of management n 1, 5, & 10 -year performance data for option and for an appropriate market index n Any shareholder fees (sales loads, redemption fees, etc. ) n Annual Operating expenses expressed as % 35

Participant Disclosure Proposed Regulations 4. Investment Information (continued) B. Upon Request Disclosures n Prospectuses n Financial or shareholder reports, to the extent provided to the plan n Value of a share or unit & valuation date n List of portfolio assets for “plan asset” vehicles 36

Participant Disclosure Proposed Regulations n Below is the “Performance Information” table from DOL’s sample disclosure form at www. dol. gov/ebsa. 38

Participant Disclosure Proposed Regulations n Below is the “Fees and Expense Information” table from DOL sample disclosure form. 39

Participant Disclosure Proposed Regulations n Participant Disclosure Regulations have not been finalized, and will likely not be finalized as proposed. Could be re-proposed with new notice and comment period. ¨ Could be supplanted by Legislation. ¨ 40

The 401(k) Fair Disclosure For Retirement Security Act of 2007, H. R. 3185 (The “Miller Bill”) n n The Miller Bill would amend ERISA to impose three new requirements with respect to the fees that 401(k) and similar plans pay for services. Service Provider Disclosure: Prior to entering into any contract for services for $1, 000 or more plan administrator receive a service provider disclosure. ¨ ¨ ¨ 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. 41

Miller Bill Provisions n Would require Plan Administrators of participant-directed plans to provide participants or beneficiaries with notice of investment options. ¨ ¨ ¨ Detailed information about each investment option (i. e. investment objectives, level of risk, historical returns); A “Fee Menu” relating to all options under the plan, disclosing potential service fees that could be assessed against participant accounts; Disclosure of potential conflicts of interest. 42

Miller Bill Provisions n Would require Plan Administrators to provide participantspecific benefit statements within 90 days of the close of the plan year. ¨ Require statement to disclose several subcategories of fees assessed from each participant’s account for each investment option selected. 43

Miller Bill Provisions n Participant-directed account investment menu must include at least one nationallyrecognized index fund likely to meet retirement income needs at adequate levels of contribution. 44

Miller Bill Provisions n Would direct the DOL to enforce new requirements and create statutory penalties for failure to comply. ¨ Establishment of an Advisory Committee ¨ Creation of 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 disclose identity of noncompliant service providers. 45

401 k Plan Litigation n Class Actions against Plan Sponsors (by participants) n Class Actions against Recordkeepers (by participants and sponsors) 46

Participants vs. Plan Sponsors: The Players n n What: Class actions challenging 401 k recordkeeping and investments Who: ¨ Participants: (by class action lawyers Schlicter Bogard) ¨ Plan sponsors: Boeing; Lockheed Martin; Exelon; Caterpillar; General Dynamics; United Technologies; Bechtel; International Paper; Kraft; Northrop Grumman; Deere & Co. ; and ABB 47

Participants vs. Plan Sponsors: The Claims n n n Procedural Prudence - Did the plan fiduciaries exercise due diligence in their consideration of the plan’s compensation arrangement with service providers, including any revenue sharing component? Reasonableness of Fees – Did the plan fiduciaries cause the plan to pay excessive compensation to service providers because of revenue sharing or other circumstances? Disclosure – Did the plan fiduciaries violate ERISA in how and what they disclosed to plan participants about revenue sharing and other fees charged to the plan? 48

Participants vs. Plan Sponsors: The Claims n Claims also include – ¨ ¨ ¨ Failure to capture float and other “revenue streams” Participants investing in mutual funds pay more than their share of administrative fees Fiduciary favored its DB plan run by same manager Use of “master trust” results in “fee layers” Mutual funds vs. separate accounts, and retail mutual funds Actively managed funds functions as “passive” funds, so their higher fees not justified 49

Participants vs. Plan Sponsors: The Claims n Allegations regarding the plan’s company stock fund Cash component increases tracking error versus stock ¨ Investment management and other fees not justified ¨ “Forcing” participants to own company stock in order to participate in the 401 k plan ¨ 50

Participants vs. Plan Sponsors: Disclosure of Rev. Sharing to Participants n Disclosure not required ¨ Hecker v. Deere (CA 7 2009) – nothing in ERISA specifically requires disclosure of revenue sharing to participants. ¨ Taylor v. United Technologies (MSJ 2009) – rev sharing info is not material to reasonable investor 51

Participants vs. Plan Sponsors: Disclosure of Rev. Sharing to Participants n Disclosure may be required (or advisable) ¨ Tussey v. ABB – disclosure not required, but could affect participant’s “control” under 404(c). ¨ Kanawi v. Bechtel – failure to disclose could potentially support a fiduciary breach claim and affect 404(c) relief 52

Participants vs. Plan Sponsors: The Section 404(c) Defense n Some courts have held that 404(c) is a defense to claims that selection of plan investment options was imprudent. Langbecker v. Elec. Data Sys. Corp (CA 5 2007) ¨ Hecker v. Deere & Co. (CA 7 2009) ¨ 53

Participants vs. Plan Sponsors: The Section 404(c) Defense n Other courts disagree ¨ Tussey v. ABB, Inc. (2008) ¨ Tittle v. Enron Corp. (S. D. Texas 2003) (whether 404(c) shields fiduciaries is a question of fact). 54

Participants vs. Plan Sponsors: The Section 404(c) Defense n Hecker v. Deere & Co (CA 7 affirms motion to dismiss 2/09) ¨ Plan offered a sufficient mix of investments so that inclusion of “expensive” funds did not constitute a breach (plan had brokerage window) ¨ even if there was a breach as to fund selection, section 404 c precluded liability n Rehearing sought ¨ Suggests that sponsors have no duty to review fees so long as participants have thousands of choices (brokerage window) ¨ DOL disagrees 55

Participants vs. Plan Sponsors: Revenue Sharing n Taylor v. United Technologies (MSJ for UT granted 3/3/09) ¨ Properly selected mutual funds ¨ Recordkeeping fees were reasonable when compared to market ¨ Not required to disclose to participants that revenue sharing was used to reduce amount UT paid to recordkeeper in fees ¨ UT properly monitored cash in stock fund 56

Suits vs. Recordkeepers n Participants vs. Recordkeepers – Included as defendants in participant suits vs sponsors See ABB, Deere complaints ¨ Adds - an opportunity to allege self-dealing based on recordkeeper’s receipt of revenue sharing ¨ n Plan Sponsors vs. Recordkeepers Defendants: Nationwide, Principal, Hancock, ING, American Skandia, Paychex, Fidelity ¨ Sponsors allege that recordkeeper was a fiduciary and that receipt of revenue sharing involved a conflict of interest ¨ 57

Suits vs. Recordkeepers Recordkeeper’s Fiduciary Status n Is recordkeeper a fiduciary in plan’s selection of investment funds? ¨ ¨ ¨ Hecker v. Deere & Co. (2007)- Fidelity not a fiduciary Columbia Air Services v. Fidelity (2008) - Fidelity dismissed Tussey v. ABB (2008) - Fidelity could be a fiduciary 58

Suits vs. Recordkeepers Recordkeeper’s Fiduciary Status n Does recordkeeper have fiduciary discretion to add/delete investment funds? Charters v. John Hancock (2008, plaintiff’s MSJ partially granted) - Hancock could be a fiduciary ¨ Phones Plus v. Hartford (2007, MTD denied): Hartford could be a fiduciary based on ability to change funds available under annuity contract. ¨ Haddock v. Nationwide (2006): Nationwide may be a fiduciary ¨ 59

Questions? Jennifer E. Eller, Esq. - (202) 861 -6604 Groom Law Group, Chartered 1701 Pennsylvania Avenue, NW Suite 1200 Washington, DC 20006 jee@groom. com 60