June 2011—Legislative Intelligence Update | Deadlines Extended on New Disclosure Rules and Determining Reasonableness of Compensation

Welcome to this edition of IMCA's Legislative Intelligence update. This month's update discusses the Department of Labor's proposal to extend the effective date on new disclosure rules and also to extend the initial disclosure deadline under the new disclosure rules for participant-directed individual account plans. This update also includes information on recent court rulings regarding to what extent plan fiduciaries have a responsibility to prudently select and monitor the service providers to the plan, including whether the fees charged by the service providers are reasonable.

The purpose of this update, prepared by Morgan Lewis, is to give members legislative and public affairs intelligence and analysis and is strictly informational and educational. IMCA, as an education and credentialing organization, does not lobby legislators or regulators nor advocate for any particular legislative or regulatory position either on its own or through its relationship with Morgan Lewis.

If, after reading this update, you have additional questions please contact IMCA using the "Questions? E-mail IMCA" button at the bottom of this e-mail. We will either respond personally to your inquiry or include a response in an upcoming issue.
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ERISA

Deadlines Extended on New Disclosure Rules

Two new disclosure rules come into effect at the end of 2011: 1) Section 408(b)(2) disclosures to be made by service providers to pension plans about their services and their direct and indirect compensation, which may apply to investment consultants; and 2) participant disclosures to be made by plan administrators of participant-directed retirement plans (generally 401(k) plans), who may require assistance from investment consultants to compile the necessary information.

In February 2011, the Department of Labor (DOL) had announced its intention to extend the effective date for complying with the new Section 408(b)(2) service provider disclosure rules to January 1, 2012. In May, DOL formally proposed to extend the effective date and also to extend the initial disclosure deadline under the new disclosure rules for participant-directed individual account plans. The initial disclosure deadline for participant disclosures had been 60 days after the start of the plan’s first plan year after November 1, 2011 (February 29, 2012, for calendar-year plans); it is now 120 days (April 30, 2012, for calendar-year plans).

Because these extensions were issued as proposals, DOL accepted comments through June 15, 2011, which permits interested parties to submit requests for additional time. However, informal statements by DOL officials have indicated a reluctance to further extend these deadlines. Therefore, firms should move forward with their compliance efforts with the goal of providing the required service provider disclosures by January 1, 2012, and the initial participant disclosures by April 30, 2012.

Determining Reasonableness of Compensation

Under ERISA, plan fiduciaries have a responsibility to prudently select and monitor the service providers to the plan, including whether the fees charged by the service providers are reasonable. Plans often rely on their consultants to determine whether the fees being charged by the plan’s service providers continue to be reasonable in light of market conditions. This practice was called into question by the court decision in George v. Kraft Foods Global Inc., No. 10-1469 (7th Circuit, April 11, 2011), rehearing denied (May 26, 2011).

Kraft employees who participated in the company’s 401(k) plan sued the company and the plan fiduciaries for breaches of fiduciary duty under ERISA by, among other things, paying excessive fees to the plan’s recordkeeper. The plaintiffs argued that the excessive fees were the result of the plan fiduciaries failing to solicit periodic bids (about once every three years) from competing recordkeepers since initially hiring Hewitt in 1995.

The lower court rejected this argument, finding that the fiduciaries’ duty to act prudently as to the recordkeeping fees was satisfied by their reliance on the advice of their consultants. However, the 7th Circuit overturned this ruling. It said that the lower court had incorrectly discounted the view of the plaintiffs’ expert, who took the position that it was imprudent for the fiduciaries to fail to solicit bids from other recordkeepers through a “request for proposal” (RFP) process, and that the plan was paying about twice as much as it should have for recordkeeping services. The 7th Circuit sent the case back to the district for trial on this issue. One judge dissented, questioning the conclusion that plan fiduciaries could not rely on the advice of consultants as a basis not to solicit competitive bids. He said that the evaluation of a service provider and its fees presents “difficult questions” that require the court to “leave room for the discretion which fiduciaries must be granted to perform their task.”

The question raised by this decision is whether the ERISA prudence obligation requires plan fiduciaries to engage in periodic RFPs to determine the reasonableness of the fees of their service providers. The court did not actually go that far, leaving the issue to be decided at trial. However, because plan sponsors and fiduciaries generally want to have claims against them dismissed early in the litigation, rather than having to bear the costs of a trial, they may ask whether they would be better protected against litigation if they adopt a periodic RFP process.

The problem this poses is that RFPs also can be costly and burdensome. In addition, RFPs, like advice from consultants, could be open to challenge. There could be a dispute as to whether an RFP was sent out to a sufficient number of potential providers or to the right group of providers. Another problem is that providers who receive RFP requests from the same plan every three years, but never get any business from the plan, are less likely to respond or, if they do respond, to submit a serious proposal, which undermines the effectiveness of the RFP process. For these reasons, it is not clear that a periodic RFP process would provide useful information or the type of protection that plan sponsors and fiduciaries are looking to achieve.

Plan sponsors and fiduciaries are best protected by being able to show a well-reasoned and documented process, and consultants are in a good position to assist them in doing so. To address the issue of RFPs, that documentation can include an explanation as to why it is not appropriate to engage in an RFP process at that time, if that is the case, and why it is proper to rely on other sources for determining the reasonableness of compensation. While detailed documentation may not be sufficient to get a complaint dismissed, it may help end the litigation at the summary judgment stage, which is still short of a trial.