Making Sense of Fee Disclosure: a Participant's PerspectiveDocument Transcript
MAKING SENSE OF FEE DISCLOSURE: A PARTICIPANT’S PERSPECTIVE WHITE PAPER … MAY 2012Gina Gurgiolo, JD, LL.MSENIOR CONSULTANTINTRODUCTIONIn October 2010, the Department of Labor finalized regulations under ERISA §404(a) that will generally requiresponsors of ERISA-governed retirement plans to provide an initial annual fee disclosure notice to participantsand eligible employees by August 30, 2012. Over the past several months, most employers and their serviceproviders have built a good understanding of the participant fee disclosure requirements and how to comply.Now, as the race to compliance readiness is nearing its end, an important and evolving consideration has cometo the fore. That is, are participants actually going to understand the information reported on the fee disclosurenotice?The primary stated objective of the 404(a) regulations is to provide participants with foundational plan andinvestment information to aid them in making well-informed decisions about how they participate in theirretirement plan. Without proper planning, however, this critical objective could be lost amidst a vast sea ofnumbers and foreign financial jargon. By anticipating potential 404(a) disclosure confusion and fallout, plansponsors can be more certain that the fee disclosure information provided to participants will prove to bemeaningful.Summary of the 404(a) RegulationsThe participant fee disclosure regulations under ERISA §404(a) are one leg of a three-legged retirement planfee disclosure stool. The first leg of the stool is the expanded disclosure of service provider fees on Schedule Cof the Form 5500 beginning with the 2009 filing year. The second leg is the service provider-to-plan sponsorfee disclosure required under the ERISA §408(b)(2) regulations, which were made final after much ado inFebruary, 2012. The third and final leg is the disclosure of plan and investment-related information by the plansponsor to the plan’s eligible employees who have not yet enrolled, active and terminated participants withaccount balances in the plan, and beneficiaries who have the right to make investment decisions as a result of
MAKING SENSE OF FEE DISCLOSURES … 2the passage of a beneficial interest in plan assets. 1 The disclosure of this plan and investment-relatedinformation is mandated by the regulations published under ERISA §404(a).For purposes of context, the investment of plan assets is governed by the fiduciary standards set forth inERISA §§404(a)(1)(A) and (B). These bedrock standards require plan fiduciaries to act prudently and for theexclusive benefit of the plan’s participants in all respects. Today, most plan sponsors delegate the right to directplan investments to participants rather than retaining that responsibility under ERISA. While plan sponsors arenot actually deciding how to invest the dollars in a participant’s plan account, they must still prudently choosethe menu of investments from which participants make their investment selections and ensure that applicablefees are reasonable. The regulations under ERISA §404(a) apply to retirement plans where the right toinvestment direction has been passed on to participants.In the prelude to the ERISA §404(a) regulations, the Department of Labor introduces the objective of the 404(a)regulations as follows: “Plan fiduciaries must take steps to ensure that participants and beneficiaries are madeaware of their rights and responsibilities with respect to managing their individual plan accounts and areprovided sufficient information regarding the plan, including its fees and expenses and designated investmentalternatives, to make informed decisions about the management of their individual accounts.” This primaryobjective of the 404(a) regulations is affirmed by the Secretary of Labor and the Assistant Secretary of Labor inthe associated News Release issued in conjunction with the 404(a) regulations. Stated simply, the objective ofthe 404(a) regulations is to ensure that participants have the information necessary to make wise decisionswith regard to their retirement plan accounts. Looking further into the 404(a) regulations themselves, themassive volume and brain-damaging technicality of the very specific information that must be disclosed toparticipants under the 404(a) regulations can cause almost immediate skepticism that this objective will actuallybe accomplished.Plan-Related InformationThe three categories of plan-related information required to be disclosed to participants under the 404(a)regulations are general plan information, administrative expense information, and individual expenseinformation. This plan-related information must be provided to participants on or before the date that they canfirst direct investments and annually thereafter. Each category of plan-related information is more fullydescribed below.The 404(a) regulations define general plan information to include six specific pieces. They are: • Information on how the participant can provide investment instructions; • An explanation of any limitations on investment instructions, including any investment transfer restrictions; • A description of how voting, tender or similar rights may be exercised;1 For convenience, all of the people who must receive the annual disclosure information under the ERISA §404(a) regulations are collectively referredto as “participants” throughout the remainder of this paper.
MAKING SENSE OF FEE DISCLOSURES … 3 • Identification of all designated investment alternatives offered to participants under the plan; • Identification of all designated investment managers; and, • A description of any brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan.With regard to administrative expense information, the 404(a) regulations require plan administrators to provideinformation regarding all fees for administrative services to the plan that may be allocated to participantaccounts. These administrative expenses are not reflected in the total annual operating expenses of any of theplan’s designated investment alternatives. An example of such a fee would be a recordkeeping fee charged bythe administrative service provider. This disclosed information must also include an explanation of theallocation method of such administrative expenses. For example, the administrative expenses may be allocatedto participants on a pro rata or per capita basis.Individual expense information includes any fees that may be charged to the participant’s account on a “pertransaction” or individualized basis. For example, distribution, loan and QDRO processing fees, investmentadvice fees, self-directed brokerage account fees, transfer fees, redemption fees, sales charges, commissionsand similar expenses must be disclosed if they are not reflected in the total annual operating expenses of anydesignated investment alternative.With regard to individual expense information, the 404(a) regulations also require that plan administratorsprovide participants and beneficiaries with a quarterly statement of the actual dollar amount of fees charged tothe participant’s account. More specifically, participants must be provided with a quarterly statement including: • The dollar amount of the fees and expenses actually charged to the participant’s account during the preceding quarter; • A description of the services to which the charges relate; and, • If applicable, an explanation that some of the plan’s administrative expenses for the preceding quarter were paid from the total annual operating expenses of one or more of the plan’s designated investment alternatives (for example, through revenue sharing arrangements, 12b-1 fees or sub-transfer agent fees).Investment-Related InformationIn addition to the plan-related information described above, the 404(a) disclosure to participants must alsoinclude a hefty dose of investment-related information. Some of the investment-related information must beprovided automatically and some must be provided upon request.
MAKING SENSE OF FEE DISCLOSURES … 4Investment-related information that must be provided automatically includes: • The name of each designated investment alternative, and the type or category of each (for example, stable value fund, money market fund, large-cap mutual fund). • The performance data for each designated investment alternative available under the plan. For investments where the return is not fixed, the disclosure must include the average total return of the investment for 1-, 5- and 10- year periods (or for the life of the designated investment alternative, if shorter) ending on the date of the most recent calendar year. The disclosure must also include a statement indicating that an investment’s past performance is not necessarily an indication of its future performance. For investments with a fixed rate of return, both the fixed annual rate of return and the term of the investment must be disclosed. If the rate of return is adjustable, participants must be so informed and provided with the current rate of return, the minimum guaranteed rate of return, if any, and the phone number or website to obtain the most recent rate of return information. • The name of an appropriate broad-based securities market index and its performance relative to the plan’s designated investment alternatives over the 1-, 5- and 10- year periods (or for the life of the designated investment alternative, if shorter). The benchmarks cannot be administered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter, unless the index is widely recognized and used. • The amount and a description of each shareholder-type fee and any restriction or limitation that may be applicable to a purchase, transfer or withdrawal of the investment. For those investments where the return is not fixed, the following additional information must be disclosed: o The total annual operating expenses of the investment expressed as a percentage calculation (i.e. the expense ratio); o The total annual operating expenses of the investment for a one-year period expressed as a dollar amount for a $1,000 investment; o A statement indicating that fees and expenses are one of several factors that participants should consider when making investment decisions; and, o A statement that the cumulative effect of fees and expenses can substantially reduce the growth of a participant’s account, including an invitation to visit the Employee Benefit Security Administration’s website for an example demonstrating the long-term effect of fees and expenses. • A website address providing access to more specific information regarding each designated investment alternative. • A general glossary of terms to assist participants in understanding the designated investment alternatives, or a website address that provides access to the glossary along with an explanation of the purpose of the website.After investing in a designated investment alternative under the plan, a participant must receive any materialsrelating to any voting, tender or similar rights that are passed on to the participant.
MAKING SENSE OF FEE DISCLOSURES … 5Investment-related information that must be provided upon request includes: • Copies of prospectuses or similar documents for unregistered investment options; • Copies of any financial statements or reports, such as statements of additional information and shareholder reports, or similar material; • A statement of the value of a share or unit of each designated investment alternative, including the date of valuation; • A list of assets in the portfolio of each designated investment alternative that constitutes a plan asset, and the value of each such asset or the proportion of the investment that it comprises.Investment-related information must be provided in a comparative format, such as a chart, to help participantsevaluate and compare the disclosed information for each of the plan’s designated investment alternatives. Thecomparative chart must be easy for the average participant to understand. The Department of Labor provided amodel comparative chart in the 404(a) regulations. 2The initial annual 404(a) notice must generally be provided to participants by August 30, 2012. Thereafter,404(a) notices must be provided to participants on an annual basis. A specific due date for the post-2012annual 404(a) disclosures is not mandated. Newly eligible participants must be provided with the 404(a)disclosure prior to their enrollment in the plan. Participants generally must begin to receive their initial quarterlystatements reporting the dollar amount of actual fees paid by November 14, 2012.The consequences of failing to comply with the 404(a) regulations are severe—the entire plan could beconsidered to be a prohibited transaction under ERISA, the fiduciary protections of ERISA §404(c) could belost, 3 substantial fiduciary liability could ensue, and the Department of Labor could levy a penalty of up to 20%of plan assets. Compliance is an absolute must. Thankfully, the Department of Labor has specifically statedthat a plan sponsor will not be liable for the completeness and accuracy of information used to satisfy therequirements of the 404(a) regulation so long as the plan sponsor reasonably and in good faith relies on theinformation received from or provided by a service or investment provider. Since service providers, especiallyrecordkeeping vendors, will be creating the majority of 404(a) disclosure notices in support of their plansponsor clients, this is especially welcomed news for plan sponsors.Readability of 404(a) DisclosuresA quick read through the specific requirements of the 404(a) disclosures is more than a little daunting. TheDepartment of Labor’s model comparative chart is four standard pages long with just a few sample investmentsfor purposes of illustration. Plans with dozens of fund options and/or multiple service providers might expect tosee 404(a) disclosures that could easily span anywhere from 10 to 40 (yes, 40!) pages, or more in the most2 The model comparative chart may be found at www.dol.gov/ebsa/participantfeerulemodelchart.doc.3 ERISA §404(c) provides fiduciary protection from liability for investment losses where participants are able to direct their own investments and plansponsors who elect its protection comply with specified requirements.
MAKING SENSE OF FEE DISCLOSURES … 6extreme instances. In addition to its length, the model chart uses language that is not common to the averageparticipant’s vernacular.Recall that the Department of Labor requires that the comparative chart provided under the 404(a) regulationsbe easy for the average participant to understand. Using the Flesch-Kincaid Grade Level Readability Test, awidely accepted measure of readability, the model chart scores somewhere between 51 and 71 out of 100possible points, depending on the version and the formatting capabilities of the calculator being used. A scoreof 80-89 is considered to be an easy-to-read document. Thus, despite the variety of potential scores that themodel chart may receive under the Flesch-Kincaid Test, the model chart does not score in the easy-to-readcategory under any circumstances. At the lower end of the model chart’s scoring range, a score of 50-59typically marks a fairly difficult to read document.Using a much less scientific approach to assessing the readability of the model chart, the author of this paperprovided a sample comparative chart from one of the largest retirement plan service providers in the industry toa population of five participants in 401(k) plans. Each participant was asked the same question: if you receivedthis information from your employer, would you understand it? Each of the five participants responded that notonly would they not understand it; they probably would not read the entire document before putting it aside inconfusion or frustration.This informal research is bolstered by the results of the recently concluded 2011 Wells Fargo Retirement PlanSponsor Survey. Only 5% of the plan sponsors surveyed said that the 404(a) disclosure requirements will leadparticipants to make better choices. This report is particularly interesting since top officials from the Departmentof Labor and the regulations themselves state that the primary objective of the 404(a) regulations is to helpparticipants make well-informed decision. Further, 49% of the survey participants stated that participants will beconfused by the 404(a) disclosures.Whatever the measure applied, the totality of circumstances would lead most people in the retirement plansindustry to conclude that the Department of Labor’s primary objective of getting the fee disclosure informationin the hands of participants to help them make decisions within their plan is unlikely to be satisfied in the nearterm. The confusion that the dissemination of this information is likely to cause will perhaps prompt participantsto ask their employers questions. Ideally, employers will be prepared to respond to those questions in ameaningful way.Fee Compression: An Intended Consequence?In the Fact Sheet accompanying the 404(a) regulations, the Department of Labor estimates that the totalindustry cost of implementing and complying with the 404(a) regulations in 2012 is $425 million. Over the 10-year period spanning from 2012-2021, the cost of complying with the 404(a) regulations is estimated to be $2.7billion. However, over the same time period, the Department expects that plan fees and expenses charged byservice providers will decrease noticeably to help offset these costs. In fact, between 2012 and 2021, theDepartment projects lowered plan fees and expenses to the tune of $14.9 billion in the aggregate as a result of
MAKING SENSE OF FEE DISCLOSURES … 7the 404(a) fee disclosure regulations. Why would the Department expect such a substantial drop in plan-relatedfees resulting from the 404(a) regulations?For the first time in the history of retirement plans, an estimated 72 million participants will see exactly whatthey pay in order to participate in their employer-sponsored retirement plan. According to numerous participantsurveys conducted over time, most retirement plan participants believe that they pay nothing in order toparticipate in their retirement plan. These 72 million participants who have weathered recent market downturnsand sluggish economic growth will now learn that they pay money in order to save for retirement. This news isnot expected to be popular.With the advent of explicit baggage fees, handling fees, late fees, restocking fees and the like, our societaltolerance for incidental fees is constantly being tested. Couple that with mounting skepticism over the financialpractices of “Corporate America” and allegations of corporate greed, and fee tolerance is even further lowered.Several large banks planning to launch monthly debit card user fees in the fall of 2011 halted their plans after averitable consumer uprising against them played out via public and social media demonstrations. Fees oftenprompt negative emotional responses, such as confusion (i.e. what am I getting in return for the payment of thisfee?) and annoyance (i.e. why should I have to pay this fee to this wealthy corporation?).Now that 72 million people will know the exact amount in dollars that they are paying in order to save forretirement, the Department of Labor expects retirement plan service providers to reduce their fees. In otherwords, service providers will be getting naked in front of participants for the first time and they areconsequentially expected to lose a few undesired pounds. Participants will likely have questions/demands oncethey see the fees they pay in explicit terms, and long lines may form outside the benefits director’s door.Since October 2010 when the 404(a) regulations were finalized, the retirement plans industry has in fact seendramatic compression in the fees quoted by retirement plan service providers. Based on fee benchmarkingdata collected by the Multnomah Group over the prior 18 months, a hypothetical plan that may have once beencharged 0.50% of assets annually is now being charged 0.20%-0.25% of assets annually. Perhaps serviceproviders are perceptive—they “skinnied down” their fees before participants receive their disclosure notices, inorder to avoid a debit card fee-type insurrection. But at what cost? Will service levels decrease along with fees?Whatever the case, it is more than rational to conclude that the Department of Labor has an ulterior objective todecrease fees paid by plan participants. The Department abundantly hints at this less overtly stated mission inthe 404(a) regulations and collateral documents, and in the public remarks of its highest ranking officials.Compounded over time, a 0.25% reduction in fees has a very meaningful and positive effect on a participant’sretirement plan account, and the Department understands this well. With a potential retirement saving deficitcrisis on its hands, the Department is seeking to capitalize on all opportunities to increase the number of dollarsaccumulated in anticipation of retirement. From a participant’s perspective, this could be a significant ancillarybenefit of the 404(a) regulations.
MAKING SENSE OF FEE DISCLOSURES … 8CONCLUSIONThere is little doubt that the 404(a) regulations will change the game. Some sources estimate that 83% ofretirement plan participants are unaware of the fees that they pay under their respective retirement plans.People who learn that they are being charged fees for the first time tend to have immediate, visceral, negativeemotional responses to this new information. Those reactions are likely to result in a confused and irritatedparticipant population. Employers who are the most prepared to respond to the myriad of questions anddemands they are likely to receive once 404(a) disclosures are delivered to participants will be the mostsuccessful in quieting potential discontent. A little proactive planning in this regard will go a long way. Astrategy that includes acknowledgement of the participant questions, validation of their concerns and promptfollow up with any additional, understandable information that can possibly be provided will quickly resolveparticipant confusion and anxiety. Employers that use the 404(a) disclosures as a springboard to attempt tonegotiate lower fees with service providers and communicate these efforts with participants will win the day.Because every plan’s circumstances are different, the information provided in this paper is intentionally general.Contact your Multnomah Group consultant for 404(a) disclosure fallout planning assistance that is morespecific to your plan.Multnomah Group, Inc.Phone: (888) 559-0159Fax: (800) 997-3010www.multnomahgroup.com† This White Paper is not intended to be legal advice and should not be construed as such. Information relayed herein isrepresentative of the Multnomah Group’s experience and current understanding of the law. While the Multnomah Group has madeevery reasonable effort to ensure that the information contained herein is factual, we do not warrant its accuracy. Additionally, thisWhite Paper does not embody a comprehensive legal study, but rather reflects the information most often sought by our clients. Asthe information contained herein is general in nature, you are urged to contact your legal adviser with specific questions related toyour plan.