QP Steno offers a unique tool that can assist with the evaluation of a service provider’s fees. The reports generated by this tool give plan sponsors the ability to see how much time, effort and cost is going into each of the provider’s activities, and it can break out the provider’s gross compensation across different activities and convert such compensation into an hourly rate, project rate, or per-participant rate.
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Meeting The Fiduciary Challenges of 401(k) Fee Evaluation
1. MEETING THE FIDUCIARY CHALLENGES OF 401(K) FEE EVALUTION
Prepared by The Wagner Law Group
On behalf of QP Steno, LLC.
January 13, 2015
Important Note
The Wagner Law Group has prepared this white paper on behalf of QP Steno, LLC. (“QP
Steno”). This paper addresses critical factors which may be considered by plan sponsors and
other fiduciaries in evaluating the fees and services provided to the plan. In the future, there may
be legislative, regulatory or judicial developments which have a material impact on the conduct
of such fiduciary reviews and modify the standards by which plan fees and services are to be
evaluated. Please be sure to consult with your own legal counsel concerning such future
developments.
This white paper is intended for general informational purposes only, and it does not constitute
legal, tax or investment advice on the part of The Wagner Law Group or QP Steno and its
affiliates. Plan sponsors and other fiduciaries should consult with their own legal counsel to
understand the nature and scope of their responsibility under the Employee Retirement Income
Security Act of 1974 (“ERISA”) and other applicable laws.
2. ii
EXECUTIVE SUMMARY
Fiduciary Challenge of Evaluating Plan Fees. The prudent evaluation of fees and services is
one of the most critical and challenging duties imposed on plan fiduciaries under ERISA.
However, many plan sponsors do not have the expertise or the appropriate tools to evaluate fees
in a meaningful fashion under ERISA.
Fee-Related Duties Under ERISA. The DOL has been involved in a broad range of rulemaking
relating to fee disclosures and the fiduciary duty under ERISA to protect participants from
excessive fees. In general, plan fiduciaries have a duty to ensure that all plan fees are in fact
reasonable. A plan fiduciary may only authorize the payment of a provider’s fee from the plan if
it is able to determine that the fee is limited to “reasonable compensation” for the provider.
Fee Evaluation Process. Under ERISA, plan sponsors must gather information concerning the
qualifications of the service provider as well as the quality of its services. Furthermore, it must
obtain additional data as necessary so that it may evaluate the reasonableness of the fee in light
of the services provided. The plan sponsor should seek the advice of an expert if it lacks the
experience or skills necessary to conduct a reasonable investigation or evaluation of fees for
purposes the fiduciary review.
Challenges for Plan Fiduciaries. Many plan sponsors do not have the expertise or the
inclination to track the services that are being delivered by the plan’s providers. Although plan
sponsors may obtain ERISA fee disclosures from a provider, many do not understand what is
being described in these complex disclosures. They may also fail to seek the information
necessary to establish a context for purposes of determining the reasonableness of the fees.
Fiduciary Solution Offered By QP Steno. QP Steno offers a unique tool that can assist with the
evaluation of a service provider’s fees. The reports generated by this tool give plan sponsors the
ability to see how much time, effort and cost is going into each of the provider’s activities, and it
can break out the provider’s gross compensation across different activities and convert such
compensation into an hourly rate, project rate, or per-participant rate.
Advantages of QP Steno Services. Consistent with their duties under ERISA, plan sponsors are
able to use QP Steno’s tool to help them track the actual services that are being delivered by a
provider. The reports that are generated can help plan sponsors establish a context for purposes
of determining the reasonableness of the fees. The tool can also help plan sponsors manage their
plans. For example, it can help determine which particular services are being utilized, and
whether they are being delivered at an efficient cost and achieving desirable outcomes.
QP Steno Fee Payable From Plan Assets. To the extent the plan fee for QP Steno’s services is
deemed to be reasonable by a plan sponsor, plan sponsors would also be able to authorize the use
of plan assets to pay this fee. Of course, the determination of whether a particular plan’s assets
may be utilized for the payment of any expense is ultimately a decision that must be made by the
responsible plan fiduciary and it must be permitted under terms of the plan document.
3. INTRODUCTION
Qualified retirement plan sponsors share a common fee-related challenge under the
Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Specifically, the
prudent evaluation of fees and services is one of the most critical and challenging duties imposed
on plan fiduciaries today.
The Obama Administration and Congress have articulated numerous concerns about the
retirement system, with frequent references to the complexity and lack of understanding about
fees.1
A series of class-action lawsuits have been filed on behalf of 401(k) plan participants,
which continue to work through the judicial system, alleging breaches by plan fiduciaries of their
fee-related duties under ERISA. The Department of Labor (“DOL”), the federal agency whose
mission is to promote the integrity of retirement plans and the 401(k) marketplace, in recent
years has issued new and extensive regulatory requirements in this area. Fee disclosure and fee
evaluation has been a key underpinning of this DOL rulemaking, and will necessarily remain so
for the indefinite future.
This white paper will discuss the various fee-related duties that must be undertaken by
plan sponsors and other fiduciaries when managing a plan for the exclusive benefit of their
participants, and how QP Steno’s services can add significant value to that effort in a manner
consistent with the requirements of ERISA.
FIDUCIARY CHALLENGE OF EVALUATING PLAN FEES
Many plan sponsors do not have the expertise or the appropriate tools to evaluate fees in
a meaningful fashion under ERISA. They may not know what the correct fiduciary standards are
for evaluating plan fees, and they may not have the necessary conceptual framework for making
a proper evaluation. Some plan sponsors may even fail to track the various forms of direct and
indirect compensation that are earned by plan service providers, including key providers such as
the plan’s recordkeeper, third party administrator (“TPA”) and financial advisor.
Few sponsors have the expertise and the commitment required to track the scope of the
services that are actually being delivered on behalf of the plan and its participants. How often
does the plan’s financial advisor meet with the employees, and how many employees attended
each of these meetings? Did the meetings focus solely on enrollment, or did they also include
sessions about plan investments and establishing an appropriate risk profile? Did the applicable
service agreements specify the number of reports to be prepared by the recordkeeper and TPA?
If so, have these conditions been satisfied? How much of a service provider’s time was allocated
to work on behalf of the plan sponsor, investment committee, HR department and participants?
Some plan sponsors utilize fee benchmarking studies to help them get a “feel” for
whether a vendor’s fees are competitive. But a plan fiduciary cannot determine if a fee is
reasonable based solely on a fee benchmarking comparison. The reasonableness of a fee can
only be properly understood in the context of the relative value of the services being delivered.
1
See Annual Report of the White House Task Force on the Middle Class, February, 2010.
4. 2
FEE-RELATED DUTIES UNDER ERISA
DOL Rulemaking on Plan Fees. To understand how QP Steno can add substantial value
as a tool for plan sponsors, it is important to first consider the current regulatory environment
and how it has evolved. Over the last twenty-five years2
, the DOL has been involved in a broad
range of rulemaking relating to fee disclosures and the fiduciary duty under ERISA to protect
participants from excessive fees. This has been driven in part by the increasing complexity of
investment products and services, often rendered by a provider (and affiliates) in bundled
arrangements under a wrap fee. This has made it extremely challenging for plan sponsors to
properly evaluate the fees and services provided to the plan and its participants.
In response to these challenges, the DOL implemented three key regulatory initiatives,
well known at this point for improving fee disclosures and increasing transparency. First, it
enhanced the reporting requirements for plan sponsors on the annual Form 5500, Schedule C3
,
requiring plan sponsors to report the amount of the direct and indirect compensation earned by
the plan’s service providers. Second, under the auspices of ERISA Section 408(b)(2), the DOL
adopted a fee disclosure regulation (the “408(b)(2) Regulation”)4
requiring a covered service
provider to deliver an initial fee disclosure to the responsible plan fiduciary (typically the plan
sponsor5
) reasonably in advance of entering into a contract or arrangement for services. The
failure to do so, or to provide timely updates for any changes or errors, means that the service
arrangement is not “reasonable” for purposes of Section 408(b)(2), triggering a prohibited
transaction under ERISA along with the related monetary penalties and excise taxes. Lastly, the
DOL issued final regulations, known as the “404a-5 Regulations,” to ensure that participants in
defined contribution plans receive sufficient disclosures concerning the fees and expenses
associated with the plan’s services and investments.6
General Fiduciary Duty . ERISA Section 404(a)(1)(A) generally provides that when
selecting and monitoring service providers (including the fees and services provided) plan
sponsors must (i) act prudently and solely in the interest of the plan’s participants and
beneficiaries, and (ii) discharge their duties for the exclusive purpose of providing benefits and
defraying reasonable expenses of administering the plan.7
In other words, plan fiduciaries have a
duty to ensure that all plan fees are in fact reasonable, and this determination must be made
prudently and solely in the interest of plan participants.
Prohibited Transaction Rules. Plan sponsors also have an obligation to avoid “prohibited
transactions” under Section 406 of ERISA, unless the transaction qualifies for an “exemption”
from these restrictions. The use of plan assets to pay service providers is deemed to be a
2
For example, before it issued formal regulations, DOL held hearings in the 1990’s on the general topic of 401(k)
fees. It published a detailed booklet (“A Look at 401(k) Plan Fees”) and report (“Study of 401(k) Fees and
Expenses”), available on the DOL website. It also issued numerous Advisory Opinions that provided guidance on
fees and potential conflicts of interest. See, e.g., DOL Adv. Op. 97-15A, 97-16A, 2003-09A.
3
72 Fed. Reg. 64731 (Nov. 16, 2007). Schedule C generally applies to all “large” plans with 100 or more
participants.
4
DOL Regulation §2550.408b-2(c), published 77 Fed. Reg. 5632 (Feb. 3, 2012).
5
For purposes of this white paper, it is assumed that the plan sponsor is the plan fiduciary responsible for evaluating
plan fees and services.
6
DOL Regulation §2550.404a-5, published 75 Fed. Reg. 64910 (Oct. 20, 2010).
7
This duty is independent of and in addition to the duty of a fiduciary to avoid prohibited transactions under ERISA.
See the language in the preamble to the 408(b)(2) Regulation at 77 Fed. Reg. 5634.
5. 3
prohibited transaction, but the statutory exemption under ERISA Section 408(b)(2) permits such
payment if the following conditions are met:
(i) the services are “necessary” (in the sense of being appropriate or helpful) for plan
operation,8
(ii) the services are provided under a “reasonable contract or arrangement,”9
and
(iii) no more than “reasonable compensation”10
is paid by the plan.
Therefore, a plan fiduciary may only authorize the payment of a provider’s fee from the
plan if the fiduciary is able to determine that the fee is limited to “reasonable compensation” for
the provider. As discussed above, a provider’s arrangement will only qualify as a “reasonable
contract or arrangement” if the provider furnishes comprehensive fee disclosures in accordance
with the requirements of the 408(b)(2) Regulation. The disclosure must include the following:
A description of the services;
The status of the service provider as an ERISA fiduciary or registered investment adviser
(if applicable);
A description of all direct and indirect compensation, including the payer of indirect
compensation;
A description of any compensation paid among related parties;
A description of any compensation payable upon termination of the service arrangement;
and
The manner of receipt of the provider’s compensation.
The 408(b)(2) Regulation is designed to ensure that the plan sponsor receives sufficient
information concerning the total direct and indirect compensation earned by the service provider.
Of course, it is the plan sponsor’s job to actually evaluate and understand the fee disclosure
provided and to also properly evaluate the reasonableness of the provider’s fee. This must be
done not only to gain the benefit of exemptive relief under ERISA Section 408(b)(2), but to
satisfy the independent and ongoing duty under ERISA Section 404(a) to prudently select and
monitor the plan’s providers, including their relevant services and fees11
. The penalty under
ERISA for a plan sponsor breach of fiduciary duty is substantial, involving personal liability for
losses resulting from the breach, a 20% civil penalty on amounts recovered pursuant to any
settlement with DOL, and the imposition of excise taxes12
.
8
DOL Regulation §2550.408b-2(b) provides that a service is considered necessary for the plan’s operation if it is
“appropriate and helpful…in carrying out the purposes for which the plan is established or maintained.”
9
See The 408(b)(2) Regulation below.
10
DOL Regulation 2550.408bc-2(b)(1) provides that the finding of whether compensation is “reasonable” depends
on the facts and circumstances of each case.
11
ERISA §404(a)(1)(B) requires a plan fiduciary to discharge its duties to the plan with the care, skill, prudence and
diligence that a “prudent man acting in a like capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims.” Thus the plan sponsor must discharge its fiduciary duties to the
plan, including its duty to avoid prohibited transactions and to limit plan fees to reasonable expenses only, with the
same level of skill and diligence that a prudent expert would use.
12
See ERISA §409, and Internal Revenue Code of 1986 (“Code”) §4975.
6. 4
FEE EVALUATION PROCESS FOR PLAN FIDUCIARIES
Fee Evaluation Criteria. When making a decision to engage (or to continue to engage) a
service provider, plan sponsors must engage in an objective process designed to elicit the
information necessary to assess the following:
(1) the qualifications of the provider,
(2) the scope and quality of the services offered, and
(3) the reasonableness of the fees charged in light of the services provided.13
Thus, the plan sponsor must evaluate plan fees in a proper context after it has gathered
sufficient information to make a reliable evaluation. Specifically, it must gather information
concerning the provider as well as its services. Furthermore, in addition to gathering information
concerning the fees charged by the provider, it must obtain additional data as necessary so that it
may evaluate the reasonableness of the fee in light of the services provided. In no event should a
plan sponsor evaluate plan fees based solely on the amount of the fee alone. Doing so would
lead plan sponsors to select the cheapest providers, which could hurt plan participants especially
if an incompetent firm is selected. Fees must be evaluated in the context of value received for
dollars spent, and not for the sole purpose of finding the lowest fee.
Seeking Expert Assistance. Implementing and following a prudent fee evaluation process
requires skill and expertise. Thus, the plan sponsor should seek the advice of an expert if it lacks
the experience or skills necessary to conduct a reasonable investigation or evaluation of fees for
purposes the fiduciary review.14
Challenges for Plan Fiduciaries. With regard to gathering information concerning the
qualifications of a plan’s service provider, plan sponsors are typically able to obtain this
information with little difficulty. Such information may be readily obtained through firm
brochures, pitch books, website disclosures or other marketing materials.
However, many plan sponsors do not have the expertise or the inclination to track the
scope or quality of the services that are actually being delivered by the plan’s various service
providers. Furthermore, although plan sponsors may obtain the required fee disclosures from a
provider in accordance with the 408(b)(2) Regulation, many do not understand what is being
described in these complex regulatory disclosures. Thus, they may lack the expertise to
determine the total dollar amount that is being paid to the provider from the plan. Moreover,
they may fail to seek the additional information that is necessary to establish a context for
purposes of determining the reasonableness of the fees.
13
See DOL Field Assistance Bulletin (“FAB”) 2002-3 (Nov. 5, 2002). FAB 2002-3 states in part that (i) the
responsible plan fiduciary must assure that the compensation paid directly or indirectly by the plan to its investment
or service provider is reasonable, (ii) to assess the reasonableness of such compensation, the fiduciary must obtain
sufficient information regarding the fees or other compensation received by the provider, and (iii) to obtain
sufficient information, the fiduciary must engage in an objective process designed to elicit the information necessary
to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged
in light of the services provided. See also DOL Information Letter to T. Konshak (Dec. 1, 1997).
14
See, e.g., Liss v. Smith, 991 F. Supp (278 (S.D.N.Y. 1998).
7. 5
FIDUCIARY SOLUTION OFFERED BY QP STENO
QP Steno is an independent third party that focuses on providing software and online
tools that are designed to measure fees in relation to the plan services provided, and to produce a
tracking report for such purposes. The firm does not serve as a fiduciary, but it supports the
fiduciary process by providing a meaningful basis which may supplement the efforts of a
fiduciary to prudently assess fees for purposes of ERISA. QP Steno offers a unique tool that can
assist with the evaluation of a service provider’s fees by giving plan sponsors the following: (i)
the ability to track the actual services delivered by the plan sponsor, and (ii) an easy-to-
understand methodology and framework for evaluating the reasonableness of the fees of the
provider.
It does so by capturing the specific functions and services that are being provided. For
example, it will track the service provider (such as a financial advisor, TPA, attorney,
accountant, recordkeeper), the duration of time spent on each identifiable activity, and the
participants involved.15
It then allocates an appropriate portion of the fee to each activity type.
QP Steno can then generate reports by time frame, by service provider, by participant or by
activity. The reports give plan sponsors the ability to see how much time, effort and cost is
going into each activity and use that data as part of its overall fee evaluation process.
Specifically, the reports can break out the provider’s gross compensation across different
activities and to convert such compensation into an hourly rate, project rate, or per-participant
rate.
ADVANTAGES OF QP STENO SERVICES
As discussed above, when evaluating plan fees, sponsors have a fiduciary duty to track
the scope or quality of the services that are being delivered by the plan’s service provider. QP
Steno gives plan sponsors the ability to track the activities of the provider and to see how they
are in fact spending their time. Plan sponsors also have a related duty to gather sufficient
information so that they have the proper framework and context to properly evaluate the
reasonableness of the fees of the provider. The reports that can be generated through QP Steno’s
service can provide much needed transparency and context for fiduciaries when making their fee
evaluations. For example, without the benefit of additional information, it would be challenging
for any person to determine whether a financial advisor’s annual fee of $15,000 was reasonable.
But this task would be far less challenging if the financial advisor’s gross fee were converted to a
per-project or hourly rate, with a corresponding breakout of the advisor’s specific activities and
the hours worked in each specific activity.
There are many related advantages for plan sponsors that decide to utilize QP Steno’s
services. The tool is specifically designed to help plan sponsors by recording and tracking
providers, tasks, time spent, the number of participants involved and the allocation of cost. In
addition to assisting with backward-looking fee evaluations, the tool offered by QP Steno can
also assist with the prospective monitoring of fees and services. Its reports can also provide
critical fee and service information in a business format that can be readily understood by plan
15
The service provider can load its individual activities or bulk load them using a CSV file exported from its
preferred customer relationship management system. QP Steno can also export files to the service provider’s system
where it becomes the primary tracking mechanism.
8. 6
sponsors. It can also enable plan sponsors to spot both favorable and unfavorable trends and take
preemptive action where necessary.
Identifying the nature and frequency of each specific task performed enables the plan
sponsor to evaluate and measure the service deliverables established under the applicable service
contract. It also establishes an ongoing measurement of service utilization, and whether the
provider is working on plan matters that actually need attention. For example, plan sponsors can
use the tool to determine which particular plan services are being utilized by specific
participants, and whether they are being delivered at an efficient cost and are achieving desirable
outcomes.
QP STENO FEE PAYABLE FROM PLAN ASSETS
As discussed, plan assets may be used to pay the reasonable expenses of administering
the plan.16
The plan document must permit the payment of plan fees (or at least not prohibit it).
To the extent the plan fee for QP Steno’s services is deemed to be reasonable by a plan sponsor,
plan sponsors would also be able to authorize the use of plan assets to pay this fee. Of course,
the determination of whether a particular plan’s assets may be utilized for the payment of any
expense is ultimately a decision that must be made by the responsible plan fiduciary.17
Plan
sponsors who are interested in QP Steno’s services as an aid to discharging their fiduciary
responsibilities should evaluate the availability of plan assets within the context of their own
applicable facts and circumstances.
CONCLUSIONS
Plan sponsors have a fiduciary duty under ERISA to evaluate each service provider’s
qualifications, the quality of its services and the reasonableness of its plan fees. Given the
challenges of tracking the actual services provided by providers as well as gathering sufficient
information to evaluate the reasonableness of a provider’s fees, plan sponsor should consider
utilizing QP Steno’s services. The tool offered by QP Steno can help plan sponsors track the
services that are actually being performed by a provider and also help them determine the
associated costs for each service type. Reports may also be generated through this tool,
converting the provider’s gross fee to an hourly rate, project rate or per-participant rate. QP
Steno’s services and reports can help plan sponsors follow a prudent process and meet their fee-
related duties under ERISA. The tool can also help plan sponsors manage their respective plans
and service providers more effectively.
A0137987-2
16
ERISA §404(a)(1)(A)(ii).
17
See DOL Adv. Op. 2001-01A, 97-03A.