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DOL issues 'final rule' on 401(k) fee disclosure rules

The Labor Department today issued much anticipated fee disclosure rules for providers of services to employee pension benefit plans.

According to the department, “the new rules are aimed at assisting plan sponsors in assessing the reasonableness of contracts or arrangements, including the reasonableness of the service providers' compensation and potential conflicts of interest.”

Translation: Plan fiduciaries should find it easer to assess the actual fees that plan providers charge.

It should be noted, however, that the Labor Dept. also branded the new rules as the 'interim final rules' and pushed back their implementation until July 16, 2011.

Nevertheless, Brian Graff, executive director of the American Society of Pension Professionals and Actuaries, lauded the DOL's new rules. “We believe these new fee disclosure rules benefit both plan sponsors and providers,” he noted in a press release. “Providers now have clear guidance on what disclosures are required, and plan sponsors will have the information they need to make informed choices about their retirement plans.”

The new rules — technically interim final rules — have been the source of much controversy. Critics have long charged that 401(k) and other defined-contribution-plan participants do not have a clear sense of the fees and expenses charged by plan providers. Those charges, they argue, can take a sizable bite out of the funds in the retirement plans.

A provision to require providers to disclose fees in defined-contribution plans was initially included in a Congressional tax extenders bill introduced last month. But the provision led to great uncertainty, particularly for advisers who were already bracing for the new DOL law. It ultimately was stripped from the measure. Published reports at the time said Congress was expected to let the Labor Department address the issue of fee disclosure.

That's what has happened.

The new rules — referred to as the 408(b)(2) rules after a section in the Employee Retirement Income Security Act of 1974 — require registered representatives, investment advisers and others working with 401(k) plan sponsors to provide detailed overviews of their services and compensation, as well as declare whether they are acting as fiduciaries.

Indeed, all service providers — both bundled and unbundled — will have to disclose all fees in a consistent manner, including those arising from record-keeping services. Backers of the new rules said plan sponsors will be able to make a more accurate assessment when comparing the fees of competing plan providers.

The final rules do differ from the department's initial proposal. Notably, they not require a formal written contract spelling out the disclosure obligations. Instead, the rules focus on the substance of the disclosure that must be provided. In addition, the final rules modify the categories of service providers that must comply with the disclosure requirements, including fiduciaries, investment advisers and record keepers or brokers who make investment alternatives available to a plan.

GAO report - Better regulation needed

What GAO Found The sponsors of 401(k) plans face conflicts of interest from service providers assisting in the selection of investment options because of third-party payments and other business arrangements. For example, providers who help sponsors to establish and maintain their plans may receive third-party payments from investment fund companies.

The payments, sometimes called revenue sharing, create a conflict of interest because the provider may receive greater compensation from certain funds. Moreover, providers are reported to commonly structure their relationships with sponsors in a manner that avoids being subject to fiduciary standards under the Employee Retirement Income Security Act (ERISA). According to several industry experts, many sponsors, particularly of smaller plans, do not understand whether or not providers to the plan are fiduciaries, nor are they aware that the provider’s compensation may vary based on the investment options selected. Such conflicts could lead to higher costs for the plan, which are typically borne by participants.

In certain situations, participants face conflicts of interest from providers that have a financial interest when providing investment assistance. For example, although investment education is defined as generalized investment information, providers may highlight their own funds as examples of investments available within asset classes even though they may have a financial interest in the funds. According to industry experts, participants perceive education as investment advice. Thus, participants may not understand that the provider is not a fiduciary adviser required to act solely in participants’ best interests.

Also, several industry experts expressed concerns that providers stand to gain higher profits from marketing investment products outside of plans to participants, a practice known as cross-selling. For example, if participants use their plan provider for Individual Retirement Account rollovers, they may not understand, because of insufficient disclosures, that fees are often higher for products offered outside the plan and that the provider may not be serving as a fiduciary adviser. Consequently, participants may choose funds that do not meet their needs and pay higher fees, which reduce their retirement savings.

While Labor has taken steps to address the potential for conflicted investment advice provided to sponsors and participants, more can be done to ensure they receive impartial advice. In fiscal year 2007, the Employee Benefits Security Administration (EBSA) began a national enforcement project that focuses on the receipt of improper or undisclosed compensation by certain providers, but its enforcement efforts are constrained to fiduciary providers and limited by EBSA’s approach for generating cases. In addition, EBSA issued regulations to revise the definition of an ERISA fiduciary and require enhanced disclosure of providers’ compensation and fiduciary status.

These regulations, as currently specified, would help EBSA and sponsors detect and deter conflicted investment advice. However, the regulations do not require that certain disclosures be made in consistent or summary formats, which may leave sponsors with information that is not sufficient or comparable.

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