Plan fiduciaries need to respond to changing industry practices. The next challenge in protecting plans may be fees for non-plan related financial products.
ERISA requires that plan fiduciaries discharge their duties “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use.” This mantra is repeated so frequently that it is easy to overlook some of its implications. This blog will discuss some of these (perhaps overlooked) implications.
Is That Bar Getting Higher?
The prudence standard is based on the behavior of an expert “familiar with such matters.” The challenge is that as experts continue to up their game the prudence standard continues to evolve and, in some ways, demand more of plan fiduciaries. Similarly, ERISA’s reference to the “circumstances then prevailing” serves as a reminder that plan fiduciaries must keep track of evolving industry trends and practices and need to recalibrate the exercise of fiduciary responsibilities accordingly.
Perhaps the best example of the difficulty of staying on top of fiduciary obligations is the level of scrutiny imposed on fees charged to plans, including recordkeeping fees and investment fees. The past few years have seen increased fee disclosures, a number of high-profile lawsuits, and the growth of lower cost investment options. In effect, under the circumstances now prevailing, prudent experts who are familiar with such matters (e.g., fiduciaries) now scrutinize plan fees differently–e.g., more often, more carefully and more aggressively — than they did five or seven years ago.
In effect, fiduciary practices that have stood still have fallen behind.
The Reasonable Contract Requirement: Lost in the Shuffle?
Plan fees (including recordkeeping and investment fees) have dropped precipitously over the past ten years and there is tremendous pressure on plan providers to continue to lower fees. And vigilant fiduciaries are a part of that pressure.
But plan providers will not necessarily stand still in the face of pressure to lower fees. It is reasonable to expect that providers will develop alternative sources of revenue. And, in light of the scrutiny over plan fees, it is also fair to anticipate that new revenue sources alternative will not be part of plans’ direct costs.
Indeed, we are starting to see some increased awareness of providers’ alternative revenue models. For example, an article in the New York Times (The Finger-Pointing at the Finance Firm TIAA, October 21, 2017) described claims against TIAA regarding the sale of non-plan financial products to 403(b) participants. And, not surprisingly, these claims soon resurfaced in a lawsuit (the plaintiffs’ amended complaint in Sacerdote v NYU Medical Center, alleging that providers’ access to participant data was used to generate revenue for providers through ancillary products outside of the plan’s formal fee structure).
So, fiduciaries need to keep up with service providers’ practices and protect against the next generation of fiduciary claims. As we consider these evolving circumstances now prevailing, it is important to highlight fiduciaries’ obligations to monitor provider revenues that are generated for providers as a result of their plan services – even if such revenue is not actually generated through the plan.
Section 406(a) of ERISA generally prohibits a fiduciary from entering into a transaction for plan services with a “party in interest” unless the transaction meets specific requirements established by ERISA and the DOL. And, ERISA defines the term party-in-interest to include a person providing services to a plan. So, the prohibition under 406(a) includes any transaction with existing service providers. As noted by the DOL “a service relationship between a plan and a service provider would constitute a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a ‘party in interest’ to the plan.”
This could be problematic. The requirements under 406(a) are independent of the general prudence rules and so, in effect, a fiduciary can negotiate the most prudent transaction in the world – but it can still result in a prohibited transaction.
However, ERISA also offers a solution to this problem: Section 408(b)(2) of ERISA permits a plan to enter into a “reasonable arrangement” for “services necessary for the establishment or operation of the plan …if no more than reasonable compensation is paid therefor.” And so, contracts and other arrangements with existing service providers are prohibited – unless the contract or arrangement meets additional standards and is exempted from the prohibition.
So far, so good. But there are a couple of wrinkles:
◘ Section 408(b) requires both a “reasonable arrangement” as well as “reasonable compensation.” This requires review of plan terms beyond the actual fees paid by the plan.
◘ In 2012 the DOL issued regulations expanding the requirements for a “reasonable” contract. Under these requirements, a transaction with a service provider is not reasonable (and, therefore, is a prohibited transaction) unless the service provider discloses “comprehensive information about the compensation that will be received in connection with the services provided.” (emphasis added).
• The information to be provided includes both direct compensation (such as fees paid directly from the plan) and indirect compensation (such as fees paid to a service provider from other parties).
• These rules “should be construed broadly to ensure that responsible plan fiduciaries base their review of a service contract or arrangement on comprehensive information.”
• If the service provider fails or refuses to furnish the requested information, then the plan fiduciary must report the failure to the DOL and “shall terminate the contract or arrangement as expeditiously as possible, consistent with the duty of prudence.” DOL regulation section 2550.408b-2(c)(1)(ix)(G).
As noted, these rules were adopted in 2012 and service providers have (presumably) been providing information on their compensation in compliance with these regulations.
What Does It All Mean Now?
Over the past few years fiduciaries have (justifiably) focused on fees that directly impact plans: recordkeeping fees, the use of retail vs institutional share classes, and the use of active vs passive investments. However, in light of a growing risk that providers will seek more non-plan compensation from plan participants, it may be time for fiduciaries to more carefully scrutinize providers’ indirect (non-plan) compensation. Indeed, 408(b)(2) of ERISA may require it.