We have blogged in the past about how important it is for ERISA fiduciaries to monitor the fees and compensation that their plans’ service providers receive for their services. Recently, the Department of Labor (“DOL”) issued guidance about revenue sharing payments in Advisory Opinion 2013-03A (the “Opinion”). The Opinion first answers a narrow question about potential issues for financial service providers. It then spends considerable time warning fiduciaries to be careful about how they negotiate with service providers over the use of revenue sharing payments. While we do not want to understate the importance of reminding fiduciaries of their duties, the Opinion was somewhat disappointing in that all it did was highlight these fiduciary issues rather than provide more specific solutions. Still, the Opinion sets forth in writing what DOL officials have said informally for some time now: that the DOL expects fiduciaries to be able to demonstrate that they reviewed their fee disclosures and took any action necessary to ensure that their service arrangements do not create any fiduciary or prohibited transaction issues. This blog will explore these issues.

Background

Before discussing the fiduciary issues that the Opinion described, we first should describe the nature of these revenue sharing arrangements. Financial institutions that provide services to a plan often receive payments in connection with the investments offered under the plan. These payments include Securities and Exchange Commission Rule 12b-1 fees and other shareholder and administrative services fees, and they generally are called “revenue sharing” payments. After the DOL finalized its fee disclosure regulations in 2012, many fiduciaries started to scrutinize these arrangements more heavily than they had in the past.

The Opinion described a typical response of fiduciaries upon learning about their revenue sharing arrangements. The Opinion explained that Principal Life Insurance Company (“Principal”) agreed with some plans to record bookkeeping credits based on the amount of the revenue sharing payments. These credits could then be used to reduce plan expenses or be deposited into participant accounts. These bookkeeping credits often are called “ERISA Accounts.” Principal’s question to the DOL was whether the ERISA Accounts were plan assets for purposes of ERISA.

That question is rather narrow, but it is important to financial service providers because if these accounts are plan assets, any person who has authority to manage such accounts could be an ERISA fiduciary. Prohibited transaction and other ERISA rules also would apply to those accounts. Essentially, Principal sought comfort that it would not be a fiduciary or have conflicts of interest with respect to these amounts, at least before they are deposited into a plan. The DOL held that in cases similar to Principal’s fact pattern, where the institution keeps the revenue sharing amounts with its own general assets, such amounts will not be plan assets, even if the institution sets money aside for ease of administration. In contrast, if the institution sets money aside in an account that is only for the benefit of the plan, it is a plan asset.

Fiduciary Guidance… and Lack Thereof

Ideally, the Opinion would have explained appropriate methods for plan sponsors to use these revenue sharing accounts. After all, once these amounts are deposited into the plan, they become plan assets, and fiduciaries must act in accordance with their duties when making decisions about how to use these amounts. We already mentioned that two common uses are using the funds to offset plan administration expenses and to deposit these amounts into participant accounts. The latter approach raises a question of how to allocate such deposits. For example, should they be allocated equally among all participants, or only to those participants who invested their accounts in funds that generated the revenue sharing? Regardless of the approach, it is unclear whether the plan document should address revenue sharing and ERISA Accounts.

Instead, most of the Opinion explained generally that ERISA’s fiduciary rules still apply to these revenue sharing credit contracts. The DOL explained that a fiduciary must act prudently and solely in the interest of the plan participants and beneficiaries in deciding whether to enter into, or continue, an ERISA Account arrangement. This includes:

  1. Assuring that the compensation the plan pays directly or indirectly for services is reasonable, taking into account the services provided to the plan as well as all fees or compensation received by the service provider from any revenue sharing.
  2. Obtaining sufficient information regarding all fees and other compensation received by the service provider with respect to the plan’s investments to make an informed decision as to whether the service provider’s compensation for services is no more than reasonable.
  3. Prior to entering into such an arrangement, making sure that the fiduciary understands the formula, methodology and assumptions used by the service provider in arriving at the amounts to be returned to the plan or used to pay plan service providers following disclosure of all relevant information pertaining to the proposed arrangement.
  4. Overseeing and periodically monitoring the arrangement and the performance of the service provider, and monitoring that payments due to the plan are correctly calculated.
  5. Obtaining sufficient information to assure that any other service providers to the plan who are paid directly by the main service provider are paid no more than reasonable compensation for the services provided by them to the plan.

These points follow a natural progression from the fee disclosure regulations finalized last year and are consistent with comments from DOL officials at various conferences and presentations. When explaining the fee disclosure regulations, the DOL officials have explained that the purpose was to give fiduciaries information they need to evaluate whether the fees their service providers are charging are reasonable. If those fees are not reasonable, the fiduciaries need to negotiate lower fees or find another service provider who will charge reasonable fees. Otherwise, the fiduciary could be causing the plan to engage in a prohibited transaction.

Next Steps for Fiduciaries

We believe that the practical steps that fiduciaries should follow after the Opinion include the following:

  1. Understand the amounts of the revenue sharing payments and how they will be used to reduce plan expenses or be credited to participant accounts.
  2. Enforce these agreements and make sure the service providers follow through with their obligations.
  3. Periodically benchmark or review fees to determine whether arrangements that are more favorable to the plan are available in the marketplace.
  4. Document the steps taken to demonstrate compliance with these rules.

All of this could sound as though the DOL is imposing new responsibilities on fiduciaries, but the DOL would say fiduciaries always have had these responsibilities. In any event, the Opinion represents the latest in an increasingly long line of guidance that emphasizes of the importance of assuring that service provider agreements are reasonable. Fiduciaries should consult with counsel to make sure they are making these determinations properly.