Washington Update: What Do You Need to Know?

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Washington Update What Do You Need to Know?

• Marcia S. Wagner, Esq.

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Priority Objectives from Washington

• Outlook on U.S. Private Retirement System
• Retirement security remains a major priority.
• Pushing for reform through Congress and DOL.
• White House Task Force on the Middle Class
• Newly created by President Obama in 2009.
• Chaired by Vice President Biden, and includes
  Secretaries of Labor and Treasury.
• Used to coordinate Administrations agenda.
• Improving the DC Savings System
• Obama Administrations proposals target 401(k)
  plans and providers.
• Blurring of lines between White House and DOL.
• Coordinated actions to improve retirement
  security.

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1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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ERISA and Conflicts

• Fiduciary standards under ERISA are the highest
  known to the law.
• Conflicts can not be mitigated through
  disclosure.
• Must eliminate conflict or meet conditions of a
  PTE.
• DOLs current definition for investment advice is
  based on 5-factor test
• Advice on value or advisability of investments,
• that is provided on a regular basis,
• pursuant to a mutual agreement or understanding,
• that such services will serve as a primary basis
  for investment decisions, and
• that individualized advice will be based on the
  particular needs of the plan.

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Two Specific Changes Are Proposed

• DOL releases proposed regs on Oct. 21, 2010.
• Proposed regs broaden existing regulatory
  definition of investment advice fiduciary.
• Existing definition of investment advice
  requires
• Mutual understanding or agreement that advice
  will serve as primary basis for plan investment
  decisions.
• Advice provided on regular basis.
• DOL proposal for new investment advice definition
  merely requires
• Any understanding or agreement that advice
  may be considered for plan investment decisions.
• Advice no longer needs to be provided on regular
  basis.

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Safe Harbor for Avoiding Fiduciary Status

• Proposed regs introduce new safe harbor.
• Non-fiduciary advisor must be able to demonstrate
  that plan client knows, or reasonably should
  know.
• that advice is being made by advisor in its
  capacity as purchaser or seller of securities,
  and
• that advisor is not providing impartial
  investment advice.
• 2 specific activities are exempted under safe
  harbor.
• Non-fiduciary investment education under DOL
  Interpretive Bulletin 96-1.
• Platform providers marketing of investment
  alternatives to plan (and providing related info)
  if it discloses that it is not providing
  impartial advice.

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Potential Impact on Providers

• Financial advisors - brokers
• Brokers would need to change their service model
  and re-define their role.
• If serving non-fiduciary role, must disclose they
  are not providing impartial advice.
• If serving fiduciary role, must avoid variable
  compensation (and prohibited transactions).
• Other service providers
• Platform providers must disclose they do not
  provide impartial advice (to avoid fiduciary
  status).
• TPAs that provide advisory services in exchange
  for variable compensation must also provide
  disclaimer.

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Outlook for DOL Proposed Regs

• Proposal is consistent with Administrations aim
  to reduce conflicts.
• If adopted, many advisors would be forced to
  adopt fee-leveling or change nature of advisory
  services.
• Proposed regs expected to draw heavy comments.
• February 3, 2011 deadline for submitting written
  comments to DOL.
• Public hearing on March 1, 2011.

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New Fiduciary Standards Under Dodd-Frank Act of
2010

• Dodd-Frank Wall Street Reform and Consumer
  Protection Act of 2010.
• Empowers SEC to impose fiduciary standard on
  brokers with respect to retail clients.
• After completing its study on standards of care
  for brokers and RIAs on Jan. 21, 2011, SEC
  staffs report recommends uniform fiduciary
  standard.
• Financial advisors who are non-fiduciary brokers
  are currently subject to a duty of suitability
  only.
• SEC rulemaking may impose new disclosure
  obligations and fiduciary standards on brokers.
• SEC changes would be separate and in addition to
  DOL changes to ERISA fiduciary definition.

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1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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DOL Finalizes Participant Fee Disclosure
Regulations

• DOL issues final regs on Oct. 14, 2010.
• Generally consistent with 2008 proposed regs.
• DOL press release explained that existing law did
  not require plans to provide necessary
  information.
• Types of plans covered
• New regs apply to DC plans with
  participant-directed investments.
• Covers plan even if not designed to comply with
  ERISA Section 404(c).
• Coverage of participants
• New regs apply to all eligible employees.

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Annual and Quarterly Disclosure of Plan-Related
Information

• Must disclose general info about plan.
• Must include explanation of general admin.
  service fees and individual expenses on annual
  basis.
• Must disclose dollar amount of fees/expenses
  charged to participant accounts on quarterly
  basis.
• Disclosure only required for fees/expenses not
  embedded in expenses of investments.
• If service provider only receives indirect
  compensation from investments, providers fees
  are not subject to this disclosure requirement.
• But must disclose that a portion of general
  admin. service fees is paid from expenses of
  investments.

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Annual Disclosure of Investment-Related
Information

• Must disclose fee and performance-related info
  for plans investment alternatives.
• This disclosure must be in comparative format.
• Must be provided on annual basis.
• Required information for disclosure in
  comparative format includes
• Name and type of investment option
• Investment performance data
• Benchmark performance data
• Total annual operating expenses for each
  investment and any extra shareholder-type fees.
• Internet website address

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Other Requirements

• Info that must be available upon request
• Prospectuses, shareholder reports and financial
  statements provided to plan.
• Form of disclosure
• Separate or combined with SPD and/or statements.
• Must be understood by average participant.
• Impact on sponsors other fiduciary duties
• No relief for duty to prudently select/monitor
  plans providers and investments.
• New regs modify ERISA 404(c) disclosures.
• Effective date
• Plan years beginning on or after Nov. 1, 2011

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Potential Impact on Providers

• Administrative service providers
• New regs will impact TPAs and bundled providers.
• Automatic delivery of fund prospectuses will no
  longer be required under ERISA 404(c).
• Financial advisors
• No special disclosure requirement for fees of
  brokers receiving indirect compensation only.
• RIA fees presumably must be disclosed on annual
  and quarterly basis as general administrative
  fee.
• Plan participants are likely to scrutinize plans
  investments and fees, impacting sponsors and
  advisors.

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1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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When Are Service Providers Conflicted?

• Plan sponsor is looking for provider of
  administrative services.
• Provider offers two options
• Services ordered a la carte 10,000.00
• Pre-packaged services and menu 4,000.00
• Plan sponsor may incorrectly conclude
  pre-packaged option is best for participants.
• Doesnt realize that provider receives hidden
  compensation from funds and fund managers.
• Full compensation may be more than 10,000.
• Hidden cost is actually shifted to participants.
• Provider has incentive to steer uninformed
  clients to more profitable option.

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Retirement Security Initiative

• Improving transparency of 401(k) fees.
• Administrations goal is to make sure workers and
  plan sponsors are getting services at a fair
  price.
• Pushing to finalize DOLs 2007 proposed regs
  this year.
• Rationale for proposed 408(b)(2) regs.
• DOL efforts to educate plan sponsors about 401(k)
  plan fees started with Nov 97 hearing.
• Plan sponsors still not asking the right
  questions.
• DOL will now require providers to furnish the fee
  info sponsors should be requesting.

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Covered Providers and Disclosures

• Covered Service Providers
• Fiduciaries (including ERISA fiduciary or RIA).
• Providers of recordkeeping and brokerage
  services.
• Providers of accounting, actuarial, legal and
  other professional services if they receive
  indirect fees.
• Required to disclose compensation in writing.
• Disclosure must be provided before entering into
  contract.
• Formal contract and disclosure of conflicts not
  required.
• Indirect compensation requires more detailed
  disclosure.
• Service-by-service disclosure of fees is
  generally not required.

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Disclosure of Compensation

• Format and manner of disclosure
• Dollar amount, formula, percentage of plan
  assets, per capita charge, or any other
  reasonable method.
• Whether fees will be billed or deducted and any
  other manner of receipt must be disclosed.
• Compensation shared among related parties
• Generally, compensation paid to affiliates or
  subcontractors does not have to be disclosed.
• But must disclose if payment flows to related
  party on transactional basis (e.g., commissions,
  12b-1 fees).
• Special Rules for Platform Providers
• Must provide basic fee information for each
  investment alternative.
• Requirement can be met by passing through fund
  prospectuses.

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Timing of Disclosures UnderInterim 408(b)(2)
Regulations

• Timing requirements for disclosures.
• Disclosure must be made reasonably in advance of
  entering into, extending or renewing services.
• Changes to information must be made no later than
  60 days after provider becomes aware of change.
• Erroneous information will not result in a
  violation if provider has acted in good faith and
  with reasonable diligence.
• Errors and omissions must be disclosed within 30
  days after coming to light.

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Prohibited Transactions and Interim 408(b)(2)
Regulations

• If provider fails to make disclosure, plans
  payment of fees is a prohibited transaction.
• Disclosure failures can be cured.
• Plan must make written request for information,
  and provider must respond within 90 days.
• Refusal or inability to comply with request
  requires plan fiduciary to notify DOL.
• No conflicts of interest for fiduciaries.
• 408(b)(2) disclosure does not cure self-dealing
  violations.
• Outlook
• Effective date delayed from Jul. 16, 2011 to
  Jan. 1, 2012, but further changes may be
  on horizon.

23
1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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Background on Target Date Funds

• Popular default investment vehicle for 401(k)
  plans.
• Typically, formed as open-end investment
  companies registered under the Inv. Co. Act.
• Defining characteristic glide path which
  determines the overall asset mix of the fund.
• Performance issues in 2008 raise concerns,
  especially for near-term TDFs.
• Based on SEC analysis, the average loss for TDFs
  with a 2010 target date was -25.
• Individual TDF losses as high as -41.

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Recent Developments for TDFs

• DOL and SEC at Senate Special Committee on Aging
  hearing on TDFs (Oct. 28, 2009).
• Investor Bulletin jointly released by DOL and
  SEC.
• DOLs fiduciary checklist on TDFs is pending.
• SEC proposal for TDF advertising materials.
• If name has target date, tag line disclosure
  needed.
• Advertising must include glide path information.
• On Nov. 30, 2010, DOL proposes rules on TDF
  disclosures for participants, amending
• QDIA regs issued under PPA of 2006
• Participant-level fee disclosure regs that were
  finalized on Oct. 14, 2010 but are not yet
  effective.

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DOLs Proposed Changes to QDIA Regs

• Background on QDIA Regs
• Participant deemed to be directing investment to
  default choice if QDIA requirements are met.
• Default investment must be a QDIA, and QDIA
  notices must be provided to participants.
• DOL proposes change to QDIA notice for TDFs.
• Explanation and illustration of TDFs glide path.
• Relevance of target date (e.g., 2030) in TDF
  name.
• Disclaimer that TDF may lose money after
  retirement.
• DOL also proposes general changes to QDIA notice
  (even if not a TDF).

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DOLs Proposed Changes to Participant-Level Fee
Disclosure Regs

• Background (recap)
• New rules will require disclosure of plan-related
  fees and annual comparative chart for plans
  investments.
• DOL proposes change to annual comparative chart
  for TDFs (even if not a QDIA).
• Must include appendix with additional TDF info.
• Same info as required for QDIA notice.
• Informal follow-up guidance from DOL
• TDF prospectus is unlikely to satisfy QDIA notice
  and annual comparative chart requirements, as
  proposed.
• DOL will not provide model target date
  disclosures.

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Conflicts of Interest in TDFs

• Conflicts arise when a fund of funds invests in
  affiliated underlying funds.
• Conflicts are permitted because fund managers are
  carved out from ERISAs fiduciary requirements.
• Are fund managers ever subject to ERISA?
• Firm requested clarification on scope of
  carve-out.
• In Adv. Op. 2009-04A (Avatar Associates), DOL
  declined to rule that the TDF managers are
  fiduciaries.
• Implications of DOL guidance
• Plan sponsors are alone in their fiduciary
  obligation.
• Must ensure TDFs (and underlying funds) are
  appropriate plan investments.

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Congressional Proposal for TDFs

• Senator Kohl announced his intent to introduce
  new legislation (Dec. 2009).
• Concerns over high fees, low performance or
  excessive risk in many TDFs.
• Would impose ERISA fiduciary status on TDF
  managers when TDF used as QDIA in 401(k) plans.
• Senator Kohls proposal differs from DOL approach
  to improve disclosures to employers and
  participants.

30
1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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Retirement Security and Annuitization

• Obama Administration believes lifetime income
  options facilitate retirement security.
• Initiative to reduce barriers to annuitization of
  401(k) plan assets.
• DOL / IRS issued a joint release with requests
  for information on Feb 2, 2010.
• RFI addresses education, disclosure, tax rules,
  selection of annuity providers, 404(c) and QDIAs.
• The Retirement Security Project
• Released 2 white papers on DC plan annuitization.
• Proposed use of annuities as default investment.

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Other Recent Developments in DC Plan
Annuitization

• Two types of legislative proposals.
• Encourage annuitization with tax breaks
  Lifetime Pension Annuity for You Act, Retirement
  Security for Life Act.
• Annual disclosure of what 401(k) plan balance
  would be worth as annuity Lifetime Income
  Disclosure Act.
• IRS addressed qualification requirements for DC
  plans in PLR 200951039.
• Variable group annuity investment options
• No surprise interpretations on age 70 ½ minimum
  distribution and QJSA rules.

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Lifetime Income Hearing bySenate Special
Committee on Aging

• Senate hearing held on June 16, 2010.
• The Retirement Challenge Making Savings Last a
  Lifetime.
• Start of legislative debate on lifetime income
  options.
• DOL and Treasury provide early analysis on RFI
  concerning lifetime income options.
• More than 800 responses to RFI.
• Concerns expressed against government takeover of
  401(k) plans.
• DOL and Senator Kohl clarify that there is no
  interest in mandating lifetime income options.

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Joint Hearing by DOL, IRS and Treasury in
September 2010

• Purpose is to investigate 5 focused topics.
• 2 areas of general policy-related interest.
• Specific concerns raised by participants.
• Alternative designs of in-plan and distribution
  lifetime income options.
• 3 areas of specific interest.
• Fostering education to help participants make
  informed retirement income decisions.
• Disclosure of account balances as monthly income
  streams.
• Modifying fiduciary safe harbor for selection of
  issuer or product.

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1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
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Automatic IRA Legislation Proposed

• Automatic IRA Act of 2010 introduced in both
  Senate and House.
• Senate version introduced on Aug. 6, 2010.
• After phase-in period over 4 years, employers
  with 10 or more employees must set up Auto IRAs.
• Covers all employees who are age 18 with 3
  months.
• Choice of Traditional or Roth IRA (Roth is
  default).
• Investment firms not required to sell Auto IRAs.
• 3 investment options only, which must be
  low-cost.
• Noncompliance results in100-per-employee
  penalty.
• New tax credit for small employers of 250 for
  start-up costs, and 1,000 tax credit for 401(k)
  plans.

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Automatic IRA Legislation Proposed

• House version introduced on Aug. 10, 2010.
• Differences from Senate version.
• All employers with 10 or more employees are
  immediately covered (and no phase-in over 4
  years).
• Default choice for employee is Traditional IRA
  (and not Roth IRA).
• 3 investment options for Auto IRAs are somewhat
  different than in Senate version.
• White Houses 2012 budget proposal includes
  Automatic Workplace Pensions initiative.
• Automatic IRA legislation remains high priority
  for Obama Administration.

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1. Broader Fiduciary Definition2. Fee
Disclosures to Participants3. 408(b)(2)
Disclosures4. Default Investments - TDFs5.
Lifetime Income Options6. Automatic IRA
Legislation7. A Game Plan for Clients
39
Final and Proposed Rules Will Impact Many Plan
Clients

• 408(b)(2) Fee Disclosures
• Providers must furnish detailed fee disclosures
  by Jan. 1, 2012.
• Will also impact plan sponsors directly.
• Plan sponsors have duty to ensure plans fees are
  reasonable under ERISA.
• Duty will extend to fee information included in
  providers 408(b)(2) disclosures.
• Sponsors are likely to need assistance in light
  of complexity of plan arrangements.
• Advisors can assist in prudent evaluation of fees
  and, if necessary, in search for alternative
  arrangements.

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Fee Disclosures to Participants

• Many participants may be caught off guard by fee
  disclosures under the new rules.
• New rules become effective January 1, 2012 for
  calendar year plans.
• Advisors can help plan sponsors prepare.
• Discuss with plans recordkeeper and determine
  impact of new rules on existing fee disclosures.
• Meet with participants and review fee information
  through educational sessions.
• If sponsor has fee-related concerns, remind
  sponsor that its fiduciary review process can be
  enhanced.

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Target Date Disclosures

• Provide meaningful TDF disclosures to
  participants as a best practice right now.
• Provide key information about TDFs glide path,
  landing point and potential volatility.
• Also facilitate sponsors prudent review of the
  plans TDF series.
• Assist in the fiduciary review of the fund of
  funds structure, glide path, underlying funds
  and risk.
• Special review of TDFs for participants in or
  nearing retirement (e.g., 2015 TDF).

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Washington Update What DoYou Need to Know?
Marcia S. Wagner,
Esq. 99 Summer Street, 13th Floor Boston, MA
02110 Tel [phone] Fax [phone]
Website www.erisa-lawyers.com marcia_at_wagnerlawgro
up.com
A0049764