fiduciaries & 401(k) fees: do new disclosure rules= new exposures?

FIDUCIARIES & 401(K) FEES:

DO NEW DISCLOSURE RULES=

NEW EXPOSURES?

Introductions

MODERATOR: • Gregory C. Braden, Esq., Partner, Morgan Lewis &

Bockius LLP

PANELISTS: • Gary A. Gotto, Esq., Attorney, Keller Rohrback • James T. Hynes, Esq., Technical Director, Travelers • Andrea D. Lieberman, Esq., Managing Director &

Claims Advocate, Marsh USA Inc.

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Background on Fees Litigation

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• Two types of fees litigation– Plan Fiduciary/Sponsor claims (i.e. St. Louis firm cases)– Product/service provider claims

• The claims attack common practices in the industry including:– Use of mutual funds in 401(k) plans– Revenue sharing by mutual funds with service providers– Actively managed vs. passively managed funds


• Discovery has been used to add new claims– Investment losses- imprudent selection of investment

options– Prohibited transactions- alleged receipt of

consideration by plan sponsor/fiduciaries in connection with fees paid by plans

– Excessive fees- “float” on plan benefit payments– Allegedly excessive recordkeeping fees– Losses due to “investment drag” on unitized employer

stock funds5


• The claims seek hundreds of millions or billions of dollars in damages & are asserted against fiduciaries of large company 401(k) plans– No plaintiff has won anything in a final adjudication except in the

Consolidated Edison case ($372,000 judgment) – The 7th & 3rd Circuits have affirmed three Rule 12 dismissals– District Courts have typically certified classes, but the 7th Circuit

recently vacated class certification- International Paper & Boeing– Three of the cases have been settled in the $15-18 million range

• Will that change with the disclosure regulations?

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New Fees Disclosure Requirements Introduction

• Recent DOL initiative – to improve disclosure of service & investment fees charged to plans & conflicts of interest –3 parts: – Disclosure of service provider compensation by plan

administrators– effective for 2009 plan year annual reports

– Disclosure of service provider compensation by certain service providers– effective April 1, 2012 (as recently extended)

– Participant-directed individual account plans – disclosure of investment fees & other investment fund information to participants – eff. in 2012

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New Fees Disclosure RequirementsSchedule C - Disclosure

• Form 5500 Schedule C publicly available online• Elective for 2009 Plan Years Schedule C must

disclose:– Direct compensation to service providers– Statement whether service provider received indirect

compensation and if so whether it was “eligible.”• “Eligible”= disclosed in detail by the service provider

• The amount of indirect service provider compensation not “eligible.”

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New Fees Disclosure Requirements408(b)(2) - Disclosure Rules

Section 408(b)(2) Background– Exemption from prohibited transaction rules –provider may

provide services to a plan & receive compensation, IF the services are:

• “Necessary”• Provided under a reasonable contract or arrangement• Provided for no more than reasonable compensation

– 1977 regulation – for the “reasonable contract or arrangement” condition, the plan MUST be able to cancel the contract without penalty on “reasonably short notice under the circumstances”

– 2010 amended regulation – adds disclosure requirements9


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• Penalties for Violation– Prohibited transaction for the plan fiduciary – personal

liability for any losses to the plan• Plan fiduciaries can be protected from liability for service provider

disclosure violations under a class exemption, discussed below

– Prohibited transaction for the service provider - excise taxes on the “amount involved” for each year until corrected

• Personal liability for losses or illicit profits if the service provider is a fiduciary


• Purpose– DOL concern – service compensation arrangements too

complicated and fraught with conflicts of interest– Purpose of new rules – help plan sponsors, fiduciaries

obtain information from service providers- help assess the reasonableness of compensation, evaluate possible conflicts of interest, & satisfy ERISA reporting & disclosure obligations

– Important – disclosure requirements are independent of ERISA’s general fiduciary obligations to act prudently and loyally, which may require additional review & due diligence

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• Covered Plans– Only retirement plans normally subject to ERISA– Omits:

• Welfare plans • IRAs, SEPs, SIMPLES, owner-only plans (such as

“Keogh” plans) that are subject to the prohibited transaction excise tax rules (but generally not to the ERISA fiduciary rules)

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• Rules apply only to certain “covered” service providers – primarily those DOL views as most likely to give rise to conflicts of interest:– Service as ERISA fiduciary/registered investment adviser – Includes a fiduciary to a “plan assets” entity in which a

plan has a direct equity investment, but not downstream plan assets entities

• Non-“plan asset” funds not covered

New Fees Disclosure Requirements408(b)(2) Disclosure Rules Covered

Service Providers

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Service Providers

• Recordkeeping or brokerage services to a participant-directed individual account plan that are connected with designated investment alternatives – i.e., intermediaries who offer bundled services with a platform of investment options

• Certain other specified services – including brokerage, consulting, third party administration & investment advice– for which the service provider, its affiliate or subcontractor reasonably expects to receive “indirect” or certain types of bundled service compensation- perceived conflict

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• Minimum compensation threshold –covered only if the service provider reasonably expects to receive ≥$1,000 in direct and indirect compensation

– De minimis exclusion – nonmonetary compensation valued at $250 or less during the term of the contract is excluded


Service Providers

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New Fees Disclosure Requirements408(b)(2) Disclosure Rules - Types of

Compensation

• Direct compensation – received directly from the covered plan

• Indirect compensation – received from a source other than the covered plan or plan sponsor, or (reflecting bundled arrangements) the covered service provider, its affiliate or subcontractor

• Note - payments from plan sponsors – not covered under either category

New Fees Disclosure Requirements

408(b)(2) Disclosure Rules

Disclosure Requirements

• Disclosures to be made to a “responsible plan fiduciary”:– Description of the services, incl. statement as to whether providing

services as a (a) plan fiduciary, (b) fiduciary to a plan asset entity, or (c) registered investment adviser

– Description of the covered service provider’s (or affiliate’s or subcontractor’s) direct & indirect compensation – what the party reasonably expects to receive

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New Fees Disclosure Requirements408(b)(2) Disclosure Rules - Disclosure

Requirements

• Rules on Compensation Disclosure:– Can be aggregate or service-by-service– Can be a monetary amount or formula– Describe the manner in which compensation is received

and whether any termination charges– For indirect compensation – identify services covered

and the payer– Goal – sufficient information to permit evaluation of the

reasonableness of the compensation


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• Additional disclosures for plan asset funds – compensation charged for acquisition, sale, transfer or

withdrawal – annual operating expenses– other ongoing expenses

• Additional disclosures for bundled service arrangements – charges set on a transaction basis– charges directly against the covered plan’s investment– Note – other than the foregoing, no breakout required of

any allocation of fees within the bundle

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New Fees Disclosure Requirements408(b)(2) Disclosure Rules -

Recordkeeping Services• What are Recordkeeping Services? Services related to plan

administration & monitoring of plan & participant transactions – Enrollment– payroll deductions and contributions– offering designated investment alternatives and other covered plan

investments, loans, withdrawals, and distributions– maintenance of covered plan & participant accounts, records, statements

• Special disclosure rules- Additional disclosures for recordkeeping & brokerage arrangements for participant-directed individual account plans– compensation charged directly against the amount of investment on

acquisition, sale, transfer or withdrawal annual operating expenses– other ongoing expenses

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New Fees Disclosure Requirements408(b)(2) Disclosure Rules -

Recordkeeping Services

• Can be met by using the disclosure materials of the issuer of the designated investment alternative, if an unaffiliated regulated entity (such as a third-party mutual fund)– This rule protects the service provider from liability for

inaccurate disclosure– Creates an exception to the general rule that does not

require unbundling of fees, so recordkeeping fees, or their equivalent costs, must be separately disclosed.

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408(b)(2) Disclosure RulesRecordkeeping Services -

Disclosure Timing• Initial disclosure - reasonably in advance of the date

of the contract (i.e. 30 day allowance for a non-plan asset entity)

• Changes – as soon as practicable, but not > than 60 days after the date the service provider learns ofthe change

Disclosure Errors:• No violation if the service provider makes a good faith

error, IF the error is disclosed as soon as practicable, and no later than 30 days from discovery of the error

408(b)(2) Disclosure RulesRecordkeeping Services - Disclosure

Timing

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• Service provider must furnish any compensation-related information required for the plan to comply with the ERISA reporting & disclosure requirements, within 30 days of receipt of the request

• This ties these rules to the Form 5500 Schedule C disclosure requirements, and also extends to any other ERISA reporting and disclosure requirements

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408(b)(2) Disclosure Rules Recordkeeping Services

• Class Exemption for Responsible Plan Fiduciaries– If the covered service provider fails to make a required

disclosure, resulting in a prohibited transaction, the responsible plan fiduciary can be exempt from liability for that violation if:

• The fiduciary did not know of the disclosure failure & reasonably believed the required information was disclosed

• Upon discovering the disclosure failure, the fiduciary requests the information in writing from the service provider


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• If the service provider fails to comply, the fiduciary notifies DOL, not later than 30 days following the specified dates– DOL has provided a sample notice form on its website

• The fiduciary makes a determination whether to terminate or continue the contract with the service provider

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• If the class exemption conditions are met:

• The responsible plan fiduciary is exempt from liability;

however,

• The service provider still has a prohibited transaction

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408(b)(2) Disclosure RulesRecordkeeping Services

• Current Status of New Rules:

• Regulation issued in “interim final” form

• Originally scheduled to be effective July 16, 2011

• DOL ultimately decided to extend to April 1, 2012

• “Final” regulation expected before 12/31/11, but not yet submitted to OMB (typically requires 90 days for review), so schedule unclear

• Several changes expected in “final” regulation,” so the industry may seek a further extension (at least for the new requirements)

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• Compliance Steps for Service Providers– Determine which services are “covered” services

– Determine which clients are “covered” plans

– Develop disclosure materials that meet the new rules

– Provide these materials to existing clients by 4/1/12

– Develop procedures for delivering these materials to new clients beginning no later than 4/1/12

Litigation Implications

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• Disclosures will provide a wealth of data to potential plaintiffs

• Claims that plans paid excessive or above market fees will be easier to formulate with public data available

• Comparisons to payments made by other plans for similar services will be easier

• As disclosure process evolves, potential plaintiffs may be able to monitor plans’ expenses & compare them with market comparables on a near to real time basis

Coverage ImplicationsPolicies Implicated in ERISA

Litigation

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Sponsor Fiduciaries• Fiduciary policy• D&O policy

– ERISA exclusion– Only covers individuals named in status as a fiduciary or

involved in Plan administration

Investment Advisers/Service Providers• E&O policy

– Fees themselves may be excluded

Coverage ImplicationsThe Fiduciary/Pension Trustee -

Liability Policy

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Coverage• Protects sponsor organization, benefit plan, & employee from

loss for:• a breach of fiduciary duty (Defined by ERISA)

– administrative error

Wrongful Act• Any violation of any of the responsibilities, obligations or duties

imposed upon fiduciaries by ERISA or any similar common or statutory law to which a plan is subject

• Administrative acts, errors, or omissions in the performance of administrative duties

• Status as fiduciaries


Liability Policy

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Insured• Directors, Officers, general partners, management

committee members, member of the board of managers or employees of a sponsor organization or a plan

• The named sponsor and any subsidiary• The benefit plans sponsored solely by the sponsor

organization (or jointly with a labor organization)


Liability Policy

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• Payment of benefits

• Criminal or deliberate fraudulent acts

• Knowing or willful violations of any statute

• Profit or advantage to which insured was not legally entitled

• Events and injuries covered by other policies, i.e. BI & PD

• Pending & prior litigation as a specified date

• Prior circumstances reported to previous insurers

• Matters which may be deemed uninsurable under the law

Coverage Implications“Fees” Claims Have Been Made on Fiduciary

Policies

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• Retail vs. institutional shares• Sponsor uses its own affiliates as the investment manager• Investment manager of defined contribution plan were former executives

of sponsor – hired without a bidding process• Allegation that fees for administering DB plan were subsized by excessive

fees for administrating DC plan• Allegation that fees for other services (e.g. payroll) were subsidized by

excessive fees for administering DC plan• Claims involving unitized company stock fund• Faulty description of fund – “Stable Value Fund”• Claims for failure to capture “float”

Coverage Implications“Fees” Claims Have Been Made on Fiduciary

Policies

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• High Publicity but low volume• Approximately 30 class actions as opposed to over

200 “stock drop” class actions• The ‘proprietary funds’ class actions (Ameriprise)• Harder to dismiss on Rule 12 motions

– Exceptions in Third and Seventh Circuits (Unisys, John Deere, Exelon)

– Three settlements in $15-18 million range

Coverage Implications401(k) Stock-Drop Litigation -

Basic Claims

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• Stock price was “artificially inflated” due to materially adverse undisclosed information

• Fiduciaries knew or should have known about the adverse information, and overridden the plan terms & sold the stock

• Fiduciaries misled the participants and/or failed to disclose material information

• Fiduciaries labored under conflicts of interest and/or should have appointed an independent fiduciary

• Fiduciaries should have protected employees because they were aware of employee bias toward employer stock

Coverage Implications401(k) Stock-Drop Litigation - Basic

Defenses

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• Fiduciaries cannot override plan documents.• (Presumption of Prudence) Fiduciaries have no

duty to override plan terms unless employer faces impending collapse or other similarly severe circumstances

• Fiduciaries cannot trade on inside information• Fiduciaries fulfilled ERISA disclosure obligations• “Efficient market” eliminates causation on

nondisclosure claim

Coverage Implications401(k) Stock-Drop Litigation - Basic

Defenses – cont’d

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• Causation + Section 404(c) – plan participants chose to invest in employer stock. That choice – not the decision to offer a stock investment – are the true cause of their losses

• Procedural prudence

• Substantive prudence

401(k) Stock-Drop Litigation Status of the Case Law

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• Decisional authority mixed• Second, Third, Fifth, Sixth, Ninth (and arguably

Seventh) Circuits adopted presumption of prudence – Some courts won’t grant motions to dismiss– Leads to settlements – sometimes large settlements– Other (courageous) courts have granted motions to

dismiss on the theory that employer stock investments are to be treated differently than other investments

Settlements of ERISA Security Holder Lawsuits

0

100

200

300

400

500

600

700

800

2004 2005 2006 2007 2008 2009 2010

2003 Settlements 2004 Settlements 2005 Settlements

2006 Settlements

2007 Settlements

2008 Settlements

2009 Settlements

2010 Settlements

$150.5 Million

$208.2 Million

$711.7 Million

$294.4 Million

$161.2 Million

$150.7 Million

$330.4 Million

$126.2 Million

Coverage ImplicationsOther Examples of Claims (Cont’d)

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• A sponsor in an elaborate and covert scheme to deny benefits to workers terminated employees shortly before they qualified for retirement benefits.

• The PBGC brought an action against a manufacturing company that transferred underfunded pension plans and a group of associated businesses to a corporation created specifically to acquire the plans and businesses in order to evade pension liability.

• The U.S. DOL sued a plan for failure to diversify its investment portfolio, and failure of the trustee to monitor and enforce investment agreements between the plan and the investment firm.

Median Fiduciary Liability Limits Purchased (Compared to Plan

Assets)

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0 10 20 30 40 50 60

Median Limits (in Millions)

Above $5 Billion

$2.5 - $5 Billion

$1 -$2.5 Billion

$501 Million - $1 Billion

$250-$500 Million

$0-$250 MillionPe

nsio

n A

sset

s M

anag

ed (I

n M

illio

ns)

What are the Implications of These Purchasing Habits?

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• Are clients properly evaluating/perceiving the risk for Fiduciary/Pension Trustees?

• Do Policyholder’s expect some coverage to under the D&O or other Insurance?

• Does the use of third-party vendors by policyholders change the perception of the risk?

• Is the Plaintiff’s bar inclined to settle based solely on amount of insurance available?

• Ramifications of inadequate limits for litigation

Many thanks to …

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• Gregory C. Braden

• Gary Gotto

• James T. Hynes

• Andrea D. Lieberman

fiduciaries & 401(k) fees: do new disclosure rules= new exposures?

Documents

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