In prior entries, we have discussed a variety of issues related to the fee disclosure responsibilities of broker/dealers and financial advisors. This month, we’ll address the impact of the 408(b)(2) disclosure regulations on third party administrators.
Unlike broker/dealers and financial advisors, who often don’t have written agreements with their retirement plan clients, TPAs have historically described the services that will be provided and the fees that will be charged for such services in their client service agreements.
TPAs typically receive compensation for administrative services, often including a base fee and a per-participant fee, as well as fees for processing transactions (e.g., loans, QDROs, and distributions). Many TPAs also provide consulting services, for which they typically receive hourly fees.
If the TPA doesn’t receive any other compensation (such as revenue sharing or payments from other service providers), they may not have to do any additional disclosure in order to comply. Of course, it’s always wise to have existing agreements reviewed by an ERISA attorney or advisor familiar with the 408(b)(2) regulations to ensure compliance.
It’s also possible that TPAs may find that they are not required to provide disclosures under the 408(b)(2) regulations based on the manner in which they are compensated. For example, if a TPA only receives fees that are always paid by the sponsor out of pocket (as opposed to being paid from plan assets), a 408(b)(2) disclosure may not be required. Amounts paid directly by the sponsor are not included in the regulations’ definition of compensation.
However, TPAs may want to provide disclosures even if they aren’t receiving any compensation that would be classified as direct or indirect compensation under the regulations. First, given the focus on fee disclosure, clients will likely demand some type of disclosure, whether it is required or not.
Second, and perhaps more importantly, if there is any chance that a TPA would ever be compensated out of plan assets rather than out of the sponsor’s pocket, it is essential that the TPA provide a disclosure. Recall that a service provider is required to disclose, prior to entering into an arrangement with a plan fiduciary, all direct and indirect compensation they reasonably expect to receive over the life of the arrangement. If the disclosure is not provided, and the TPA later receives compensation that is covered by the regulations and no disclosure has been provided, there will be a prohibited transaction for failure to disclose. This could happen, for example, where a sponsor who typically pays out of pocket is unable to pay a bill and directs the plan to pay it.
At that point, it will be too late to provide disclosure. The disclosure was required to be provided reasonably in advance of entering into the arrangement. As such, it would be better to err on the side of “unnecessary” disclosure rather than risk both client relations issues and potential prohibited transactions.
Another issue relates to compensation paid to the TPA by a service provider, such as an insurance company or a mutual fund provider. This compensation is typically paid for services the TPA provides either directly to the service provider in connection with mutual client plans or to the plans themselves on the service provider’s behalf.
In the past, some TPAs have disclosed these payments to their clients while others took the position that it was unnecessary to do so. In the absence of clear guidelines on fee disclosure, good arguments could be made for either approach.
Following the effective date of the 408(b)(2) regulations (currently April 1, 2012), TPAs will likely be required to provide their clients with disclosures about the compensation they anticipate receiving from service providers. This compensation would appear to fall into the category of “indirect compensation” under the regulations.
Whether TPAs are disclosing these payments for the first time, or have done so in the past, the new public awareness and focus on fee disclosure will bring reasonable compensation issues to the fore. Recall that the purpose of the 408(b)(2) regulations is to provide plan fiduciaries with sufficient disclosure of fees and services in order to determine whether the arrangement with the service provider is “reasonable.”
As such, TPAs will need to analyze whether the compensation they are receiving from clients and service providers is, on the whole, reasonable based on the level of services provided to the plan. One possible approach is to determine whether or not the fees charged directly to clients should be offset by the amounts received from other service providers. Many TPAs already do so, essentially determining that they need to earn a certain amount on each case and adjusting the fees charged directly to the client to account for amounts received from other sources.
Of course, many TPAs will find that, based on the level of services they provide to their clients, it is reasonable to retain both client fees and service provider payments. Either way, it is essential for TPAs to review each client individually and determine whether the fees and revenue they earn for each is reasonable in light of the services provided. Once this analysis is complete, a TPA can confidently answer any questions that may arise, whether from clients or the DOL.
These are only a few of the issues a TPA may encounter when preparing to comply with the 408(b)(2) regulations. In a future entry, we will discuss the impact of the participant disclosure regulations on TPAs.