Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

12b-1 fees and other revenue sharing arrangements have really become the guts and glue of the retirement plan business. The marketplace has come to rely upon these critical arrangements to subsidize plan administration, investment advice and a whole range of services enjoyed by plans and participants. The fees are now subject to prior disclosure rules under 408b-2 and (very limited) reporting under schedule C. They have become such a fixture in marketplace that there seems to be a growing sense that these fees belong to  the plans whose assets generate them, and that fiduciaries are somehow entitled to them.

Except that this isn't quite so. There is actually another competing set of fiduciary rules which need to be considered when dealing with revenue sharing, and 12b-1 fees in particular.

Remember the true nature of 12b-1 fees: they are paid from mutual funds to distributors under their selling agreements with an investment company to promote the mutual fund.  Payments are made from a mutual fund's assets under that fund's 12b-1 program, authorized by the SEC's Rule 12b-1 to the  Investment Company Act of 1940,  in order to  promote that mutual fund and to  defray the related distribution costs.   It must be approved initially by the investment company's board of directors as a whole, and separately by the investment company's “independent” directors. If the 12b-1 plan is adopted after the sale of fund shares to the general public, it also must be approved initially by a vote of at least a majority of the mutual fund’s voting securities.  

The mutual fund's Board members are under the fiduciary obligation to the fund shareholders to make sure that those 12b-1 fees are being used for the benefit of promoting and distributing the fund's shares. I invite you to read the preamble to the 2010 proposed changes to the 12b-1 fees which outlines this obligation in detail. It also contains some great statistics on the use of these fees.

So how is it, then, that a fund's self-serving distribution payment designed solely to promote the best interest of the mutual fund become subject to the ERISA rule that compensation generated by the plan be paid in the interest of the plan?

Its important to parse out just how this works.  

Starting with the basics, it is the fund distributor who is contractually entitled to the 12b-1 payment, not the plan, and for very specific distribution purposes. The mutual fund's Board has already had to make a fiduciary determination that the fee is reasonable, in the best interest of the mutual fund shareholders, and that its payment complies with Rule 12b-1.  

Separately, the ERISA plan's fiduciary can only permit the purchase a mutual fund which has a 12b-1 program if the amount of the 12b-1 fee is reasonable from the plan's point of view, regardless of whether the mutual fund feels its reasonable.  Going into this determination of reasonableness, however, would be things like how the particular 12b-1 charge stacks up against other competing funds that the plan may be able to purchase and whether, or to what extent, the mutual fund's distributor (who really does now control the use of the 12b-1 fee to which it is entitled under its selling agreement with the mutual fund) will be used to offset service or other costs incurred by the plan.

It is so easy to presume that the 12b-1 fees belong to the plan, especially because of their pervasive nature in the marketplace. But don't make this mistake. In the end, a plan's ability to benefit from 12b-1 fees is only a derivative one.  A plan has no inherent right to a 12b-1 fee generated by the assets it purchases. The right to those fees belong solely to distributor, one who is paid under a selling agreement for promoting the interests of the mutual fund-not the plan.  The plan 's fiduciaries obligation is to make sure that the fee is reasonable, that the total amount a distributor receives off of the plan (including 12b-1 fees) is reasonable and, if the distributor commits to sharing the fee, that the commitment is properly honored.  

By the way, It is also important to understand that there can be an element of sales commission built into that fee, payment of which is also  acceptable under ERISA as long as certain conditions are met- a point I have noted in the past.  

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 Sales compensation on financial products sold to employer plans has always been a critical piece of making the private retirement system work, particularly in the small to mid-size marketplace. As policymakers attempt to adopt different policies to increase the “penetration” of plans in this important segment of the marketplace, no such effort will really be successful unless professionals are paid for the work it takes to get plans to those employers.  It is the financial service companies which pay sales commission on their products which really makes these policy initiatives work. 

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The disclosures related to 408()(2) are really just a precursor to the next step: the imposition of the prohibited transaction taxes and penalties related to compensation which fails to meet those standards.  It looks like the regs have the effect of shifting the application of the rules related to the "amount involved" in the transaction a bit. The "amount involved" in the transaction is the amount upon which the prohibited transaction taxes and penalties will be assessed.

Well prior to the new 408(b)(2) regulation, the DOL had developed guidance on the application of the prohibited transaction penalties. Compensation would be subject to penalty to the extentt that it was not reasonable. This meant that the penalties and taxes (the two are coordinated by the IRS and the DOL) only applied to the amounts above what would be a reasonable amount. (By the way, if you are looking for the manner in which to compute the correction and penalty amounts, you will need to reference the Tax Code-including the  tax rules governing foundations under 53.4941(e)).

What the new disclosure rules have done is establish the principal that ANY compensation for which proper disclosure has not  been made will not be considered reasonable. This means the "amount involved in the transaction" will be the entire amount of the improperly (or non) disclosed compensation.  The "to the extent" rule will then only apply to that compensation which has been properly disclosed but is unreasonable.

The application of the PT rules like these tend toward the  arcane, but will now become a central part of the service provider's life.

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Now that the initial 408(b)(2) disclosures are out, the challenge becomes understanding them. Beyond just understanding whether or not the fees disclosed are reasonable (a challenge in itself), the disclosures do something arguably more important: they take us behind the looking glass, opening a window to a world with which most are not familiar, but which is critical to the operation of 401(k) and 403(b) plans. The disclosures provides hints to, and sometimes disclose, the complex series of relationships and financial arrangements which make possible the daily trading and investing of the assets in individual account plans, on both NAV and insurance platforms, and the manner in which those parties involved in those relationships are paid for those services.

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It has been quite a time the past few weeks, with working through the details of MEP transitions to the 408(b) 2 July 1st effective date. With a little break to come up for air, I’d like to comment on something for post July 1 consideration, the variable non-registered group annuity contract.

This type of contract remains one of my favorite products in the 401k space. It can, if so designed, serve merely as an efficient investment platform, or serve as a complete package of financial and administrative services, with flexible pricing and compensation. Most of these contracts have within them the fixed account, which typically has enhanced guaranteed returns of the sort never available out of money market funds or the non-insurance “stable value” funds. Wirehouses and their reps typically have a great deal of disdain for these products, which I could never quite understand. Biases, though, often do get in the way of sound businesses judgments.

These contracts, however, are not simple investments. They have a number of moving pieces , which can make them a challenge to review for 408b2 purposes. And many of the insurance company disclosures I’ve seen are far more complicated than need be.

So I offer the following list for these who need to look at the disclosure related to these products under 408(b)-2:

-Trust or not. These contracts do not need to be held by a trustee, but sometimes they are. You need to know if they are so held, because the trustee will be a CSP, and their fees will need to be disclosed and understood.

-Fixed account or not. Most of the contracts have a fixed account into which variable account assets can be transferred. The fixed account, if one which is based on the insurer’s general account, will have no separate 408b2 disclosure. So don’t look for one.

-Variable separate accounts. The assets in these accounts are plan assets. If they hold mutual funds, you typically will not find an investment management fee, but you may find a sort of account fee. Take a look at it. If the funds in the account are actively managed outside of a mutual fund, look for a separate investment management fee.

-Fiduciary status. Depending on the structure of the separate accounts, the insurer may be a fiduciary of the separate account (they’ll never be one with regard to the fixed account). Look for whether or not, and to what extent, they have fiduciary status.

-Allocation models. Many insurers are offering asset allocation and management programs to plans and participants, for managing the separate account investments. Look to see if there is fiduciary status involved in these programs, and the fees related to them.

-Contract charges. Most of these contracts have separate contract or administrative charges. These are related to the fact that they really are providing a package of financial services (such as free trading between a wide range of mutual funds, and in active monitoring those funds). In assessing this fee, make sure you understand the sorts of services you are getting for that fee.

-Termination provisions. Look for surrender charges and market value adjustments. Sometimes, they are worth it given the rate of return being paid under the general account, and for payment of services from your insurance agent. But understand them.

-Commissions. Look to the amount of commissions being paid, and whether you are getting the support you need. Commissions are not bad things; as a matter of fact, they are necessary for many plan sponsors to get the kind of information and support they need in order to adopt and maintain the plan. Just make sure they are reasonable.

-Annuity disclosure. Virtually all of these contracts offer the right to annuitize at a certain prce. You will likely receive this disclosure, but they rarely have a significant  impact on the fees charged on the investment portion of the contract. Unless you are cnsidering offering anutization, don't spend a lot of tme on this.

By the way, the issues related to a registered group annuity contract, which are typically offered in the 403(b) space, can be different. I will handle those in a separate posting. 

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 Many of you know of me as being well versed in 403(b) matters; others are familiar with my work in annuities; others still consider my familiarity with MEPS or ERISA  broker dealer issues. But the heart and soul of my practice over the past nearly 30 years has really been the fiduciary rules-in particular, the application of the prohibited transaction rules. From private placements, to securities trading, to product development, to sales and marketing, and all manner of issues in between, the prohibited transaction rules have been an integral piece of my practice, woven into  much of what I have done and continue to do. It is an arcane world, full of unusual concepts-just see what happens when you try to determine under the regs just what is  the "amount involved in a transaction" -and the computation of the penalty often seems like an art to itself.  

They are also very powerful rules, with the capability of significant impact; I have seen uncertainties in their application virtually shut down insurance company general account private placements for a period of time. And given that the value of the assets in IRAs and retirement plans are equal to some 85% of the value of publicly traded securities in the U.S., they will serve as a growing shadow regulation on a large piece of the U.S. economy over time.

It is also why 408b2 is also so intriguing to me. It has the potential for some pretty serious ramifications. Though we get lost in the detail of timely meeting the new disclosure requirements, the real impact will occur once the dust settles, and when we have to deal with all manner of prohibited transactions- arising either from failure to properly disclose compensation or from what is revealed by the disclosure itself.

Interestingly enough, one of the most serious of the impacts of 408b2 promises to arise from application of Code section 4975, not from ERISA Section 406 to which 408b2 is connected.  For those not familiar with it, Code section 4975 is the Tax Code's corollary of the prohibited transaction rules under ERISA's Title 1. By a quirky operation of the ERISA Reorganization Plan, the DOL has the authority to issue the regs by which the prohibited transaction tax under 4975 is operated (except for computation of the tax itself), and thus 408b2 acts to interpret 4975 as well. There are, by the way, important distinctions between 4975 and 406 which will come into play (for example, 4975 does not apply to 403(b) plans, but will apply to non-ERISA IRAs).

4975 imposes a tax on the prohibited transaction. It is not a penalty (though there is a penalty in 4975 for failure to timely pay the initial tax and correct the transaction), like under ERISA Section 406. It is a tax on a transaction. Period. There is strict liability for the taxes.  Once the prohibited transaction occurs, the tax liability attaches, and there is a duty to report and pay that tax. The IRS has no ability to waive that tax-unlike the prohibited transaction penalty under ERISA, which grants the DOL the ability to waive penalties-other than through the issuance of a formal prohibited transaction exemption by the DOL.  

This is even if the transaction occurred without any intent to engage in the transaction, or even if it occurred when engaged in doing what is ultimately in the best interests of the plan and participants. 

The 408b2 regs have an important PT exemption for the responsible plan fiduciary (which also applies to the 4975 tax) under certain conditions, should there be a failure of disclosure, but this exemption does not run to the service provider who fails to make a timely disclosure. And even then the exemption only runs to the disclosure itself, not the actual prohibited transaction which may be disclosed under 408b2.

The rubber has not yet begun to hit the road.... 

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With all of the intense activity in the marketplace related to providing the initial 408b-2 and 404a-5 disclosures in a timely manner, there is what I could only describe as a "sea change" occurring, relatively quietly, behind the scenes in financial service firms related to the ongoing responsibilities under the DOL's new disclosure rules.  For these firms, the issue isn't really just about disclosure. Because 408b-2, in particular, is a prohibited transaction rule, its really all about keeping the revenue generated from ERISA retirement plans. Its about being able to stay in business.

This means that financial service firms have a huge economic stake in not just making the initial disclosure, but also in making sure that permanent compliance procedures are established, implemented and audited on a routine basis. Firms should also be taking a closer look at their myriad of revenues streams to make sure that not only are they reported correctly, but that there is a Prohibited Transaction Exemption that otherwise permits the revenue. 

A firm, then, is faced with a quandary. "ERISA compliance" staffs (to the extent a firm has this function) have generally had the function to answer technical questions and provide procedural guidance to operation staff and clients. There really has been no enforcement "teeth." The only part of these financial firms that really have had to have serious "control" functions have been the securities law compliance staff. It is typically only these staffs which have the expertise necessary to establish, implement, audit, enforce and report regulatory requirements on the firms'  substantive business. And it appears that it is the securities compliance staff to whom firms are turning to institutionalize ongoing 408b-2 compliance.

I had the pleasure of being on a panel with Gigi Fuhry and Jim Downing at the National Society of Compliance Professionals meeting in Chicago on " Integrating ERISA Compliance Into the Securities Compliance Program," where we outlined the framework of an ERISA Compliance program that can built into the securities compliance practice. The NSCP itself now has training modules which are designed for the Compliance professionals who now find themselves confronted with ERISA.  I've linked to a compliance list the three of us developed.

Welcome, securities compliance, to our world!

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If plan assets are used to purchase a typewriter at Office Depot for the exclusive use by the plan in its administration by the plan sponsor (and the plan sponsor is not Office Depot, an affiliate, or its not a plan also covering Office Depot's employees), the purchase is merely a direct expense of the plan which is not subject to the prohibited transaction rules. If the plan paid an unreasonable amount for that purchase, it may be a fiduciary breach, but it wouldn't be a prohibited transaction.  It is not subject to 408(b)(2).

If, on the other hand, the plan leased several computers from Office Depot for the exclusive use by the plan in its administration, and there was an ongoing maintenance contract also purchased, the arrangement becomes subject to the prohibited transaction rules. An unreasonable payment for that purchase becomes subject to the prohibited transaction rules-and Office Depot would be required to return the unreasonable compensation, and be subject to the prohibited transaction tax. It is subject to 408(b)(2).

In the first example, Office Depot is neither a "party in interest" under ERISA Section 3(14)(b), nor a "disqualified person" under the Code's PT corollary, 4975((e)(2)(B)-which defines a party in interest/disqualified person as a "person providing services to the plan."  This means that mere sale of the typewriter by a non-party in interest to the plan isn't going to be a prohibited transaction, even if the price is unreasonable.

In the second example, the lease and the maintenance contract are likely both to be seen as providing services to the plan, which then makes Office Depot a party in interest to the plan subject to the PT rules.  Any unreasonable compensation would need to be returned by Office Depot.

The purchase of typewriters and computers from an office supply store is not covered by the new 408(b))(2) regulations, which only covers specified transactions. But example 2 is still governed by 408(b)(2), generally.

So why do I even bother raising this? This whole area of party in interest status under ERISA was a hot topic a few years back in the Mertens and Harris Trust (not the Hancock case, but Smith Barney) Supreme Court cases, where the Court was deciding whether or not to allow ERISA lawsuits against non-fiduciary parties-in-interest. But its important now, once again, because it really does serve as a threshold issue to the new 408(b)(2) regs.

If a person is a not a party in interest, (here, if the party is not one providing services to a plan, or a subcontractor of one providing a service to a plan), 408(b)(2) will not apply, or it will not apply until you are providing a service. So lets consider a few things:

Lets say an insurance agent is selling a group annuity contract (or a QLAC, for that matter) to the plan. She sells the contract, receives a commission, and walks away from the plan. The insurance company now deals directly with the plan, and the agent is out of the picture (which may happen for a number of reasons), and is not a subcontractor of the insurance company in the provision of services. I would argue that the agent is not a party in interest, so that 408(b)(2) would not apply to the payment of trail commissions to her. Schedule A reporting, however, would still need to be done. And unless she is consider a subcontractor of the insurance company for the services it provides, the insurance company would not disclose that compensation under 408(b)(2). In reality, most sales folks stay involved in a plan when receiving commissions, and do provide services (which triggers 408(b)(2)), but not always. 

Lets say that a promoter of a private placement or a hedge fund approaches a plan to sell the plan interests in a partnership or the fund. The sale is successful, the commission is paid, and the promoter walks away-the partnership or the fund now deals directly with the plan.  I would argue that the promoter is not a party in interest. You can sell, as I have said in the past, 'til the cows come home (or at least until your "sales" becomes "service", which is, under many circumstances though, inseparable-either as a CSP or a subcontractor).

And here's a much tougher one: suppose a marketing company related to a mutual fund complex approaches an advisory firm offering to pay $50,000 to sponsor a golf outing for the firm's advisors. The $50,000 payment is not related to, or based upon any level of production the mutual funds receive from the advisory firms clients.  It would appear that, under these circumstances, the marketing firm is not a party in interest which would need to report, and (even it were otherwise a CSP to a plan) this may not be indirect compensation that the advisory firm or the marketing firm would need to report to a responsible plan fiduciary, either (though there would be a potential PT issue, outside of 408b2, if the firm promoted this arrangement to influence its advisors). This type of arrangement, by the way, would have had to have been reported under the original iteration of the 408(b)(2) regs.

What this discussion points out is something that has been lost in the massive 408(b)(2) discussions in the market: this is about prohibited transactions, and prohibited transactions have ALWAYS been, uneasily, very fact specific. A slight shift in the facts will often determine whether or not a prohibited transaction has occurred.

So it is around what I call the "edges" of 408(b)(2). Though the regs will apply to a significant part of very common transactions and relationships, there are a number of them where the answer is not so clear. And, as with other eccentric prohibited transaction matters, a close look at the particular facts will be determinative.

Discretion being the better part of valor,  we should take seriously DOL's caution that the regs will be read broadly, and error should be made on the side of disclosure. But sometimes the rules will just not apply, and in circumsatnces that may be surprising.

 __________________

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The DOL continues with its sensitivity to the challenges created for 403(b) plan sponsors in the transition to an employer accountable world. In today's release of the final 408(b)(2) regs, the DOL provided tremendously needed relief for 403(b)plans. The language from the preamble speaks for itself:

The Department was persuaded by commenters on the interim final rule to exclude all or that part of a Code section 403(b) plan (hereafter “403(b) plan”) that consists exclusively of “frozen” contracts or accounts, as described in the Department’s Field Assistance Bulletins addressing the limited application of the annual reporting requirements to such contracts or accounts.  Plan sponsors and fiduciaries likely would be unable to comply with this rule because they often have no dealings with the relevant plan service providers and are unable to obtain information about these contracts and accounts.  Accordingly, paragraph (c)(1)(ii) of the final rule now provides that, in the case of a Code section 403(b) plan subject to Title I of ERISA, the “covered plan” would not include annuity contracts and custodial accounts described in section 403(b) of the Code with respect to which the plan sponsor ceased to have any obligation to make contributions (including employee salary reduction contributions) and in fact ceased making contributions to such contracts or accounts for periods before January 1, 2009.  Further, the contract or account has to have been issued to a current or former employee before January 1, 2009; all the rights and benefits under the contract or account have to be legally enforceable against the insurer or custodian by the individual owner of the contract or account without any involvement by the employer; and such individual owner has to be fully vested in the contract or account. 

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Freedom and liberty are not merely themes sounded by politicians in political campaigns, or in rousing marches by military bands (though I am personally  particularly fond of them!), nor are they ideas which you will typically see being discussed in a piece about retirement issues. But they are themes woven into the fabric of our our everyday life, without our often even even being aware of them. They form not only the basis of our own civil society, but (believe it or not) are deeply embedded in the holy texts of the major religions. 

But there is a risk nowadays in even referencing these two grand ideas in today's political environment: instead of being viewed as the firm basis of how the vast majority of us quietly operate, they seem to have been outrageously hijacked by political extremists (such as of the libertarian/Ron Paul/ Tea Party sort-of which I am not so inclined) for some specific end.

In spite of all that, there is something well worth mentioning along these lines about the striking impact of the work we do, something we are not prone to see while working the fine minutiae of our chosen profession.

If we step back for a minute, we can see the extraordinary policy underlying 408(b)(2), the prohibited transaction rules and the exclusive benefit rules (which apply even to non-ERISA plans).  These rules seek to set aside and protect from others the individual wealth of those who accumulate benefits under these plans. It became pretty plain to me while reading Absolute Monarchs, by John Norwich (a history of the Catholic Popes, which really is a brief history of the absolute power of royalty as well as the church over individuals), where, historically, an individual's financial well being was wholly dependent on the whims of powers that be.

We now have something very odd in man's modern history. The value of the funds which are now protected for participants in retirement plans by the Code, ERISA or both approximates 85% of the value of publicly traded securities in the United States.  Though this seemingly huge amount is not yet adequate to establish broad retirement security, it is material enough to take note: these pooled funds are outside of the legal reach of the unaccountable "whims" of those who have something other than the best interests of the participants at heart.  Imagine that. A significant and growing portion of society's wealth is institutionally dedicated in funded pools to the individual's well being, which are difficult to access by an abusive use of power which has so often corrupted society-and jeopardized freedom and liberty-in the past. 

The only way this really works, however, is by things like 408(b)(2); by enforcement of the prohibited transaction rules; and by giving serious attention to the exclusive benefit rules. And all of this is dependent on what appears to be non-sensical minutiae upon which we daily work.

There is a reason I like doing what I do......

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 A while back, I did a piece on the manner in which the 408(b)(2) regs applied to the variable investment accounts under a group annuity contract held by a retirement plan, in particular, 401(k)plans; and a "light" piece on its application to general account products. In that I hear more and more rumblings  about the "fixed investment" portion of these accounts under 408(b)(2), it may be helpful to take another, more detailed look at how that reg applies to such accounts.

The first thing that comes to mind when looking at the regs for these purposes is the thing I noted in that previous blog: regardless of what you may think about 408b2 and the requirements now imposed by the rules, this reg has been craftfully drafted. The pieces fit together nicely, and complex issues with regard to investment products have been meaningfully addressed in as simple and direct manner as possible.There may be a few interpretaive issues that need to be resolved (which is to be expected), and 403(b) issues continue to be a serious challenge, but this is a fine piece of technical writing.

So it is with the "guaranteed account," "stable value fund" or "fixed account" within these group annuity contracts.  The 408(b)(2) pieces fit well together.

First, it may be helpful to read my piece on general accounts, and how they work. This can go a long way in understanding why 408b2 applies in the way it does. It is one of my favorites, because it includes a Dick Van Dyke clip from "Mary Poppins." That blog only generally addressed the 408b2 issue.

Next, the fiduciary needs to know whether or not the investment account is a contractual obligation of the insurer,  backed by the "general assets" of the insurer, or if it is part of a "separate account" (see my above noted blog on this). Confusion may arise from the variety of marketing names these funds may be called: the general account product will sometimes be called a "stable value fund" (typically because the crediting rate is set by use of an unrelated, third party index), which may be confused by a "stable value" mutual fund or collective trust interest which is offered under the annuity contract's variable investment separate accounts.

Once you know that fund is a fixed obligation of the insurer from its general account, you need to see what kind of Covered Service Provider (CSP) is the insurer.  It will not be considered an "A" type with regard to the fixed account, because it is not a fiduciary with regard to the management of the assets of the general account backing its contractual promise (a book could be written on this point, alone).  It may be a "B" type of CSP if, under the contract, the insurer is a "recordkeeper."  It will not typically be a "C"  type of CSP because, even though it is insurance, the insurer will not usually receive indirect compensation (as that term is defined by 408b2) related to that account (but keep in mind that these contracts may be part of an annuity where separate accounts are used-and thus indirect comp typically received-for which "C" status may occur). 

What needs to be disclosed?

-If the plan will only buy a group annuity contract with a fixed fund from the insurer, and the insurer will not provide any participant level recordkeeping services, then the insurer may not even be a CSP that will need to report under the new 408(b)(2) regs. The only complication will be the reporting of commissions. 

-If the insurer is a "B" CSP, then two things will need to be reported:  (i) a description of any compensation that will be charged directly against the account balance in connection with the acquisition, sale, transfer of, or withdrawal from the product, like surrender charges; and (ii)  description of any ongoing expenses such as mortality and expense charges or contract charges.

What will NOT need to be reported, however, is any "spread" between the crediting rate under the contract and the investment return on the insurers' general account, as the regs specifically exempt "operating expenses" from needing to be reported from a fixed account.

Didn't say it would be easy, but it all does fit together nicely.....

__________________

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.    

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Important Update. On June 21, IRS announced the extension of the 8955-SSA deadline to January 17, 2011, for which no Form 58 extension will need to be filed. The announcement is here

The challenges continue for 403(b) plans, as the IRS and DOL continue to implement their plan level rules in the 403(b) space. The most recent: the IRS's Form 8955-SSA  and instructions for the 2009 plan year, released on June 18th. You will need Adobe X to open them.  It is due to be filed by August 1, with a 2 1/2 month extension permitted if you file a separate Form 5558.

The Form 8955-SSA replaces the old Schedule SSA to the Form 5500, where former employees with vested account balances remaining in the plan are reported.

Prior to 2009, ERISA 403(b) plans (the only 403(b) plans required to file a Form 5500) never had to file a Schedule SSA because the Form 5500 instructions never required them to do so. Curiously enough, it appears that the DOL may never really have had the authority under ERISA Section 110 to waive its filing in prior years because it is required under Code Section 6057(a), not under ERISA. Here's the language, by the way, from the 2008 5500 instructions:

"403(b) Arrangements: A pension plan or arrangement using a tax deferred annuity arrangement under Code section 403(b)(1) and/or a custodial account for regulated investment company stock under Code section 403(b)(7) as the sole funding vehicle for providing pension benefits need complete only Form 5500, Part I and Part II, lines 1 through 5, and 8 (enter pension feature code 2L, 2M, or both). Note: The administrator of an arrangement described above is not required to engage an independent qualified public accountant, attach an accountant’s opinion to the Form 5500, or attach any schedules to the Form 5500."

Now to the tough part.  For ERISA 403(b) plans for which no SSA has ever been filed, how far back does a 403(b) plan sponsor need to go in reporting past participants? Conni did quite a piece on this for our Thompson Publishing newsletter. She strongly makes the case, with which I concur (but, please, check with your own counsel), that Rev Proc 2007-71 is actually determinative here. Oversimplifyng it, under 2007-71, 403(b) contracts which were issued prior to 1/1/2005, and to which no contributions have been made after 12/31/2004 (but loans, 90-24 transfers and other such things may also come into play), are not considered part of the 403(b) plan.

If you use this as a starting point, it would appear that the plan sponsor may need to go back to the 2005, 2006, 2007, 2008 and 2009 plan years, list all terminating participants from those years, and provide that to their current and deselected vendors. Then they will need to find which of those former employees have a current account balance (as of plan year end 2009)-but only if they had made a deposit to those contracts after 2004. And only for those years in which the plan was an ERISA plan. There is a bit more to it as well, as you are really trying to see who you can exclude for 2007-71 purposes.

A caution: the IRS has not taken this positiion on this. What really would be helpful is if the IRS issued relief telling us we only need to report those who left employment after January 1, 2009. 

408(b)(2) also comes into play here.  I had blogged on the "Flushing Effect" of 408(b)(2), where deselected ERISA 403(b) vendors will be required to make disclosures to plan sponsors in order to keep the comp on these contracts. I suspect that a number of employers will be surprised by these disclosures, and be receiving notices on contracts they may not realize exist.  This, in turn, is likely to cause consternation about the data on the 5500 filings in the past-and the new 8955- which then may need to be amended.

Its not getting any easier.  

__________________

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I would think that it is a basic law of physics that, whenever you attempt to apply a number of different and complicated principles to a single object, that the consequences on that object will be hard to predict, or even readily ascertained.

So it is with a potential impact 408(b)(2) may have on many 501(c)(3) sponsors of ERISA 403(b) plans. It shows up when you take an 403(b) ERISA plan, impose a fundamentally new set of basic principles (by way of the 2007 403(b) tax regulations); revoke its exemptive relief  from reporting requirements (the Form 5500); while nearly simultaneously superimposing a tremendous new disclosure scheme (participant and service provider disclosures);  there are inevitably going to be some unusual results.

Take a typical example. A hospital sponsors an ERISA 403(b) plan with 10,000 current employees. Over time, it has merged with a number of different hospitals, each which had separately maintained its own 403(b) arrangements in the past with a wide number of vendors. The hospital, in anticipation of the problems with the 2007 tax regulations, consolidated all the affiliates plans into a single platform on 1/1/2009.

Over its history, though, it and its affiliated hospitals had selected and deselected a number of other vendors (no one is quite sure how many) many with whom they have long lost contact.

All of these contracts over the history of the plans have been owned by the individual participants. Though the employer did have an audit done, it did not report many of those "lost" deselected vendor contracts, as it didn't know much about them or the vendors. They reported those old plans as merging with the 2009 Form 5500.

The deselected vendors all still have some old contracts that participants have hung onto,  even after those participants have left the employee of the hospital. The records of the vendor shows that these were ERISA contracts, and that they earn a "mortality and expense", or some other contract charge, and they are indeed "recordkeepers" for the investments in those contracts as defined by 408(b)(2). In order to prevent that compensation from being prohibited, and from the need to be prudent, the vendor decides to make the required disclosures to the hospital's "responsible plan fiduciary-" with whom they have not had contact for many years.

Imagine that fiduciary's surprise when it receives these "blasts from the past," the ghosts of decisions made long ago, often by folks with which they were never affiliated with at the time decisions were made. 

The hospital never knew about these contracts for which they are receiving disclosures, but can't ignore them.  They have just completed all of their work with regard to participant fee disclosures, but now someone is telling them that there may be a dozen more companies' investment products upon which they have to report. They also just filed their 2010 Form 5500, and didn't report many of these contracts as assets of the plan.  

Now what? This is just one scenario, they are others which may be likely once vendors seek to comply with 408(b)(2) on their books of old ERISA contracts. Though the regulator view may be that this flushing of old contracts is a good thing, it can actually be quite a mess to sort through-including whether or not you still have relief and can exclude them from compliance responsibility under Rev Proc.2007-71, and just at a time when the IRS is beginning their 403(b) 2009 audits. I suspect that the management of the problems can only resolved by closely looking at all of the particular facts which will apply to the plan.

I leave it to your imagination as to the myriad of difficulties this may cause; as there are potentially many. I also may be wrong, and this may never happen.......

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 I have had the pleasure recently of making a presentation to the National Society of Compliance Professionals Midwest Compliance Meeting with Chris Guanciale of PlanMember Services. The NSPC is a nonprofit membership organization dedicated to serving and supporting compliance officials in the securities industry. What we had to say to them was not particularly good news for these overworked professionals. 

There has been a distant relationship in the past between the application of securities law and the application of ERISA. See, for example SEC Release 33-6188 (among other releases) where the SEC describes its essentially "hands off " position with regard to retirement plans.

Over the past few years, with the new found activism of the DOL and the growing impact of retirement plans in the securties market (as of 3rd quarter last year, retirement plans-both ERISA and non-ERISA- had a value equal to about $16 trillion, which was some 88% of the value of publicly traded securities in the Unitied States. Individual account plans like most 401(k) and 403(b) plans, are a "mere" $4 trillion dollars of that total, or some 23% of the value of publicly traded securities), this distance has been "shortening". I have blogged a number of times on this point. 

So now we have the new 408(b)(2) regs, which I often term as potential "business busters" because they speak to the fundamental basis of doing business in this very large retirement plan marketplace: getting paid for the services provided. If you are in this business, compliance with 408(b)(2) is a fundamental issue, because it is a prohibited transaction exemption. Without compliance with 408(b)(2), the business often cannot receive some of their compensation for services related to ERISA retirement plans.

The sorts of things 408(b)(2) covers are at the heart of the Security Compliance Professionals' practice: disclosure, particularly with regard to fees generated off of investments. It seems that "Compliance" is really the only institutional structure many financial firms have under which they can implement, manage and control their 408(b)(2) practices.  And any new "fiduciary" rules only further complicates this task.

Attached is the outline provided for this presentation. Hopefully, you'll find it helpful. 

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Working through the technical terms of 408(b)(2) is not much different than putting together a picture puzzle. There are a lot of pieces which fit together in some very precise ways. But, in the end, the disclosures which are required are pretty straightforward and-even given the work needed to describe certain ”wrapped” services and estimating their costs- can be made very simply. Keep in mind Asimov’s concept of “Minimum Necessary Change," upon which I blogged a while back.

Long pages of disclosure are not necessary or warranted. 

There are certain keys to making it work, and making the disclosure simple. Keep a few things in mind:

•  Are you really a “Covered Service Provider” (CSP) that has to make a disclosure (see, for example, my piece on annuity investment accounts)? Remember, a CSP has a direct contract or arrangement with the plan, and that is the party that has to disclose-and only certain service providers are subject to disclosure rules. So, for example, a TPA which doesn't maintain the financial records (such as where a 401(k) plan is funded with allocated group annuity contracts; or for most 403(b) plans which are funded with individual annuity and custodial contracts);  whose fees are paid directly by the employer or the plan; and for which the TPA doesn't receive 12b-1 fees, commissions, or other indirect compensation are not CSPs and need not disclose under the new reg.

• Are you an affiliate or a subcontractor? If so, you don’t need to disclose, but the CSP needs to disclose what they pay you. This generally may include insurance agents who sell annuity contracts to 401(k) or 403(b) plans, and who are likely to be "subcontractors" because of their servicing the contract with things like enrollment services.The caution to those folks: make sure you understand what the actual CSP is saying about you.

• Make sure you are a “recordkeeper” before you commit to making financial disclosures. Many TPA’s are not 408(b)(2) recordkeepers on much of their business.

• Keep the disclosures simple, short and sensible. Check existing documents first, as most of the required disclosures may already be in the existing service agreement, policy or other existing agreement.

• For those who will receive indirect comp from a number of sources, try to standardize what you say about them, and create a short disclosure statement. Only send to those plans which generate that comp.

•  Over-disclosure is as bad as under-disclosure. Review and edit the description of indirect comp programs that others give you, to make sure it actually applies to you and properly describes your role in it all.

• Tweak your contract form to accommodate what you say in the disclosure, if necessary. Many existing contracts will not need to be changed to meet the rules.  Even then, however, consider incorporating some helpful changes when renewing the contract.

It does get a bit messier where data on the underlying investment needs to be disclosed, but even this is straightforward and can be simply made from existing data from accessible sources, and can be made in a standardized format.

Follow these guidelines, and you may be surprised with how simple the 408b2 disclosures may really be.

___________________________

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The DOL's newly delayed 408(b)(2) regs are particularly striking in that they demonstrate a growing sophistication, and efficiency, on the part of the EBSA staff in its approach to retirement plan financial products and services. The regs are short, by almost any measure of federal regulations, yet they are packed with meaningful rules which will apply in different ways to different product and services.  

The marketplace is a fast moving one, with complex instruments and services being used in new and unusual ways. Keeping up with this whirlwind is a challenge for the industry and employers, let alone a government regulatory agency which must somehow craft rules which have broad application to ever-shifting, complex and unanticipated circumstances.  Though not always successful, the DOL is approaching its learning curves impressively-including the way in which continues to seek to know and understand what it does not.

A prime example of this is the manner in which the 408b2 rules apply to variable investment accounts within the annuity contracts used to fund 403(b), 401(k) and other 401(a) plans. What is fascinating is that the word "annuity" only shows up with regard to IRAs;  the words "individual," "group," "variable," "fixed," "registered," or "non-registered"-all of which are descriptors of a variety of different sorts of annuity contracts- never show up; and the word "insurance" only appears once. Yet, it provides clear guidance on how these investment products are to be regulated. 

Lets take a quick look at the way the rules apply differently to registered variable annuity separate accounts (lets call these "Type 1" for purposes of this blog) typically used in the 403(b) market, and the way they apply to non-registered variable annuity separate accounts (which I'll call "Type 2") typically used in 401(k) plans.

This, by the way, is important for plan sponsors to know because they have to sort out whether they are receiving the disclosures they need, and report it to the DOL if they are not.

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