Retirement - Laws as They Pertain to the Employer & Worker

Retirement - Laws as They Pertain to the Employer & Worker Marcia S. Wagner, Esq.

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 Administration’s agenda. • Improving the DC Savings System • Obama Administration’s proposals target 401(k) plans and providers. • Blurring of lines between White House and DOL. • Coordinated actions to improve retirement security.

1. Broader “Fiduciary” Definition2. Fee Disclosures to Participants3. Participant Investment Advice4. 408(b)(2) Disclosures5. Default Investments - TDFs6. Lifetime Income Options7. Automatic IRA Legislation8. A Game Plan for Employers

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. • DOL’s 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.

Two Specific Changes Are Proposed • DOL releases proposed reg’s on Oct. 21, 2010. • Proposed reg’s 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.

Safe Harbor for Avoiding Fiduciary Status • Proposed reg’s 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 provider’s marketing of investment alternatives to plan (and providing related info) if it discloses that it is not providing impartial advice.

Potential Impact on Plans • Plans typically advised by 2 types of providers: RIAs (fiduciary) and brokers (non-fiduciary). • 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). • To eliminate conflict of interest, broker could dual-register as RIA and charge a level, asset-based fee. • 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.

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

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 staff’s 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.

DOL Finalizes Participant Fee Disclosure Regulations • DOL issues final reg’s on Oct. 14, 2010. • Generally consistent with 2008 proposed reg’s. • DOL press release explained that existing law did not require plans to provide necessary information. • Types of plans covered • New reg’s 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 reg’s apply to all eligible employees.

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, provider’s 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.

Annual Disclosure of Investment-Related Information • Must disclose fee and performance-related info for plan’s 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

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 sponsor’s other fiduciary duties • No relief for duty to prudently select/monitor plan’s providers and investments. • New reg’s modify ERISA 404(c) disclosures. • Effective date • Plan years beginning on or after Nov. 1, 2011

Potential Impact on Plans • Administrative services • New reg’s will impact disclosure/communication materials provided by TPAs and bundled providers. • Automatic delivery of fund prospectuses will no longer be required under ERISA 404(c). • Disclosure of fees payable to 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 plan’s investments and fees, impacting sponsors and advisors.

How Can Inv. Advice Be Conflicted? • Advisor to 401(k) plan receives 12b-1 fees from funds as compensation for services. • Plan sponsor asks advisor to give fiduciary “investment advice” to participants. • Prohibited conflict arises if advisor’s level of compensation can vary based on advice provided. (e.g., equity funds pay higher 12b-1 fees to advisor, creating incentive to steer participants to them) • ERISA’s prohibited transaction rules. • Conflicted advice is prohibited (even if in good faith). • PPA of 2006 added ERISA 408(b)(14) exemption.

Pension Protection Act of 2006 • PPA statutory exemption for providing participant-level fiduciary advice. • Fiduciary Adviser must be RIA, bank, insurer or broker-dealer. • Eligible Investment Advice Arrangement must have (1) level fees that cannot vary as a result of advice, or (2) advice from computer model certified by expert. • Other conditions for exemption. • Authorization from separate plan fiduciary. • Annual review by independent auditor. • Advance notice to participants with disclosures for fees and material affiliations of parties (i.e., conflicts).

Rulemaking Under ERISA 408(g) • “Rollercoaster” rulemaking for 408(g) reg’s • Proposed in Aug. ’08 and finalized in Jan. ’09. • Rules included (1) interpretive regulations, and (2) class exemption broadening relief for conflicts. • Withdrawn in Nov. ’09 over conflict concerns. • New 408(g) reg’s proposed on Feb. 26, 2010. • Does not include controversial class exemption. • Similar to interpretive portion of original rules.

Eligible Inv. Adv. Arrang. - Level Fee • New proposal is consistent with FAB 2007-1. (a) Individualadvisor must have level compensation. (b) Advisoryfirm must have level compensation. (c) Firm’s affiliates may receive variable compensation. • Example • Advisoryfirm charges asset-based fee offset by 12b-1 fees from plan’s funds (i.e., firm gets level fee). • Individualadvisor receives level compensation from advisory firm for services to plan. • Advisory firm’s affiliate is plan’s bond fund manager, earning more if participants invest in bond fund. • “Level fee” condition for Eligible Inv. Advice Arrang. does not apply to affiliates.

Eligible Inv. Adv. Arrang. - Comp. Model • Advice must be from computer model. • Must consider historical risks/returns of asset classes. • Must consider fees/expenses of investment options. • Must consider participant’s personal info. • Investment expert must certify computer model. • Computer model advice can not be followed by individualized investment advice. • Does DOL proposal favor index funds? • Model must consider historical returns of asset classes (not individual funds) and fees/expenses. • Proposed rules suggest that model should favor cheapest menu option in each asset class.

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. • Doesn’t 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.

Retirement Security Initiative • Improving transparency of 401(k) fees. • Administration’s goal is to make sure workers and plan sponsors are getting services at a fair price. • Pushing to “finalize” interim final reg’s this year. • Rationale for interim 408(b)(2) reg’s. • 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.

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.

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.

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.

Prohibited Transactions and Interim 408(b)(2) Regulations • If provider fails to make disclosure, plan’s 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.

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%.

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. • DOL’s 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 reg’s issued under PPA of 2006 • Participant-level fee disclosure reg’s that were finalized on Oct. 14, 2010 but are not yet effective.

DOL’s Proposed Changes to QDIA Reg’s • Background on QDIA Reg’s • 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 TDF’s 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).

DOL’s Proposed Changes to Participant-Level Fee Disclosure Reg’s • Background (recap) • New rules will require disclosure of plan-related fees and annual comparative chart for plan’s 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.

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 ERISA’s 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.

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 Kohl’s proposal differs from DOL approach to improve disclosures to employers and participants.

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.

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.

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.

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.

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 in$100-per-employee penalty. • New tax credit for small employers of $250 for start-up costs, and $1,000 tax credit for 401(k) plans.

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 House’s 2012 budget proposal includes “Automatic Workplace Pensions” initiative. • Automatic IRA legislation remains high priority for Obama Administration.

Final and Proposed Rules Will Impact Many Plan Sponsors • 408(b)(2) Fee Disclosures • Providers must furnish detailed fee disclosures by Jan. 16, 2012. • Rules will impact plan sponsors directly. • Plan sponsors have duty to ensure plan’s 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.

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. • Providers can help plan sponsors prepare. • Discuss with plan’s 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, sponsor should consider enhancing its fiduciary review process.

Target Date Disclosures • Provide meaningful TDF disclosures to participants as a “best practice” right now. • Provide key information about TDF’s glide path, landing point and potential volatility. • Prudently review plan’s TDF series. • Consider “fund of funds” structure, glide path, underlying funds and risk. • Special review of TDFs for participants in or nearing retirement (e.g., 2015 TDF).

Broader “Fiduciary” Definition • Employer should clarify fiduciary (or non-fiduciary) status of plan’s advisor and nature of compensation arrangement. • Many plans are successfully advised by both fiduciary and non-fiduciary advisors, but plan sponsor should be aware of advisor’s status. • Effectiveness of plan’s advisor often linked to whether he or she has specialized plan experience. • If advisor receives variable compensation (e.g., 12b-1 fees), ask how advisor mitigates any conflicts.

Retirement - Laws as They Pertain to the Employer & Worker Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.erisa-lawyers.com marcia@wagnerlawgroup.com A0050260

Retirement - Laws as They Pertain to the Employer & Worker