Article
The Employee Retirement Income Security Act (“ERISA”) contains a provision that a contract or arrangement for employee benefit plan services and the fees for those services are reasonable, the so-called “Fee Rule.” It is not well understood by retirement plan committees and is abused by some service providers to the detriment of their plan sponsor clients.
The Fee Rule requires specific action from employee benefit plan fiduciaries.
The Fee Rule is an Exemption that Qualifies Vendor Relationships
The furnishing of goods, services, or facilities between a plan and a “party in interest” to the plan generally is prohibited under the Employee Retirement Income Security Act (“ERISA”). As a result, a service relationship between an employee benefit plan and a service provider would constitute a prohibited transaction because ERISA defines any person providing services to the plan to be a party in interest to the plan.
However, section 408(b)(2) of ERISA exempts certain arrangements between plans and service providers that otherwise would be prohibited transactions. Specifically, section 408(b)(2) provides relief from ERISA’s prohibited transaction rules for service contracts or arrangements between a plan and a party in interest if the contract or arrangement is reasonable, the services are necessary for the establishment or operation of the plan, and the plan pays no more than reasonable compensation for the services.
Vendors Covered by the Fee Rule
Certain retirement plan service providers (“covered service providers”) must disclose fees and other information to an ERISA plan’s fiduciaries. In general, a covered service provider is a vendor who enters into a contract with a plan and expects to receive $1,000 or more over the life of the arrangement directly from the plan and who falls into one of the following categories: serves as a fiduciary to the plan or to an entity or investment product that holds “plan assets”; a registered investment advisor; provides recordkeeping or brokerage services in connection with making investment options available; or offers other services such as legal and accounting if the vendor expects to receive indirect compensation, (i.e., compensation that the plan or plan sponsor does not pay).
Vendors and Plan Sponsors Have Duties Under the Fee Rule
In order to assist plan sponsors with their duty to determine the reasonableness of service providers’ arrangements and compensation, the U.S. Department of Labor (“DOL”) introduced a regulation in 2010 requiring that certain service providers to pension plans disclose information about the service providers’ compensation and potential conflicts of interest. These disclosure requirements are part of a statutory exemption from ERISA’s prohibited transaction provisions. In addition to requiring vendors to make those disclosures, plan sponsors must evaluate their vendors’ disclosures and obtain clarification for any items not thoroughly understood.
What’s a Reasonable Fee?
Unfortunately, neither the DOL nor ERISA defines steps for determining the reasonableness of vendors’ fees. What’s more, no standard for doing so has emerged from any source.
In the vacuum created by the lack of a standard, recordkeepers, and investment firms seized the opportunity to “help” their clients evaluate their fees and attempted to establish benchmarking as the solution. That idea promotes the comparison of one plan’s fees to another plan’s costs with the comparator plan of the same general size.
The vendor community’s version of benchmarking has a significant flaw. It omits any mention of the design features and service quality of the plans involved in the comparison, a critical part of the reasonableness equation. While relying on that approach, many plan committees erroneously concluded that their vendor’s fees were reasonable when the opposite was true.
Unfortunately, neither the DOL nor ERISA defines steps for determining the reasonableness of vendors’ fees. What’s more, no standard for doing so has emerged from any source.
A Five-Step Prudent Procedure
Our years spent interpreting ERISA’s vague vendor monitoring principle to employers have led to the formulation of five proven compliance action steps.
Read the vendor’s disclosures.
Vendors MUST disclose their fees and the services they deliver to an employee benefit plan’s fiduciaries in writing. You should read and understand them. If disclosure is unclear or confusing, you must ask the vendor to make it understandable. Do not relent on this essential action step.
Verify that vendors adhere to their contracts.
The most crucial goal of an ERISA fiduciary is to manage a process that includes close supervision of the performance of each vendor. That starts with ensuring employees receive the services they pay for in their retirement plan.
Establish key performance indicators.
A well-constructed service agreement will define key performance indicators (“KPI”) relevant to the employer-sponsored plan type to track vendor performance. KPIs will vary by vendor category. For example, investment consultants might be evaluated based on an accounting of the hours required each calendar quarter to produce investment recommendations and an investment review report. On the other hand, recordkeepers could be subject to KPIs based heavily on transaction processing metrics.
At least annually assess and confirm vendors’ compensation for reasonableness.
A fully tailored program to ensure that vendors’ fees are appropriate leads to more than reduced costs. It can stimulate ideas for continuous improvement in operations and results for employees. That is an indispensable activity for lowering business risks. Vendors’ fees have a significant impact on retirement plan outcomes.
Factor the broad view into vendor management.
Monitoring goes beyond the basic dimensions of quality, delivery, and cost. Measuring the overall success of a vendor relationship considers its responsiveness and ability to communicate well at all levels.
Where there is a lack of a track record of solid oversight on plan-paid fees, the likelihood that a retirement plan committee may encounter unfavorable results increases during a standard government plan audit or a class action lawsuit brought by disgruntled employees.
Roland|Criss conducts annual fee assessments and delivers defensible opinions.
