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CFR Citation: 29 CFR Part 2550

RIN ID: RIN 1210-AB08

NOTICE: Part III

DOCUMENT ACTION: Proposed regulation.

SUBJECT CATEGORY: Reasonable Contract or Arrangement Under Section 408(b)(2)--Fee Disclosure

DATES: Written comments on the proposed regulation should be received by the Department of Labor on or before February 11, 2008.

DOCUMENT SUMMARY: This document contains a proposed regulation under the Employee Retirement Income Security Act of 1974 (ERISA) that, upon adoption, would require that contracts and arrangements between employee benefit plans and certain providers of services to such plans include provisions that will ensure the disclosure of information to assist plan fiduciaries in assessing the reasonableness of the compensation or fees paid for services that are rendered to the plan and the potential for conflicts of interest that may affect a service provider's performance of services. The proposed regulation will redefine what constitutes a ``reasonable contract or arrangement'' for purposes of the statutory exemption from certain prohibited transaction provisions of ERISA. The regulation, upon adoption, will affect employee benefit plan sponsors and fiduciaries and the service providers to such plans.

SUMMARY: Labor Department, Employee Benefits Security Administration,

SUPPLEMENTAL INFORMATION

(1) General

In recent years, there have been a number of changes in the way services are provided to employee benefit plans and in the way service providers are compensated. Many of these changes may have improved efficiency and reduced the costs of administrative services and benefits for plans and their participants. However, the complexity of these changes also has made it more difficult for plan sponsors and fiduciaries to understand what the plan actually pays for the specific services rendered and the extent to which compensation arrangements among service providers present potential conflicts of interest that may affect not only administrative costs, but the quality of services provided.

Despite these complexities, section 404(a)(1) of ERISA requires plan fiduciaries, when selecting or monitoring service providers, to act prudently and solely in the interest of the plan's participants and beneficiaries and for the exclusive purposes of providing benefits and defraying reasonable expenses of administering the plan. Fundamental to a fiduciary's ability to discharge these obligations is the availability of information sufficient to enable the fiduciary to make informed decisions about the services, the costs, and the service provider. In this regard, the Department of Labor (Department) has published interpretive guidance concerning the disclosure and other obligations of plan fiduciaries and service providers under ERISA.\1\ \1\ See, e.g., Field Assistance Bulletin 20023 (November 5, 2002) and Advisory Opinions 9716A (May 22, 1997) and 9715A (May 22, 1997).

In addition to technical guidance, the Department makes available on its Web site various materials intended to assist plan fiduciaries and others in understanding their obligations, the importance of fees, and the assessment of service provider relationships.\2\ The Department's Web site also provides a Model Plan Fee Disclosure Form to assist fiduciaries of individual account pension plans when analyzing and comparing the costs associated with selecting service providers and investment products.\3\
\2\ See http://www.dol.gov/ebsa/newsroom/ >
\3\ http://www.dol.gov/ebsa/pdf/401kfefm.pdf. This model form was developed jointly by the American Bankers Association, the Investment Company Institute, and the American Council of Life Insurers.

Although the Department has issued technical guidance and compliance assistance materials relating to the selection and monitoring of service providers, the Department nevertheless believes that, given plan fiduciaries' need for complete and accurate information about compensation and revenue sharing, both plan fiduciaries and service providers would benefit from regulatory guidance in this area. For this reason, the Department proposes the amendment described below relating to the conditions for a ``reasonable contract or arrangement'' under section 408(b)(2) of ERISA, as set forth in 29 CFR Sec. 2550.408b2.\4\
\4\ The Department also implemented changes to the information required to be reported concerning service provider compensation and compensation arrangements as part of the Form 5500 Annual Report. These changes to Schedule C of the Form 5500 complement the amendment proposed in this Notice in assuring that plan fiduciaries have the information they need to monitor their service providers consistent with their duties under section 404(a)(1) of ERISA. See 72 FR 64731.

(2) The Statutory Exemption for Services

Section 406(a)(1)(C) of ERISA generally prohibits the furnishing of goods, services, or facilities between a plan and a party in interest to the plan. As a result, absent relief, a service relationship between a plan and a service provider would constitute a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a ``party in interest'' to the plan.\5\ However, section 408(b)(2) of ERISA exempts certain arrangements between plans and service providers that otherwise would be prohibited transactions under section 406 of ERISA. 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 no more than reasonable compensation is paid for the services.\6\ Regulations issued by the Department clarify each of these conditions to the exemption.\7\ \5\ See ERISA Sec. 3(14)(B).
\6\ See ERISA Sec. 408(b)(2).
\7\ See 29 CFR Sec. 2550.408b2.

[[Page 70989]]

In this Notice, the Department proposes to amend the regulations under ERISA section 408(b)(2) to clarify the meaning of a
``reasonable'' contract or arrangement. Currently, the regulation at 29 CFR Sec. 2550.408b2(c) states only that a contract or arrangement is not reasonable unless it permits the plan to terminate without penalty on reasonably short notice.\8\ In the amendment described below, the Department proposes to add that, in order for a contract or arrangement for services to be reasonable, it must require that certain information be disclosed by the service provider to the responsible plan fiduciary. The Department believes that in order to satisfy their ERISA obligations, plan fiduciaries need information concerning all compensation to be received by the service provider and any conflicts of interest that may adversely affect the service provider's performance under the contract or arrangement. Accordingly, under the proposal, an arrangement would not be reasonable unless the service provider agrees to furnish, and in fact does furnish, the required information to the responsible plan fiduciary. The ``responsible plan fiduciary'' is the fiduciary with authority to cause the plan to enter into, or extend or renew, a contract or arrangement for the provision of services to the plan.
\8\ See 29 CFR Sec. 2550.408b2(c).
B. Proposed Amendment to Regulations Under ERISA Section 408(b)(2) (1) Overview of Proposed Regulation

In general, the proposal amends paragraph (c) of Sec. 2550.408b2 by moving, without change, the current provisions of paragraph (c) to a newly designated paragraph (c)(2) and adding a new paragraph (c)(1) to address the disclosure requirements applicable to a ``reasonable contract or arrangement.'' The new paragraph (c)(1) of Sec. 2550.408b 2 generally requires that, in order to be reasonable, any contract or arrangement between an employee benefit plan and certain service providers must require the service provider to disclose the compensation it will receive, directly or indirectly, and any conflicts of interest that may arise in connection with its services to the plan. (a) Scope of the Proposal

Paragraph (c)(1)(i) of the proposal describes the scope of the regulation's disclosure requirements. The Department recognizes that responsible plan fiduciaries may not always need all of the required disclosures from every type of service provider in order to evaluate the reasonableness of the service provider's compensation. Thus, this paragraph limits the proposal's application to contracts or arrangements to provide services by service providers that fall within one or more of three categories. The first category, described in paragraph (c)(1)(i)(A), includes within the scope of the regulation service providers who provide services as a fiduciary under ERISA or under the Investment Advisers Act of 1940. Paragraph (c)(1)(i)(B) includes service providers who provide banking, consulting, custodial, insurance, investment advisory (plan or participants), investment management, recordkeeping, securities or other investment brokerage, or third party administration services, regardless of the type of compensation or fees that they receive. Finally, paragraph (c)(1)(i)(C) includes service providers who receive any indirect compensation in connection with accounting, actuarial, appraisal, auditing, legal, or valuation services.

The Department believes that the compensation arrangements for services provided by the service providers enumerated in paragraphs (c)(1)(i)(A) and (B) are most likely to give rise to conflicts of interest. As to the service providers enumerated in paragraph (c)(1)(i)(C), the Department believes that requiring every service contract or arrangement with these providers to satisfy the requirements of the proposed regulation may not be appropriate or yield helpful information to plan fiduciaries. However, the Department believes that these providers perform some of the most important and potentially influential services to plans and, to the extent these service providers receive indirect compensation in connection with their services, similar conflict of interest concerns would be raised, as with other enumerated service providers.

If a contract or arrangement meets the threshold scope requirement in paragraph (c)(1)(i), then the terms of such contract or arrangement must satisfy the proposal's disclosure requirements in order to be reasonable for purposes of paragraph (c)(1), regardless of the nature of any other services provided or whether the plan is a pension plan, group health plan, or other type of welfare benefit plan. Nevertheless, the proposal's application to contracts or arrangements between plans and the listed categories of service providers should not be construed to imply that responsible plan fiduciaries do not need to obtain and consider appropriate disclosures before contracting with service providers who do not fall within these categories. Responsible plan fiduciaries must continue to satisfy their general fiduciary obligations under ERISA with respect to the selection and monitoring of all service providers. Further, contracts or arrangements with these service providers must be ``reasonable'' and otherwise satisfy the requirements of section 408(b)(2) of ERISA.

The proposal also applies only to contracts or arrangements for services to employee benefit plans. The proposed regulation, if adopted, would not apply to contracts or arrangements with entities that are merely providing plan benefits to participants and beneficiaries, rather than providing services to the plan itself. For example, a pharmacy benefit manager that contracts with an employee benefit plan to manage the plan's prescription drug program would be covered as a service provider to the plan providing third party administration or recordkeeping, and possibly consulting, services. However, if a fiduciary contracts on behalf of a welfare plan with a medical provider network, for example an HMO, a doctor that is part of the network and that has no separate agreement or arrangement with the plan would not be a service provider to the plan; the doctor merely provides medical benefits to the plan's participants and beneficiaries. (b) Disclosure Concerning Compensation and Services

If a contract or arrangement for services falls within the scope of the proposed regulation, the contract or arrangement must comply with paragraphs (c)(1)(ii) through (vi) of the proposal. Paragraph (c)(1)(ii) requires that the contract or arrangement be in writing. The proposal requires specific disclosures and representations from the service provider, and the Department believes they must be made in writing to ensure a meeting of the minds between the service provider and the responsible plan fiduciary.

The proposed regulation next provides in paragraph (c)(1)(iii) that the terms of the contract or arrangement must specifically require the service provider to disclose in writing, to the best of its knowledge, the information set forth in the proposal. The Department believes it is important for the responsible plan fiduciary to obtain assurance from the service provider that it has disclosed complete and accurate information. To ensure that the responsible plan fiduciary has the opportunity to consider all required disclosures before entering into a [[Page 70990]]
contract or arrangement with a service provider to the plan, the proposal requires that the contract or arrangement include a representation by the service provider that, before the contract or arrangement was entered into, all required information was provided to the responsible plan fiduciary.

The proposal does not prescribe the manner in which such disclosures should be presented to the plan fiduciary, other than requiring a statement by the service provider that the disclosures have been made. All of the required disclosures need not be contained in the same document, as long as all of the required information is presented to the responsible plan fiduciary in writing before such fiduciary enters into the contract or arrangement. Written disclosures may be provided in separate documents from separate sources and may be provided in electronic format, as long as these documents, collectively, contain all of the elements of disclosure required by the regulation. For example, a prospectus required by Federal securities laws, or a Form ADV required to be filed by a registered investment adviser, may include some of the indirect fee or conflict of interest information that a service provider would be required to disclose under this proposal. In these circumstances, the contracting parties are free to incorporate such materials by reference. The Department expects that the service provider will clearly describe these additional materials and explain to the responsible plan fiduciary the information they contain. The Department invites comments on whether, and the extent to which, duplicate disclosures can be avoided, while at the same time ensuring that responsible plan fiduciaries receive comprehensive, straightforward, and helpful information concerning the service provider's compensation and possible conflicts of interest.

The proposal also does not designate any specific time period prior to entering into the contract or arrangement for receipt of the required disclosures, other than requiring a representation by the service provider that all information was provided in writing before the parties entered into the contract. The Department believes it would be incumbent on the service provider to furnish current and accurate information to the plan fiduciary. Further, the responsible plan fiduciary, consistent with its general fiduciary obligations under ERISA, must ensure in its negotiations with a service provider that he or she obtains current and accurate information from the service provider sufficiently in advance of entering into the contract or arrangement to allow the fiduciary to prudently consider the information.

To facilitate the responsible plan fiduciary's determination that the service provider will receive no more than reasonable compensation, paragraph (c)(1)(iii)(A) of the proposal provides that the contract or arrangement must require the service provider to disclose the services to be provided to the plan and all compensation it will receive in connection with the services. A service provider must describe all services that it will provide, regardless of whether such services are described in the proposal's applicable scope provision. For example, if a plan consultant will provide appraisal, legal, and administrative services to the employee benefit plan in addition to its consulting services, then all of these services must be described. The subsections that follow in paragraph (c)(1)(iii)(A)(1) through (4) of the proposal clarify the requirement that the service provider disclose all compensation or fees that it will receive for its services.

Paragraph (c)(1)(iii)(A)(1) broadly defines compensation or fees to include money and any other thing of monetary value received by the service provider or its affiliate in connection with the services provided to the plan or the financial products in which plan assets are invested. Examples of compensation or fees that are covered by this definition include, but are not limited to: gifts, awards, and trips for employees, research, finder's fees, placement fees, commissions or other fees related to investment products, subtransfer agency fees, shareholder servicing fees, Rule 12b1 fees, soft dollar payments, float income, fees deducted from investment returns, fees based on a share of gains or appreciation of plan assets, and fees based upon a percentage of the plan's assets. The Department believes that an investment of plan assets or the purchase of insurance is not, in and of itself, compensation to a service provider for purposes of this regulation. However, persons or entities that provide investment management, recordkeeping, participant communication and other services to the plan as a result of an investment of plan assets will be treated as providing services to the plan.

Consistent with recommendations of the ERISA Advisory Council Working Group, the Department concludes that plan fiduciaries must receive more comprehensive information about the compensation or fees involved in plan administration and investments, including indirect compensation.\9\ Indirect compensation includes fees that service providers receive from parties other than the plan, the plan sponsor, or the service provider.
\9\ See ERISA Advisory Council Working Group report at http://www.dol.gov/ebsa/publications .

Service providers also must disclose compensation or fees received by their affiliates from third parties. For purposes of the proposal, an ``affiliate'' of a service provider is defined in paragraph (c)(1)(iii)(A)(1) to be any person directly or indirectly (through one or more intermediaries), controlling, controlled by, or under common control with the service provider, or any officer, director, agent, or employee of, or partner in, the service provider. The Department does not intend this requirement to result in any ``double counting'' of compensation. For instance, an employee's salary or a bonus that is paid to an employee from the general assets of his or her employer (i.e., the service provider) would not need to be separately disclosed, even if the employee is paid in connection with services to an employee benefit plan. The proposal merely clarifies that disclosure of any direct or indirect compensation that otherwise is required under the proposal cannot be avoided merely because such compensation is paid to an employee or agent of the service provider or an affiliate, rather than directly to such service provider or affiliate.

The proposal next provides in paragraph (c)(1)(iii)(A)(2) that if a service provider cannot disclose compensation or fees in terms of a specific monetary amount, then the service provider may disclose compensation or fees by using a formula, a percentage of the plan's assets, or a per capita charge for each participant or beneficiary. The Department understands that it is not always possible at the time the parties enter into a service contract or arrangement to know the exact amount of compensation, whether direct or indirect, that the service provider will receive for its services. However, the service provider must describe its compensation or fees in such a way that the responsible plan fiduciary can evaluate its reasonableness. For instance, the service provider must clearly explain any assumptions that would be used in determining the compensation or fees according to any such formula or other charge.

Paragraph (c)(1)(iii)(A)(3) of the proposed regulation clarifies the nature of disclosures that must be provided
[[Page 70991]]
concerning bundled arrangements. In many cases, administrative and investment services are provided to employee benefit plans in ``bundled'' arrangements, whereby a package or ``bundle'' of services is provided, either directly or through affiliates or subcontractors of a service provider. These bundles are priced to the plan by a single service provider as a package, rather than on a servicebyservice basis. For example, rather than hiring separate service providers for investment management, recordkeeping, Form 5500 annual report preparation, participant communications and statement preparation, payroll processing, and other functions, a plan fiduciary may arrange for one service provider to have all of these services performed as a bundle. The provider of the bundle may in turn use other affiliated service providers, or unaffiliated subcontractors, to provide some of the services in the bundle. However, the responsible plan fiduciary obtains a ``package deal'' and will negotiate only with the provider of the bundle.

Under paragraph (c)(1)(iii)(A)(3) of the proposed regulation, if a service provider offers a bundle of services, then a contract or arrangement must require only that the provider of the bundle make the prescribed disclosures. This bundled service provider must disclose information concerning all services to be provided in the bundle, regardless of who provides them. Further, the bundled service provider must disclose the aggregate direct compensation or fees that will be paid for the bundle, as well as all indirect compensation that will be received by the service provider, or its affiliates or subcontractors within the bundle, from third parties. Generally, the bundled provider is not required to break down this aggregate compensation or fees among the individual services comprising the bundle. For instance, the service provider would not have to break down the aggregate fee into the amount that will be charged for preparing the Form 5500 annual report and the amount that will be charged for preparing participant statements. Also, the bundled provider generally is not required to disclose the allocation of revenue sharing or other payments among affiliates or subcontractors within the bundle.

There are, however, exceptions to these rules. Specifically, paragraph (c)(1)(iii)(A)(3) requires the bundled provider to disclose separately the compensation or fees of any party providing services under the bundle that receives a separate fee charged directly against the plan's investment reflected in the net value of the investment, such as management fees paid by mutual funds to their investment advisers, float revenue, and other assetbased fees such as 12b1 distribution fees, wrap fees, and shareholder servicing fees if charged in addition to the investment management fee. Also, paragraph (c)(1)(iii)(A)(3) requires the separate disclosure of compensation or fees of any service provider under the bundle that are set on a transaction basis, such as finder's fees, brokerage commissions, or soft dollars. Soft dollars include research or other products or services, other than execution, received from a brokerdealer or other third party in connection with securities transactions. Compensation or fees that are charged on a transaction basis must be separately disclosed even if paid from mutual fund management fees or other similar fees. The Department does not believe that disclosure of these fees would require bundled providers to disclose any revenue sharing arrangements or bookkeeping practices among affiliates that could legitimately be classified as proprietary or confidential. Further, the Department believes that investmentbased charges, commissions, and other transactionbased fees paid to affiliates are just as likely to be relevant to the responsible plan fiduciary's evaluation of potential conflicts of interest, whether or not they are part of a bundled service arrangement.

Paragraph (c)(1)(iii)(A)(4) requires that the service provider also explain the manner of receipt of compensation, for example whether the service provider will bill the plan, deduct fees directly from plan accounts, or reflect a charge against the plan investment. The description also must explain how any prepaid fees will be calculated and refunded when the contract or arrangement terminates.

(c) Disclosure Concerning Conflicts of Interest

The subsections that follow in (B) through (F) of paragraph (c)(1)(iii) are intended to inform the responsible plan fiduciary of the service provider's relationships or interests that may raise conflicts of interest for the service provider in its performance of services for the plan. As service arrangements have become more complex, so have the ways that service providers are compensated, as well as the relationships among different players in the plan service provider industry. Plan fiduciaries must know of these relationships and indirect sources of compensation because they may impact the manner in which the provider performs services for the plan. There may be other, oftentimes subtle, influences on the service provider or its affiliates that may be relevant to a plan fiduciary's assessment of the objectivity of a service provider's decisions or recommendations.

The Department's attention to service providers' potential conflicts of interest is not new. For example, in 2005 the Department issued guidance with the Securities and Exchange Commission concerning potential conflicts of interest involved in pension consultant relationships.\10\ This guidance provides a list of tips and related explanations to help plan fiduciaries obtain the information necessary to ensure that engagement of the pension consultant serves the best interest of the plan's participants and beneficiaries. The Department believes that the engagement of many plan service providers presents similar issues for the plan fiduciary. Accordingly, under the proposal, a contract or arrangement must require that the service provider disclose specific information that will help the responsible plan fiduciary assess any real or potential conflicts of interest. \10\ See ``Selecting and Monitoring Pension ConsultantsTips for Plan Fiduciaries'' at http://www.dol.gov/ebsa/newsroom/fs053105.html .

Subsection (B) of paragraph (c)(1)(iii) requires that the service provider identify whether it will provide services to the plan as a fiduciary, either as an ERISA fiduciary under section 3(21) of ERISA or as a fiduciary under the Investment Advisers Act of 1940. The Department believes it is important for the responsible plan fiduciary and the service provider to understand at the outset of their relationship whether or not the service provider considers itself a fiduciary and how this status affects the nature of the services to be provided.\11\
\11\ The Department notes that persons who perform one or more of the functions described in section 3(21)(A) of ERISA with respect to a plan are fiduciaries. See 29 CFR Sec. 2509.758. Thus, fiduciary status depends on a factual analysis of a person's activities with respect to a plan. Formal agreements stating whether a person is a fiduciary are not dispositive of whether the person actually is a fiduciary under ERISA by virtue of the functions performed.

Subsection (C) requires that the service provider disclose any financial or other interest in transactions in which the plan will partake in connection with the contract or arrangement. For example, if a service provider will be buying (or advising on the purchase of) a parcel of real estate for the plan, and an affiliate of the service provider owns an interest in the real estate, the service provider will [[Page 70992]]
have to state that it has an interest in the transaction and describe its affiliate's ownership of the real estate. The responsible plan fiduciary can then weigh the nature and extent of the conflict in analyzing the objectivity of the service provider when making the recommendations.

The proposal also provides that a reasonable contract or arrangement must require the service provider to disclose its relationships with other parties that may give rise to conflicts of interest. Specifically, subsection (D) obligates the service provider to describe any material financial, referral, or other relationship it has with various parties (such as investment professionals, other service providers, or clients) that creates or may create a conflict of interest for the service provider in performing services pursuant to the contract or arrangement. If the relationship between the service provider and this third party is one that a reasonable plan fiduciary would consider to be significant in its evaluation of whether an actual or potential conflict of interest exists, then the service provider must disclose the relationship.

Conflicts also may arise when a service provider can affect its own compensation in connection with its services. Under subsection (E) of the proposal, a contract or arrangement must require the service provider to identify whether it can affect its own compensation without the prior approval of an independent plan fiduciary and to describe the nature of this compensation. A common example of this potential conflict of interest is the receipt of ``float'' compensation.\12\ If the amount a service provider receives in float compensation will not be approved by an independent plan fiduciary, then the service provider must state that it will receive float compensation and explain the nature of this compensation.\13\
\12\ Many financial service providers, such as banks and trust companies, maintain omnibus accounts to facilitate the transactions of employee benefit plan clients. The service provider may retain earnings (``float'') that result from the anticipated shortterm investment of funds held in these accounts. These accounts generally hold contributions and other assets pending investment. Plan fiduciaries also may transfer funds to an omnibus account in connection with issuance of a check to make a plan distribution or other disbursement.
\13\ For more information concerning ``float'' compensation and the information concerning such compensation that plan fiduciaries should obtain from service providers, see the Department's Field Assistance Bulletin 20023 (Nov. 5, 2002) at http://www.dol.gov/ebsa/regs/fab_20023.html .

Finally, the Department recognizes that service providers may have policies or procedures to manage these real or potential conflicts of interest. For example, a fiduciary service provider may have procedures for offsetting fees received from third parties (through revenue sharing or other indirect payment arrangements) against the amount that it otherwise would charge a plan client. Accordingly, subsection (F) of paragraph (c)(1)(iii) of the proposal provides that a reasonable contract or arrangement must require service providers to state whether or not any such policies or procedures exist and, if so, to provide an explanation of these policies or procedures and how they address conflicts of interest. The Department views this requirement as an opportunity for service providers to educate plan fiduciaries about how they address potential conflicts of interest.

(d) Material Changes to Disclosed Information

Paragraph (c)(1)(iv) of the proposal provides that a reasonable contract or arrangement must require that, during the term of the contract or arrangement, service providers must disclose to responsible plan fiduciaries any material changes to the information that is required by paragraph (c)(1)(iii), subsections (A) through (F). Changes on the part of a service provider or its employee benefit plan business may occasionally occur and may alter the information previously disclosed by the service provider. If any resulting change to the information previously disclosed to a plan fiduciary would be viewed by a reasonable plan fiduciary as significantly altering the ``total mix'' of information made available to the fiduciary, or as significantly affecting a reasonable plan fiduciary's decision to hire or retain the service provider, then the change is material. To ensure that plan fiduciaries continue to be wellinformed concerning the compensation and conflict of interest issues affecting their service provider relationships, a contract or arrangement must require service providers to notify fiduciaries of material changes within 30 days of the service provider's knowledge of the change.

(e) Reporting and Disclosure Requirements

The proposed regulation under paragraph (c)(1)(v) requires that a reasonable contract or arrangement obligate the service provider to furnish all information related to the contract or arrangement and the service provider's receipt of compensation or fees thereunder that is requested by the responsible plan fiduciary or plan administrator in order to comply with the reporting and disclosure requirements of Title I of ERISA and the regulations, forms, and schedules issued thereunder. For example, this provision would obligate the service provider to furnish information that is necessary for the plan administrator to complete the annual report on Form 5500, and information that is necessary for the responsible plan fiduciary to comply with disclosure obligations to plan participants and beneficiaries.

Of course, detailed reporting concerning some service providers may not be required for annual reporting purposes, for example because the amount or nature of the compensation paid to the service provider does not fall within the threshold or other requirements of the annual report on Form 5500. Further, not all employee benefit plans are subject to the same annual reporting requirements, for example small plans and certain selffunded welfare plans. This does not mean that service providers to these plans would not be required to fully satisfy the disclosure requirements of this proposed regulation, assuming they otherwise fall within the scope of the proposal. The Department anticipates that this proposal would apply more broadly to relationships between service providers and employee benefit plans that are not necessarily covered by ERISA's reporting requirements. The primary goal of this proposalto provide comprehensive and useful information to responsible plan fiduciaries when entering service contracts or arrangementsis different than that of ERISA's annual reporting and disclosure requirements, which provide more limited retrospective financial information on direct and indirect service provider compensation to facilitate and reinforce the broader fiduciary obligations imposed by this proposal.

(f) Compliance by Service Providers

The proposal's final requirement is contained in paragraph (c)(1)(vi). This condition provides explicitly that a service provider must comply with its obligations under the contract or arrangement as described in the proposed regulation. Not only must a contract or arrangement require disclosure from the service provider, but the service provider must actually provide all of the required disclosures in order for the contract or arrangement to be reasonable. Similarly, it is not enough for a service provider to commit in the written contract to later notify the responsible plan fiduciary of material changes to the disclosures contained in the contract; subsection (vi) requires that the service provider in fact provide such notification. [[Page 70993]]

Subsection (vi) also refers to relief that may be available to a responsible plan fiduciary when a service provider fails to comply with this requirement. In addition to this proposed regulation, the Department is publishing a proposed Class Exemption in today's Federal Register. Subject to certain conditions, this Class Exemption will provide relief from ERISA's prohibited transaction rules for a responsible plan fiduciary when a contract or arrangement fails to be ``reasonable,'' through no fault of the responsible plan fiduciary, but due to a service provider's failure to satisfy its disclosure obligations under this regulation. The proposed Class Exemption is discussed below in paragraph (2), ``Consequences of Failure to Satisfy the Proposed Regulation.''
(g) Relationship Between Disclosures and the Plan Fiduciary's ERISA Section 404(a) Duties

The parties to a service contract or arrangement that falls within the scope of paragraph (c)(1)(i) of the proposal must, at a minimum, satisfy the requirements contained in this proposal and the other conditions to ERISA section 408(b)(2) in order for the provision of services under the contract or arrangement to be exempt from ERISA's prohibited transaction rules. However, the engagement of any particular service provider will not necessarily satisfy the fiduciary's obligations under section 404(a) of ERISA to act prudently and solely in the best interest of the plan's participants and beneficiaries merely because the service provider furnishes the information described in the proposed regulation.

Section 404(a) of ERISA requires that the responsible plan fiduciary engage in an objective process designed to elicit information necessary to assess not only the reasonableness of the compensation or fees to be paid for services, but also the qualifications of the service provider and the quality of the services that will be provided.\14\ Although the steps taken by a responsible plan fiduciary may vary depending on the facts and circumstances, solicitation of bids among service providers is a means by which the responsible plan fiduciary can obtain information relevant to the decisionmaking process. A responsible plan fiduciary should not consider any one factor, including the fees or compensation to be paid to the service provider, to the exclusion of other factors. Further, a fiduciary need not necessarily select the lowestcost service provider, so long as the compensation or fees paid to the service provider are determined to be reasonable in light of the particular facts and circumstances. \14\ See, e.g., Information Letters to D. Ceresi (Feb. 19, 1998) and to T. Konshak (Dec. 1, 1997).

Further, plan fiduciaries are not limited by the disclosures required in this proposal. Plan fiduciaries may ask service providers for any additional information that they feel is necessary to their decision. For example, a responsible plan fiduciary may have questions for a service provider concerning the specific personnel that will be assigned to manage or perform services under the contract or arrangement.

Finally, although this proposal looks to disclosures made at the time a service contract or arrangement is entered into or renewed, responsible plan fiduciaries must continue to monitor service arrangements and the performance of service providers. Receipt of the disclosures described in this proposed regulation at the onset of a service relationship will not relieve plan fiduciaries of this ongoing obligation.
(h) Existing Requirement Concerning Termination of Contract or Arrangement

Paragraph (c)(2) of the regulation continues to require that service contracts or arrangements permit termination by the plan without penalty and on reasonably short notice. This requirement has not been changed, though the Department invites comments from the public as to any practical issues relating to the current regulation's requirements concerning contract termination. Specifically, the Department would like to know whether the current regulatory framework presents practical problems and whether further regulatory or interpretive guidance could address these problems.
(i) Other Statutory Exemptions Concerning Service Providers

The Department understands that, in certain circumstances, plans and service providers to such plans must rely on statutory exemptions other than section 408(b)(2) of ERISA in order to conduct business without violating ERISA's prohibited transaction provisions. Therefore, the Department invites comment on the extent to which the application of the disclosure requirements contained in this proposed regulation will affect, or may be affected by, other ERISA statutory exemptions that may relate to plan service arrangements.
(2) Consequences of Failure To Satisfy the Proposed Regulation

If the contract or arrangement fails to require disclosure of the information described in the proposed regulation, or if the service provider fails to disclose such information, then the contract or arrangement will not be ``reasonable.'' Therefore, the service arrangement will not qualify for the relief from ERISA's prohibited transaction rules provided by section 408(b)(2). The resulting prohibited transaction would have consequences for both the responsible plan fiduciary and the service provider. The responsible plan fiduciary, by participating in the prohibited transaction, will have violated section 406(a)(1)(C) of ERISA's prohibited transaction rules.\15\ The service provider, as a ``disqualified person'' under the Internal Revenue Code's (Code) prohibited transaction rules, will be subject to the excise taxes that result from the service provider's participation in a prohibited transaction under Code section 4975.\16\ \15\ See ERISA Sec. 406(a)(1)(C).
\16\ The Internal Revenue Code (Code) also provides statutory relief for transactions between a plan and a service provider that otherwise would be prohibited. Any excise taxes imposed by Code section 4975(a) and (b) for failure to satisfy the statutory exemption are paid by the disqualified person who participates in the prohibited transaction, in this case the service provider, not the plan fiduciary. See Code Sec. 4975(a), (b), (c)(1)(C), (d)(2), and (e)(2)(B).

The Department believes that this significant result will provide incentives for all parties to service contracts or arrangements to cooperate in exchanging the disclosures required by the proposed regulation. However, the Department also believes that, in certain circumstances, a responsible plan fiduciary should not be held liable for a prohibited transaction that results when a service provider, unbeknownst to the plan fiduciary, fails to satisfy its disclosure obligations as required by the proposed regulation. Accordingly, the Department also published a proposed Class Exemption in today's Federal Register. The scope of the relief provided by the Class Exemption and the conditions that must be satisfied by a responsible plan fiduciary in order to obtain such relief are discussed in the preamble to the proposed Class Exemption. The Department notes that, in general, the parties seeking to avail themselves of either the statutory exemption provided by ERISA section 408(b)(2), or the administrative exemption provided in the Department's proposed Class Exemption, will bear the burden of establishing compliance with the conditions of these exemptions.
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C. Effective Date

The Department proposes that its amendments to regulation section 2550.408b2(c) be effective 90 days after publication of the final regulation in the Federal Register. The Department invites comments on whether the final regulation should be made effective on a different date.

D. Request for Comments

The Department invites comments from interested persons on the proposed regulation and other issues discussed in this Notice. Comments should be submitted electronically by email to eORI@dol.gov, or by using the Federal eRulemaking portal at http://www.regulations.gov. Persons wishing to submit paper copies should address them to the Office of Regulations and Interpretations, Employee Benefits Security Administration, Room N5655, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210, Attn: 408(b)(2) Amendment. All comments received will be available for public inspection, without charge, at http://www.dol.gov/ebsa and in the Public Disclosure Room, N1513, Employee Benefits Security Administration, 200 Constitution Avenue, NW., Washington, DC 20210.

The comment period for this proposed regulation will end 60 days after publication of the proposed rule in the Federal Register. The Department believes that this period of time will afford interested persons an adequate amount of time to analyze the proposal and submit comments.
E. Regulatory Impact Analysis

(1) Overview of the Proposal

Under section 406(a)(1)(C) of ERISA's prohibited transaction rules, the furnishing of goods, services, or facilities between a plan and a party in interest to the plan is generally prohibited.\17\ A service relationship between a plan and a service provider would thus constitute a prohibited transaction in the absence of regulatory relief, because ERISA defines any person providing services to the plan as a ``party in interest'' to the plan.\18\ Section 408(b)(2) of ERISA, however, exempts certain arrangements between plans and service providers that otherwise would be prohibited transactions. To obtain relief under that section, the arrangement must be reasonable, the services must be necessary for the establishment or operation of the plan, and no more than reasonable compensation must be paid for the services.\19\ Regulations issued by the Department clarify each of these conditions to the exemption.\20\
\17\ See ERISA Sec. 406(a)(1)(C).
\18\ See ERISA Sec. 3(14)(B).
\19\ See ERISA Sec. 408(b)(2).

\20\ See 29 CFR 2550.408b2.

To further clarify the meaning of a ``reasonable'' contract or arrangement under section 408(b)(2), the Department proposes to amend the regulation at 29 CFR Sec. 2550.408b2(c). Under the proposal, a contract or arrangement to provide covered services to a plan would not be reasonable unless it requires the service provider to disclose, in writing, certain information before the contract or arrangement is entered into, extended, or renewed. The Department believes that, in order to satisfy their ERISA obligations, plan fiduciaries need information concerning all compensation to be received by the service provider and any conflicts of interest that may adversely affect the service provider's performance of the contract or arrangement.

The proposal requires that, in order to be considered a reasonable contract or arrangement, the contract must require the service provider to furnish the specified information to the responsible plan fiduciary. The rule also would require that the service provider comply with its contractual obligation and actually furnish the specified information. These disclosures are intended to enable the responsible plan fiduciary to ensure that no more than reasonable compensation is paid to the service provider for the services and to illustrate any actual or potential conflicts of interest that may affect the service provider's judgment.

Once adopted, these requirements will apply to all contracts or arrangements between plans (including pension plans, group health plans, and other types of welfare benefit plans) and service providers who are fiduciaries; who provide banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping, securities or other investment brokerage, or third party administration services; or who receive indirect compensation for accounting, actuarial, appraisal, auditing, legal, or valuation services to the plan (collectively ``covered services'' or ``covered providers'').

The Department's interest in this proposal stems from concerns about the fees paid for by employee benefit plans, and the ability of plan sponsors and fiduciaries to understand these fees which may be paid directly or indirectly by plans. The Department believes that greater understanding of these fees by the affected parties will increase efficiency and competition in the service provider market and generate benefits to plans and thus to plan participants. Although the Department believes this rule will have the greatest effect on service providers to pension plans, the Department identified other employee benefit plans, such as health and welfare plans, that would be affected by this regulation and could realize benefits from the proposal similar to the benefits realized by pension plans.

In a separate regulatory effort, the Department has revised Schedule C of the annual Form 5500, which is filed by most large plans. Schedule C collects information about plan service providers that were compensated in excess of $5,000. These revisions are intended to improve the reported information on compensation and revenue sharing arrangements of service providers to employee benefit plans. Similar to the proposed revisions under section 408(b)(2) of ERISA, the revisions to Schedule C are intended to help plan sponsors and fiduciaries in determining the reasonableness of the fees they pay to service providers and to help assess any potential conflicts of interest. While the proposed regulation under section 408(b)(2) of ERISA concerns the disclosure of information during the decisionmaking process, the changes to Schedule C concern the provision of retrospective information as part of a plan's annual reporting obligations.

The Department is also publishing, simultaneously with this regulatory initiative, a proposed class exemption for plan fiduciaries in certain circumstances when plan service arrangements fail to comply with ERISA section 408(b)(2). The exemption is published elsewhere in this issue of the Federal Register. In the preamble to the exemption, the Department describes how it has taken into account the availability of conditional relief under the exemption in assessing the economic costs and benefits of the regulation. The Department believes that the exemption is essential to achieve the purposes underlying the regulation.

(2) Executive Order 12866 Statement

Under Executive Order 12866, the Department must determine whether a regulatory action is ``significant'' and therefore subject to the requirements of the Executive Order and subject to review by the Office of Management and Budget (OMB). Under section 3(f) of the Executive Order, a ``significant regulatory action'' is an action that is [[Page 70995]]
likely to result in a rule (1) having an annual effect on the economy of $100 million or more, or adversely and materially affecting a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local or tribal governments or communities (also referred to as ``economically significant''); (2) creating serious inconsistency or otherwise interfering with an action taken or planned by another agency; (3) materially altering the budgetary impacts of entitlement grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) raising novel legal or policy issues arising out of legal mandates, the President's priorities, or the principles set forth in the Executive Order. OMB has determined that this action is significant under section 3(f)(1) because it is likely to materially affect a sector of the economy. Accordingly, the Department has undertaken, as described below, an analysis of the costs and benefits of the proposed regulation in satisfaction of the requirements of the Executive Order. The Department believes that the proposed regulation's benefits justify its costs. (3) Need for Regulatory Action

Employee benefit plans have evolved over the past several years, resulting in changes to both the services provided to the plans and the compensation received by service providers. Fee structures for service providers have, in some cases, become more complex and less transparent for plan sponsors or fiduciaries determining what is actually paid for services. This increased complexity also makes it more difficult to discern the service provider's potential conflicts of interest. It has also become more difficult to determine the impacts of these potential conflicts of interest on the fees paid by, or the quality of the services provided to, the plan.

Despite these complexities, when selecting or monitoring service providers, plan fiduciaries must act prudently and solely in the interest of the plan's participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan. To meet these obligations, it is vital that fiduciaries have enough information to make informed assessments and decisions about the services, the costs and the providers. In this regard, the Department has published interpretive guidance concerning the disclosure and other obligations of plan fiduciaries and service providers under sections 404, 406(b) and 408(b) of ERISA.\21\
\21\ See, e.g. Field Assistance Bulletin 20023 (Nov. 5, 2002) and Advisory Opinions 9716A (May 22, 1997) and 9715A (May 22, 1997).

To the extent that plan fiduciaries are unable to obtain this information, or unable to use it to choose among service providers in a manner that upholds their fiduciary duty, a failure exists in the market for services for employee benefit plans. This market failure results from information asymmetry between the providers of plan services who possess information about their fee structures and potential conflicts of interest and plan fiduciaries that lack this information but need it to act in the best interest of their plans. The Department believes that both responsible plan fiduciaries and service providers will benefit from this proposed regulation, which will promote the efficiency of plan fiduciaries finding and using the information they need to search for service providers. This action furthers important public policy goals of increased transparency and increased competition in the service provider market.

(4) Regulatory Alternatives

Executive Order 12866 directs Federal Agencies promulgating regulations to evaluate regulatory alternatives. The Department considered the following alternatives: Remaining with the status quo, a general regulatory framework, broad applicability, and a specific framework with limited application. These alternatives are described further below: