Fee Disclosure – “Uncovered” Fee Disclosure Advisory Services, LLC 11/12/2011 [Edition 1, Volume 2] Don’t Stop the Commissions we can help! The Day Commissions Stopped We have more than 60 years of Let’s cut right to the chase: financial advisors who do not experience providing have a disclosure document in place by April 1, 2012 with administration, consulting, the plan sponsor of a retirement plan that meets the recordkeeping, plan and systems requirements of 408(b)(2) of the regulations under ERISA design. The industry is about to should not accept any commissions on any investment enter an entirely new experience product that is or was sold in that plan sponsor’s qualified due to the Department of Labor retirement plan. Similarly, Broker Dealers should not accept Regulation 29CFR 408b-2(c). The any commissions from financial products sold in a intention of article is to assist those retirement plan after March 31, 2012 if no disclosure CSPs that may not realize that documents are in place with the plan sponsor of the they have to comply with the new retirement plan. requirements, and identify the consequences of non-compliance. Why? The reason is the new regulations under Section Also point out to the “responsible 408(b)(2) of ERISA. In general, the rules state that payment of plan fiduciary” that this new fees out of retirement plan assets is a prohibited transaction. administrative burden has been Traditionally, the rules provided that as long as the fees placed on their shoulders. Does were reasonable, the fees could be paid and no prohibited the “responsible plan fiduciary” transaction would occur. The new regulations from the US understand that if the CSP does Department of Labor require that additional standards must not have a Fee Disclosure be met to avoid a prohibited transaction. document in place by April 1, 2012, they could have breached First, the regulations identify brokers as a Covered Service their fiduciary liability? They Provider (CSP). Effective April 1, 2012, the regulations state must evaluate and determine the that before any payment of fees to a CSP are made, the CSP fees for the plan are “reasonable”. must have a written disclosure document in place. If a document is not in place, payment of fees from the plan to a CSP would be considered a prohibited transaction. The disclosure document must indicate who is providing the service, what services are being provided, the fee and the Fee Disclosure – “Uncovered” Fee Disclosure Advisory Services, LLC 11/12/2011 [Edition 1, Volume 2] basis of the fee that will be charged, and if the CSP is operating in a fiduciary capacity. Second, but possibly more significant, the Broker Dealer has the legal relationship with the client, i.e., the client legally belongs to the Broker Dealer. The financial advisor of the Broker Dealer may be providing the services to the plan sponsor, but the Broker Dealer is legally responsible for the enforcing compliance, thus, the Broker Dealer must have the disclosure document in place. If the Broker Dealer accepts the commissions from the financial vehicles used in the qualified retirement plan, but decides not to pay the financial advisor because no disclosure document is in place, then the Broker Dealer has the issue of the prohibited transaction since the Broker Dealer accepted the money from the plan without proper documentation. If the Broker Dealer pays the financial advisor, then perhaps two prohibited transactions have occurred. Third, the reasonableness of the fees must be determined by the responsible plan fiduciary. Broker Dealers and therefore their financial advisors, should help the plan fiduciary in determining the reasonableness of fees for the financial advisor’s service. So, for example, how will the financial advisor determine what additional services are provided that warrant the amount of commissions paid on a particular investment if the financial advisor is suggesting an investment product that pays a high commission than an alternative product? For example, let’s assume Lee, the financial advisor, has two clients that are desirous of changing their 401(k) vendor. One client has a $1 million in the plan and the other has $5 million in their plan. Lee normally receives a 1% finder’s fee on the initial transfer plus 40 basis points trail income. Lee would receive $10,000 commission for the transfer of the $1 million in assets and $50,000 on the transfer of the $5 million in assets. What extra services did Lee do to receive the extra $40,000 in income? What extra services did Lee’s broker dealer perform for the $5 million plan assuming that they provide an 80% payout to Lee? The services that Lee performs may be easily justified for the $5 million dollar plan. They could have multiple state locations, several shifts working, more education requirements or other servicing issues, but Lee needs to make sure that the fees would be considered reasonable by the plan sponsor who is ultimately responsible to the plan participants. What if no agreement is put in place or the fees are deemed unreasonable, or if Lee does not perform the services that are indicated in the disclosure document? All of these actions or inactions result in a prohibited transaction. Fee Disclosure – “Uncovered” Fee Disclosure Advisory Services, LLC 11/12/2011 [Edition 1, Volume 2] The correction of a prohibited transaction can be onerous, especially in a participant directed plan. The commissions must be repaid to the plan and allocated back to the participants to make them whole, including accrued earnings. As time goes on, participants change investments, terminate employment, etc., so determining who is due reallocation may be very cumbersome. In addition, the amount of the prohibited transaction is subject to a 15% excise tax and must be paid and reported to the IRS by the plan sponsor. In many small plans, the owners of the business are often the trustees, so failure to take action could be considered a breach of fiduciary duties, and could be subject to a personal liability and excise tax of 20% or more. Broker Dealers and financial institutions need to carefully consider the payment and receipt of commissions after March 31, 2012. The problem does not completely go away even if commissions are not paid or received. For example, if a financial institution has fees embedded in their retirement plan products, they need to determine what level of services are being provided to the client for those fees and are those fees reasonable for the services that are provided. If no services are being performed, the financial institution offering the products may be charging too much for their product since it previously assumed some level of service. They may need to “pay” the commissions to the Plan instead of the Financial Advisor or Broker Dealer. This is a significant issue that each financial institution and financial advisor needs to address in the very near future. The due date is right around the corner. Authors: Fee Disclosure Advisory Services, LLC – Develop administrative documentation, procedures, guidelines and standards for Financial Institutions to enable their Financial Advisors the ability to comply with Department of Labor Regulation 29 CFR 40b-2(c). The goal is to ensure that the Financial Institution and Financial Advisor are provided the procedures and support to comply with this Regulation without financial hardship or loss of business. The Principals of FDAS are Michael E. Callahan, mec@fdas- 408b2.com and Michael R. Ingenito email@example.com, (855)408-(b)(2)01. Please review our website for more information www.fdas-408b2.com. FDAS is a strategic partner with Axis Retirement Plan Platform.
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