dbr may 2012 408(b)(2)regulation impacton broker dealers[1]

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The Final 408(b)(2) Regulation: Impact on Broker-DealersBy Fred Reish, Bruce Ashton and Summer Conley

This is the third in our series of bulletins on the impact of the Department of Labor (DOL)

Final Regulation on service provider disclosures under ERISA Section 408(b)(2). In our

Alert released on February 3, 2012 [http://www.drinkerbiddle.com/DOLreleasesfinal-

408b2regulation], we described the major changes between the Final Regulation and the

Interim Final Regulation issued in July 2010. In our bulletin released on May 10, 2012

[http://www.drinkerbiddle.com/final408b2impactoninvestmentmanagers], we described

the impact of the changes on investment managers. In this bulletin, we discuss the

impact of those changes on broker-dealers. (For background purposes, you can refer to

our Alert describing the impact of the Interim Final Regulation on broker-dealers which is

available at http://www.drinkerbiddle.com/interimfinal408b2impactonbrokerdealers.)

1. Effective Date. The DOL extended the compliance effective date of the Final

Regulation from April 1 to July 1, 2012. This extension may be particularly

useful to broker-dealers who are still working on an effective disclosure strategy

and need the additional time to comply.

Key Considerations for Broker-Dealers:

> The compliance date is extended from April 1, 2012, to July 1, 2012.

> The indirect compensation disclosure must include a description of the “arrangement” pursuant to which the broker-dealer (or an affiliate or subcontractor) will receive indirect compensation.

> The preamble provides for simplified compensation disclosures for Broker-Dealers as long as the responsible plan fiduciary has sufficient information to determine the reasonableness of the broker-dealer’s compensation. Broker-dealers may also use estimates and/or a reasonable range to disclose compensation.

> “Trailing” payments received after the completion of services are still received “in connection with” those services, thus requiring disclosures.

> The DOL clarified that insurance brokers and agents selling pension plan arrangements are covered service providers if they receive indirect compensation.

Client Bulletin May 2012

http://www.drinkerbiddle.com/DOLreleasesfinal408b2regulation

http://www.drinkerbiddle.com/DOLreleasesfinal408b2regulation

http://www.drinkerbiddle.com/final408b2impactoninvestmentmanagers

http://www.drinkerbiddle.com/interimfinal408b2impactonbrokerdealers

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The Final 408(b)(2) Regulation: Impact on Broker-Dealers May 2012


2. Indirect Compensation. Under the Interim Final Regulation, broker-dealers

have been struggling with how to disclose their indirect compensation (as

well as the services, payer and calculation for such compensation). The new

requirement to describe the “arrangement” with the payer that gives rise to

the indirect compensation will create an additional hurdle for broker-dealers.

Some arrangements, such as the receipt of 12b-1 fees, may be relatively easy

to describe. However, there are many different arrangements pursuant to

which broker-dealers receive compensation that may prove more difficult. In

the preamble, the DOL described a scenario in which financial institutions

subsidizing the cost of attendance at a conference must be disclosed as

an arrangement pursuant to which the service provider receives indirect

compensation. In the example, the subsidy related to the provider’s clients and

hence was compensatory. While not addressed in the preamble, if the subsidy

does not relate to the provider’s clients, it is arguably not compensatory and not

indirect compensation. Broker-dealers will need to carefully examine these types

of arrangements to determine whether disclosure is necessary.

3. Simplified Compensation Disclosures. While parts of the final regulation (such as

the requirement to describe indirect compensation arrangements) have added

complication for broker-dealers, the DOL has provided some relief to these firms.

In the preamble, for example, the DOL noted that broker-dealers may not be able

to identify the payer of indirect compensation in advance of the arrangement

because the investments have not been purchased. This is frequently the case

with stock brokerage accounts. To address this issue, the DOL noted that

indirect compensation descriptions “may be expressed in general terms” and

if information is unknown when disclosures are made, “the description need

not identify the specific payer in advance of the service arrangement.” While

this is helpful to broker-dealers struggling with disclosures, it is limited by

DOL caveats - although general terms may be used, the disclosure must still be

“sufficient to permit a responsible plan fiduciary to evaluate the reasonableness

of such compensation in advance of the service arrangement.” Based on the

DOL’s discussions in the preamble, we are helping broker-dealers navigate how

to make disclosures in general terms (e.g., provide a schedule of transactions

and a list of who pays revenue sharing to the broker-dealer), while still providing

sufficient information for responsible plan fiduciaries to evaluate reasonableness

of the total compensation.

Further, the simplification of what must be provided in advance of an

arrangement when the broker-dealer does not know what will be purchased

raises a question as to whether a change notice will be required. The DOL

addresses only the initial notice, leaving open whether the broker-dealer must

provide a change notice when the plan actually purchases an investment. This

raises a critical issue for broker-dealers that requires guidance from the DOL. We

have commented on this issue to the DOL and hope it will be addressed when

the DOL issues the additional guidance that has been promised.

The DOL also provided relief to broker-dealers in the form of addressing

compensation ranges. In the preamble, the DOL noted that disclosing “known”

and “reasonable” ranges under the circumstances could be a reasonable

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Comments for fi360 Regarding Broker-Dealers:

form of disclosure. We caution broker-dealers to think carefully about what

range to disclose. Disclosing compensation in the range of 0 to 100 basis

points strikes us as not being reasonable – it is unlikely that a broker-dealer is

providing services for 0 basis points. Additionally, if the range is too broad, it

may be difficult for a responsible plan fiduciary to evaluate the broker-dealer’s

compensation. Finally, the DOL refers to “known” ranges, indicating that each

end of the range must be a real amount the broker-dealer may receive.

In addressing whether information can be provided electronically, the DOL noted

that this can be done (e.g., on a website), but noted that the information must

be “readily accessible” and that fiduciaries must be given “clear notification on

how to gain such access.” Thus, broker-dealers making disclosures on websites

will want to make sure they are clearly informing fiduciaries that information is

available electronically and how to access the information.

Thus, while the DOL has softened the disclosure requirements for broker-dealers

somewhat, they must be careful they do not take the DOL’s leniency too far and

fail to provide sufficient information. It is a fine line that broker-dealers should

discuss with legal counsel.

4. Stock Brokerage Accounts. In addition to presenting compensation disclosure

issues, self directed brokerage accounts present questions for broker-dealers

with respect to the recipient of the disclosures. When plan fiduciaries decide to

offer a brokerage account through a specific broker-dealer, the plan fiduciaries

are “responsible” for the selection and should receive the disclosures. However,

when a participant decides to use the broker-dealer, then the participant

becomes the decision-maker about whether and how to use the stock brokerage

account. This raises a question as to whether the plan fiduciaries or the

participant or both are the “responsible plan fiduciaries.” This is another critical

issue that remains unanswered and on which we have commented to the DOL.

The DOL’s recently issued Field Assistance Bulletin with FAQs on issues related

to the participant disclosure requirements also contains information about

brokerage accounts. For further information, see the article in our ERISA

Newsletter for Retirement Service Providers (which will be distributed shortly

after this bulletin).

5. Trailing Payments. In a footnote to the preamble, the DOL discussed how

to determine whether the $1,000 threshold for a covered service provider is

satisfied, noting that the question is whether the compensation is received “in

connection with” the contracted services rather than when the compensation is

received. Specifically, the DOL noted that “[s]ome compensation, for example,

trailing commissions, may be received after the services have been furnished,

but still be ‘in connection with’ those services.” This may raise an issue for

broker-dealers in determining to whom disclosures should be made. For

example, often a broker-dealer will have so called “orphan accounts” with respect

to which the firm receives trailing payments after the plan’s representative has

gone elsewhere. Broker-dealers are struggling with making disclosures to the

fiduciaries of these plans. Further, as the $1,000 threshold is measured over

the life of the arrangement, counting such ongoing payments makes it more

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Comments for fi360:

likely that a broker-dealer will reach that threshold and will be a covered service

provider. Broker-dealers will need to carefully review all of their arrangements so

plans with these trail payments do not slip through the cracks.

6. Insurance Brokerage. In a footnote to the preamble, the DOL addressed a

comment regarding insurance brokerage services provided to qualified plans.

When these insurance brokers receive indirect compensation (which most

do), they fall into the “catch-all” category of covered service providers. (While

the footnote refers to insurance brokerage services, in the past the DOL has

combined insurance brokers and agents, and we assume they intend to do

so here.) Our understanding is that many insurance companies have not

contemplated that agents may be covered service providers. Those insurance

companies will need to move quickly to make the necessary disclosures.

7. Asset Allocation Models. As described in our bulletin [http://www.drinkerbiddle.

com/final408b2impactonrias] regarding registered investment advisers, the

preamble’s discussion of, and the DOL’s informal position regarding, designated

investment alternatives may complicate matters for broker-dealers. If an

asset allocation model is a designated investment alternative, broker-dealers

(and recordkeepers) must provide responsible plan fiduciaries with expense

information as well as information the broker-dealer has, or can reasonably

attain, that is necessary for the participant disclosures. In recent guidance

regarding participant disclosures, the DOL addressed when asset allocation

models will be considered designated investment alternatives. Specifically, the

DOL clarified that if the model is just a vehicle for allocating among a plan’s

designated investment alternatives (and satisfies other conditions), the model is

not itself a designated investment alternative. On the other hand, if the model

is an entity in which participants invest that then invests in the other designated

investment alternatives offered by the plan, then the model itself is also a

designated investment alternative. While this guidance will help broker-dealers

determine what models require the additional disclosure information, broker-

dealers are still struggling with actually gathering the information and many will

be relying upon recordkeepers for making such disclosures.

8. Timing for Initial Disclosures. The Regulation requires that disclosures be

provided to the responsible plan fiduciary “reasonably in advance of the date

the contract or arrangement is entered into, and extended or renewed.” The

Department elected not to provide clarification as to when a contract or

arrangement begins. This is of particular concern for broker-dealers because

broker-dealers are often gathering information and presenting options to plan

fiduciaries before a formal agreement is executed. Clearly the information

should be disclosed before the plan is obligated to pay any compensation to

the broker-dealer. However, it is due before the arrangement is entered into,

which suggests it may be due before the responsible plan fiduciary selects an

investment. Broker-dealers must carefully consider when an arrangement begins

and educate representatives so they understand the importance of providing

disclosures in advance of the arrangement.

http://www.drinkerbiddle.com/final408b2impactonrias

http://www.drinkerbiddle.com/final408b2impactonrias

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Comments for fi360:

9. Guide. The Regulation provides a sample guide that can be used by covered

service providers to facilitate the disclosure process. While the guide is not

required at this time, the DOL will be issuing proposed regulations addressing

a guide requirement in the future. For broker-dealers who will be making

disclosures by cross-referencing multiple documents, the guide requirement

will likely be prospective and only require adjustments to future disclosures

sometime after the July 1, 2012, effective date.

10. Additional Guidance. As mentioned above, the DOL recently issued guidance

regarding the participant disclosure requirements in the form of frequently

asked questions and answers. We expect that the DOL will publish answers to

frequently asked 408b-2 questions in the next few weeks.

The Final Regulation provides some relief for broker-dealers in the form of relaxing

the compensation disclosures to permit estimates, general descriptions, and ranges.

Nevertheless, the relief is limited by the notion that the disclosures must still be

sufficient for responsible plan fiduciaries to evaluate the broker-dealer. Preparing the

compensation disclosures for broker-dealers will require significant time and effort.

Thus, we recommend that broker-dealers who have not started the process of preparing

disclosures do so quickly.

News & NotesUpcoming Events:

Fred Reish, Partner, Employee Benefits & Executive Compensation (EBEC) Practice, Bruce Ashton, Partner and Brad Campbell, Counsel, will be presenting at Insured Retirement Institute (IRI) 2012 Government, Legal & Regulatory Conference in Washington DC on June 26th. Fred will speak on “SEC and DOL Fiduciary Initiatives”; Bruce will present on “Product Developments: Legal and Regulatory Challenge”; and Brad will provide a “DOL Fiduciary Update.”

Bruce Ashton, Partner, Employee Benefits & Executive Compensation Practice, will be testifying before the ERISA Advisory Council on June 13th on retirement income issues.

Summer Conley, Counsel, Employee Benefits & Executive Compensation Practice will be presenting at the ISCEBS June meeting on June 6th at the Los Angeles Athletic Club. Her presentation will cover the new disclosure rules for retirement plans which will be effective July 1, 2012.

Upcoming Publication:

ERISA Newsletter for Retirement Service Providers

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© 2012 Drinker Biddle & Reath LLP. All rights reserved. A Delaware limited liability partnership

Jonathan I. Epstein and Andrew B. Joseph, Partners in Charge of the Princeton and Florham Park, N.J., offices, respectively.

This Drinker Biddle & Reath LLP communication is intended to inform our clients and friends of developments in the law and to provide information of general interest. It is not intended to constitute advice regarding any client’s legal problems and should not be relied upon as such.


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Notice:

Employee Benefits & Executive Compensation Practice Group

If you have any questions about, or would like assistance with, any of the matters

discussed in this bulletin, please contact any member of our Employee Benefits and

Executive Compensation Practice Group listed below.

Heather B. Abrigo (310) [email protected]

Kathleen O’Connor Adams(312) [email protected]

Gary D. Ammon(215) [email protected]

Bruce L. Ashton(310) [email protected]

Pascal Benyamini (310) [email protected]

Mark M. Brown(215) [email protected]

Bradford P. Campbell(202) [email protected]

Summer Conley(310) [email protected]

Barbara A. Cronin(312) [email protected]

Joseph C. Faucher(310) [email protected]

Mona Ghude(215) [email protected]

Lindsay M. Goodman(312) [email protected]

Megan Glunz Horton(312) [email protected]

Robert L. Jensen (215) [email protected]

Melissa R. Junge(312) [email protected]

Sharon L. Klingelsmith(215) [email protected]

Christine M. Kong(212) [email protected]

David Levin(202) [email protected]

Howard J. Levine(312) [email protected]

Sarah Bassler Millar(312) [email protected]

Joan M. Neri(973) [email protected]

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Cristin M. Obsitnik(312) [email protected]

Fred Reish (310) [email protected]

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Ryan C. Tzeng (310) [email protected]

Michael A. Vanic (310) [email protected]

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David L. Wolfe(312) [email protected]

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dbr may 2012 408(b)(2)regulation impacton broker dealers[1]

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