Originally published July 22, 2008
Keywords: Department of Labor, DOL, FAQs, new annual reporting requirements, Form 5500, ERISA, Schedule C, compensation, service providers, real estate operating companies, REOCs, venture capital operating companies, VCOCs
On July 14, 2008, the Department of Labor (DOL) issued FAQs (frequently asked questions) intended to help with the administration and implementation of new annual reporting requirements issued on November 16, 2007, in the form of a revised Form 5500, applicable to most ERISA plans.
Among other changes, the new Form 5500 includes a revised Schedule C that requires significantly expanded reporting of direct and indirect compensation received by (i) service providers to the plan, (ii) other persons, if eligibility for a payment or the amount of the payment is based, in whole or in part, on services that were rendered to the plan or on a transaction or series of transactions with the plan, and (iii) service providers to mutual funds, private investment funds, bank collective trusts and insurance company separate accounts in which a plan holds an interest. See our client newsletter Department of Labor Expands Annual Reporting Requirements for Service Provider Compensation."
The FAQs offer new guidance on, among other matters, reporting compensation paid by investment funds in which ERISA plans invest to their service providers, which is implicated by the broad definition of "indirect compensation" under the new Schedule C. Of the 40 FAQs, three (Questions 3, 4 and 7) shed light on the intended application of these rules to investment funds. Although not specifically addressed to investment funds, Question 40 is also relevant to investment fund reporting, as it provides some relief to the plan administrator's duty to report a party who fails to provide information required to be reported. The response to Question 40 indicates that a plan administrator is not required to report for the 2009 plan year a service provider who fails to provide complete information if the plan administrator receives from the service provider a statement that the service provider made a good faith effort to make any necessary recordkeeping and information system changes in a timely fashion, and that despite such efforts, the service provider was unable to complete the changes for the 2009 plan year.
The response to Question 3 confirms that "eligible indirect compensation" includes fees and expense reimbursement payments charged to "investment funds," and notes that the term "investment fund" was not defined by the instructions to the new Schedule C. The response goes on to explain that: "Investment funds would include mutual funds, bank common and collective trusts and insurance company pooled separate accounts." The Question 3 response further notes that, in the DOL's view, the term "investment fund" would also include separately managed investment accounts that contain assets of an individual plan.
The response to Question 4 confirms that, in the case of a plan's investment in a mutual fund or an investment fund, reportable indirect compensation does not include amounts charged against the fund for ordinary operating expenses, such as attorneys' fees, accountants' fees, printers' fees, or brokerage commissions paid in connection with effecting securities transactions within the fund's portfolio of a mutual fund or investment fund that holds plan assets, because such fees are not paid in connection with a transaction involving the plan.
The response to Question 7 provides further guidance on the scope of investment funds covered by the expanded reporting rules. First, the Question 7 response confirms the statement in the Schedule C explanation that the duty to report indirect compensation is not limited to fees paid out of plan assets. Accordingly, the fact that an investment fund is not deemed to hold plan assets appears to be irrelevant. However, the Question 7 response then goes on to state that fees received by third party service providers to operating companies, including real estate operating companies (REOCs) and venture capital operating companies (VCOCs) are generally not reportable compensation. This answer would not be affected by whether a VCOC, REOC or other operating company was wholly owned by a plan such that the assets of the entity would be plan assets. The Question 7 response notes, however, that if the REOC or VCOC pays fees to the plan's investment adviser or investment manager in connection with the plan's investment in the fund, such compensation would be reportable.
What does this mean for investments of plan assets in investment funds? Although the FAQs provide some clarification with respect to the scope of reportable indirect compensation when a plan invests in funds, they create a set of new questions. Generally the applicability of ERISA requirements follows ERISA plan assets, as determined under existing statutory and administrative rules. However, for the purpose of reporting service provider compensation, the DOL is creating a new distinction between "investment funds" (whether or not they are deemed to hold plan assets) and operating companies, which include investment funds that meet the REOC or VCOC requirements.
The FAQs do not provide guidance on entities that are neither specified investment funds under Question 3 (mutual funds, bank common and collective trusts and insurance company separate accounts) nor operating companies, including hedge funds, funds of funds and other entities that do not hold ERISA plan assets because they meet the less than 25 percent benefit plan investor test enacted by Congress as part of the 2006 Pension Protection Act. The FAQs also do not address plan investments in vehicles that are not commonly considered "investment funds," but that also may not qualify as operating companies, such as issuers of asset-backed securities, commodities pools, certain public mortgage REITs, joint ventures, etc.
Based on this, a plan administrator will need to make a determination whether or not each fund and other entity in which the plan owns an interest is an investment fund. Mutual funds (even though they are statutorily exempt from ERISA), bank collective trusts and insurance company pooled separate accounts are considered investment funds that are covered by the new reporting obligations. Most real estate funds and private equity funds may be excluded from the service provider reporting if they qualify as a VCOC or a REOC. As noted above, the status of other investment entities that do not hold ERISA plan assets, including less than 25 percent funds, is still unclear. It is important to note that real estate and private equity funds typically have the flexibility to rely on either the VCOC/REOC plan asset exception or the less than 25 percent benefit plan investor exception. Many such funds will rely on the less than 25 percent exception merely for ease of administration. If a less than 25 percent fund is ultimately determined to be included in the definition of an "investment fund," a plan administrator would have to monitor the status of such a fund to determine its status each year as either a VCOC or REOC or a less than 25 percent fund.
According to the response to Question 7, if a plan invests in real estate through title holding companies, the reporting requirements would not apply to service providers to a title holding company if it qualifies as either a VCOC or REOC, even though the assets of the title holding company would be considered plan assets of the plan. However, if the real estate assets are owned directly by the plan under a separate account arrangement, then they would be covered by the reporting requirements, according to the response to Question 3.
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