DOL Backs Down


New York—The Department of Labor Employee Benefits Security Administration (EBSA), the regulator of ERISA plans, recently approved the final changes to its disclosure requirements of indirect expenses incurred by investment managers on behalf of their pension fund clients.  After lobbying by both investment managers and the brokerage industry, the EBSA reduced its disclosure requirements for soft dollars, allowing investment managers to use current disclosure such as the Form ADV.

A year ago, EBSA proposed significant changes to Form 5500, the annual report that pension plans file with the Department of Labor, Internal Revenue Service and Pension Benefit Guaranty Corporation.  Under the original guidelines, pension plans were required to disclose the amounts of indirect expenses incurred by investment managers on behalf of the plans.  Included in this would be the commission amounts spent by investment managers in purchasing proprietary (ie, investment banking research) and third party research.

As we reported last January, the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI), among others, contested these changes, arguing that the SEC was about to propose disclosure requirements (still pending) and that providing the information required would be difficult, if not impossible.

In releasing its final version of Form 5500, EBSA reiterated that monitoring indirect expenses are part of plan sponsors fiduciary responsibilities:

“The Department believes that an annual review of plan fees and expenses as part of the annual reporting process is part of a plan fiduciary’s on-going obligation to monitor service provider arrangements with the plan.”

As such, Form 5500 still requires the reporting of indirect expenses, such as soft dollars.  However, EBSA also provided an “alternative reporting option”, which most, if not all, pension funds will follow for the soft dollar reporting requirements.  The alternative reporting option allows pension funds to rely on Form ADV disclosure and any disclosures in the investment management contract.  The information required is 1) whether the investment manager is receiving soft dollars, 2) the reason for receiving soft dollars, 3) the amount of soft dollars or the formula used to determine soft dollars.   Proprietary research is exempted from the requirement to disclose the amount of soft dollars because “it may not be practicable”.

“Similarly, ‘soft dollars’ received by an investment manager in the form of research or other permissible services in connection with securities trades on behalf of plan clients need not be separately reported on the Schedule C [of Form 5500] if disclosures in the SEC Form ADV, together with disclosures in the investment management contract, advised the plan administrator that the manager is receiving ‘soft dollars,’ the reason the person was receiving the ‘soft dollars’ payment, the amount of ‘soft dollars’ or the formula used to determine the amount of ‘soft dollars’ that the manager receives in connection with each securities transaction, and the party or parties from whom the investment manager is receiving the ‘soft dollars.’ The Department recognizes that it may not be practicable to provide a formula or estimate to calculate the value of certain types of ‘soft dollars’ non-monetary compensation at the plan level, particularly so-called ‘proprietary’ soft dollar arrangements, such as access to information from certain research specialists. In such circumstances, a description of the eligibility conditions sufficient to allow a plan fiduciary to evaluate them for reasonableness and potential conflicts of interests would satisfy the ‘amount of compensation’ prong of the disclosure alternative for Schedule C reporting.”

The good news for disclosure and transparency is the even with this significantly reduced requirement, the Department of Labor is in the vanguard of soft dollar disclosure in the US.  The new Form 5500 requirements will require investment managers to make sure their Form ADV reporting is correct—many investment managers have erroneously reported that they do not use soft dollars when in fact they use commission payments for proprietary research.  Although the amounts paid for proprietary research will not be disclosed, the fact that they are being paid for proprietary research will be a revelation for most plan sponsors (and sadly, some fund trustees.)

The fact that the DOL is in the vanguard of soft dollar disclosure is another reflection of the disarray at the SEC.  As we said last January, it is a sad state of affairs when the SEC gets lapped by the Department of Labor.  That is what has in fact happened.   There are some who maintain that the SEC will release soft dollar disclosure guidelines this year, but it is already December…

The big issue for third party research, or alternative research as we call it, is that the playing field has gotten less level.  Third party soft dollars have not gotten a pass, as proprietary research has.  Investment managers will now have to report third party research spending on a plan basis.  In other words, if an investment manager spends a total of $1 million in third party soft, the manager must estimate what portion of this total pertains to each plan.  This may be a significant disincentive for investment managers.  Endowments are not regulated by ERISA.

The changes to the Form 5500 are effective for 2009, which is filed in July 2009.


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