Fee Policy Statements.
Summary paragraph: Create a decisionmaking process for fees-and put it in writing
Art by Alex Eben MeyerIn the same way that many plans have devised, and follow, a documented investment policy, so too have some begun contemplating a similar tool for fees. Industry experts have started to discuss fee policy statements-comparable to investment policy statements (IPSs) in that they serve as a road map for a plan committee to follow in order to better manage and document retirement plan expenses. According to Michael Woomer, senior vice president of institutional and retirement plan services for Fort Pitt Capital Group in Pittsburgh, the interest in fee policy statements is a natural result of the emphasis on fees brought on in part by the Section 408(b)2 and 404(a)5 fee disclosure requirements of the Employee Retirement Income Security Act (ERISA).
The 408(b)2 regulations, according to which vendors disclose fees to retirement plan sponsors, do not specifically demand that sponsors state their policy on fees, says Rocco DiBruno, managing director at Thornburg Investment Management in Santa Fe. Still, he recommends that plan sponsors adopt these statements because of the guidelines they set forth that satisfy the Department of Labor (DOL).
The DOL is delighted when a plan has a fee policy statement, says Jason Roberts, CEO of the Pension Resource Institute in Manhattan Beach, California. "The statement is evidence that a plan is fully aware of its most important obligations, uses a prudent process and understands that the money is not [its own]," he says.
Woomer agrees that fee policy statements might be an emerging best practice, and that plan sponsors need a place to document the process of selecting service providers and funds, as well as the method for allocating revenue.
Revenue sharing and allocation might well be the impetus for fee policy statements, given the increasing number of lawsuits accusing plan sponsors of improper usage. Currently, there may be as many as 42 such cases associated with fees, says Woomer. "The DOL is getting more feedback from participants about issues in those plans," he says, adding that, during investigations, the department will scrutinize the process plan sponsors have implemented.
Roberts emphasizes that the statements are not on the DOL's "script" or its document request list, but an investigator may still ask to see documents that describe the plan's compliance with ERISA requirements. Interest varies by region, he says, adding that, based on his experience, DOL investigators tend to ask more frequently in California. "It's probably worse to have the statement and not follow it than not to have it," he notes.
Creating and Documenting a Fee Policy
The purpose of the fee policy statement is to shine a light on the mechanics of fees in a plan, Woomer says.
"Whereas an investment policy statement can get into lots of quantitative, statistical information that's overwhelming, the fee policy statement sets forth a process for how the fees are being charged, who is paying for them and what you are paying for," DiBruno says.
Plan sponsors have to understand their fees before they can create a document, sources agree. The plan sponsor has three basic arrangements to consider, Roberts says. In one, the corporation pays all the administrative expenses. In the second, the participant pays these costs. In the third, the company pays expenses, less any credit-i.e., the revenue share derived from investments. In a hybrid variation, revenue sharing is used and the plan sponsor writes a check for the difference.
Roberts advises looking at all forms of compensation in the plan and vetting each for reasonableness of fees. Before entering into any arrangement for revenue sharing, plan sponsors should ensure they are acting in the best interests of their participants. Decide whether revenue share will be applied to the plan or paid back to the service provider, and examine the methodology for how the crediting is done.
The creators of a fee policy statement are the plan sponsor, adviser and recordkeeper, who will jointly discuss how to codify a process for selecting and monitoring both plan investments and service providers, Woomer says.
According to sources, the statement should address the cost of investments-including the excess revenue from each option-plan administration costs and service provider fees.
Roberts says that he never gives plan sponsors a checklist to follow, but instead offers model policies using open-ended questions to spark a conversation. "The process is meant to stimulate information-gathering and debate," he says, "not just check a box."
"The fee policy statement details the role of how fees are paid," Woomer says. "Most plans take revenue from applicable funds in the plan to offset recordkeeper costs. As you move upmarket, plans generally go to a lower-expense-ratio fund to benefit the participants and then pay the additional costs."
Once the fee policy statement has been crafted and implemented, it still needs supervision, Roberts cautions. The statement will not work on auto-pilot. Periodically monitor the service provider, he says, to verify that the "revenue amounts are being correctly calculated and applied to the benefit of the plan."
Fee allocation is a critical issue, says Woomer. Not whether the actual costs are low or high-costs must be reasonable-but how they are handled and whether the plan has a considered, deliberate process that answers questions about fee equalization and how fees are charged. All of this should be spelled out in the statement.
"Part of being a good fiduciary is keeping these costs and fees on the radar," DiBruno says. The fee policy statement might indirectly have an impact on revenue sharing. Perhaps the plan would prefer to use zero-revenue shares. The fee discussion may address whether to include shares that have a separate recordkeeping cost or how to choose among retail, institutional shares and no revenue sharing, he says. "The discussion puts the plan sponsor in a position to ask questions of the adviser and the provider, and [to] make sure the fee policy is aligned with the plan philosophy."
Some plans might choose to have the plan sponsor pay all costs, other plans to have each participant pay the same fee. A fee policy might state that participants with higher balances should not effectively subsidize the plan costs-a task which generally falls to highly compensated employees. Woomer notes that if a plan wants to use fee equalization, the recordkeeper will need the ability to allocate fees on an equal basis.
A key question to answer is how the recordkeeper charges for its services. If recordkeeping costs are based on plan assets, at a cost of, say, 10 basis points (bps), this can be paid through fund revenue, using funds that cover the cost on an average weighted basis or by allocating in different funds-e.g., a combination of institutional classes with some higher-revenue classes to offset the expenses.
"We find out exactly what revenue the recordkeeper needs, and then we potentially will negotiate to make sure it keeps [only that]," Woomer says. "If the recordkeeper needs 12 bps to run the plan, but the fund selection generates 17 bps, where does that 5 bps go? That is part of the fee policy statement."
Sponsors should review the policies in the statement annually, with a deeper dive every three years or so if there is a change in the plan's size, recordkeeper or funds. "The point is to look over the policy and make sure nothing is going outside the lines," Woomer says. "I'd rather err on the side of being cautious and doing it more often."