The current government activity on service provider compensation includes a Form 5500 reporting requirement. The reporting requirement is imposed on plan sponsors, but disclosure of that information by advisers is necessary for plan sponsors to complete the Form. We have been advising plan providers, RIA firms and broker-dealers on these issues.

This article focuses on 12b-1 fees paid to broker-dealers in connection with mutual fund investments made by 401(k) plans. The only ERISA requirement for reporting and disclosure of 12b-1 fees by broker-dealers is for plan sponsors to report the fees paid by the plan (through its investments). This is a reporting requirement on Schedule C to the 2009 Form 5500. Note that Schedule C needs to be filed for plans with more than 100 participants and requires reporting of compensation of $5,000 or more. Thus, this requirement does not apply to small plans. However, it applies to more plans than might be expected, because the number of participants includes all of the employees who are eligible to defer, and not just on those that are deferring.

Beginning this year, covered plans will need to report certain information about “indirect” payments, which include 12b-1 fees. (Indirect payments are those which are made by anyone other than the plan or the plan sponsor. Since 12b-1 fees are paid from a mutual fund to a broker-dealer, they are “indirect.”)

Indirect fees are divided into two subcategories. The first is “eligible indirect” and the second is “other indirect.” Eligible indirect payments are subject to minimal reporting; it is a check-the-box reporting requirement. Other indirect payments must be reported in more detail.

What’s the difference between “eligible” and “other” indirect fees?

Because the rules are complex, I will discuss only the most important one...generally speaking, an indirect payment is eligible if it is a 12b-1 fee and if the broker-dealer provides the plan sponsor with written disclosures of:

a) The existence of the indirect compensation;

b) The services provided for the indirect compensation or the purpose of the payment of the compensation;

c) The amount (or estimate) of the compensation or a description of the formula used to calculate or determine the compensation; and

d) The identity of the party or parties paying and receiving the compensation.

If that information is provided in writing to the plan sponsor, the check-the-box format may be used for reporting 12b-1 fees paid to the broker-dealer for 2009.

What if those disclosures are not provided?

The plan sponsor still has the obligation to report the indirect payments to the broker-dealer on the Schedule C. However, absent those disclosures, the fees are considered other indirect payments and additional information must be reported. As a practical matter, the plan sponsor or the preparer of the 5500 will need to contact the broker-dealer to request the additional information.

If the information is not provided, Schedule C has a new section which requires plan sponsors to report any service provider (which would include a broker-dealer) that fails, upon request, to supply the information necessary to complete the Schedule C. As a practical matter, it is likely that the DOL will follow up on at least some of those failures.

However, there is a proposal that the new Schedule C requirement be delayed for a year to allow service providers to update their systems.

Our advice to our broker-dealer clients is that they should look at their existing procedures and their relationships with 401(k) providers to determine the best way to provide the disclosures for eligible indirect reporting. While it is possible that the requirement could be delayed, it is not certain. And, even if it is delayed, it is likely to be effective for 2010.

Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.


Source: Adviser Report