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Participant fee disclosure rules published by the Department of Labor (DOL) went into effect in 2012, presenting new reporting challenges for the defined contribution industry, including stable value. The key purpose of the new disclosure is to achieve greater transparency and more meaningful comparisons of investment options in participant-directed retirement plans. This article highlights some of the key investment-related disclosures required by the Employee Retirement Income Security Act (ERISA) Rule 404a-5 and particularly how these disclosures have impacted stable value investment options.
Key Impact of the Participant Disclosure Regulations on Stable Value
Many of the new investment-related disclosures in ERISA Rule 404a-5 were modeled or based on existing Securities and Exchange Commission (SEC) disclosure requirements for registered mutual funds. Stable value investment options which are non-registered investments and typically packaged as either collective trust funds or customized individually managed accounts, needed to adopt and/or modify certain investment-related disclosures in order to comply with the new participant disclosure regulations. The following are some of the key changes made to stable value disclosure as a result of the new disclosure regulations.
Total Annual Fund Operating Expenses
Given the customized nature of stable value investment products, the stable value industry as a whole did not have a commonly accepted practice for reporting a stable value fund’s total operating expenses. Thus, the DOL’s recent requirement to provide a more consistent calculation of total operating expenses for non-registered investment alternatives was a significant reporting change for the industry. In the DOL’s final ruling, it was determined that certain expenses (e.g. investment contract fees) must now be included in the total annual operating expenses of the fund. For many stable value funds, the new reporting methodology, particularly the inclusion of stable value investment contract fees, caused an increase in expense ratios. It is important to note, however, that while many expense ratios for stable value funds increased as a result of the new disclosures it has always been common practice for these fees to be reported and to be included in after-fee portfolio returns.
Annual portfolio turnover is required for most investment options and must be reported in a manner consistent with the SEC’s form N1-A or N-3, as appropriate. Money Market funds and other investment products with similar investment objectives, however, are not required to provide a portfolio turnover rate. Stable value portfolios have unique issues regarding turnover given the contract value and market value components of a typical stable value fund. Given the various nuances and unique attributes of the stable value asset class, the industry has not reached a consensus on turnover and turnover methodology may still vary.
Broad-Based Securities Market Index
ERISA Rule 404a-5 requires the use of a published broad-based securities market index. In a recent survey by the Stable Value Investment Association, the most commonly used benchmark is the 3-Month U.S. Treasury Index. Given the market value and contract components of a stable value fund however, it is typical for many stable value managers to provide multiple benchmarks depending on a client’s benchmarking needs.
Information Comparable to Short Form Summary Prospectuses
Unlike registered mutual funds, stable value funds are not required to have prospectuses. While the new regulations do not require prospectuses per say, plan administrators are now required to provide participants either automatically at predetermined intervals or upon request, with documents for all investment alternatives that are similar to short-form or summary prospectuses. As noted in the DOL’s Field Assistance Bulletin (FAB) No. 2012-02R, “Whether a document is similar to a prospectus, or a short-form or a summary prospectus, would depend on the particular facts and circumstances…Alternatively, similar to short-form or summary prospectuses, bank fund fact sheets ordinarily may be used to satisfy this disclosure requirement, because they would contain information that corresponds to that contained in short-form or summary prospectuses.” As a result of the new disclosure rules, many stable value providers have revisited the information contained in fact sheets and other informational materials produced to evaluate whether or not the literature satisfies the new disclosure requirements.
An Exception for Expense Ratios
Some stable value funds are subject to different disclosure rules. These stable value funds are considered variable return products or annuities by the DOL. A notable difference for these types of investment products is that the operating expense ratio is waived for funds having a fixed rate of return. Because some stable value funds that are made available through a general account structure provide a fixed rate of return for a stated period and transfer investment risks to the insurer, it normally would not be necessary to provide annual operating expense information for such products. Although DOL did not fully explain its rationale for excluding variable return and annuity products from the expense ratio requirement, many assume that DOL believes operating expense information is not helpful to plan participants since the investment risk is transferred to the insurer and participants’ rate of return is not dependent on the expenses associated with any segregated pool of assets. DOL clarified in the final regulations that while stable value and money market mutual funds aim to preserve principal, they are not free of investment risk and accordingly are subject to variable return provisions of the regulations.1 The above just brushes the surface of the new participant disclosure rules touching on some of the key data points that impacted stable value reporting. While not without challenges, stable value managers have been proactively working with plan fiduciaries to help them meet the ERISA 404a-5 disclosure requirements to participants.
1 See Department of Labor 29CFR Part 2550, Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans, page 29.