Is That Your (Interim) Final Answer? New Disclosure Rules Under ERISA To Impact Many Hedge Funds

Given the ever-increasing levels of investment from pension plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) in hedge funds, ERISA considerations can be significant for fund sponsors and managers, and for other service providers to hedge funds and other private funds.  Sometimes, ERISA issues can rise to the level of being significant business considerations.  The exemption under Section 408(b)(2) of ERISA from ERISA’s prohibited transaction rules permits a service provider to an employee benefit plan to receive compensation for the services in the case of “reasonable compensation” for “necessary” services under a “reasonable” arrangement.  Regulations of the U.S. Department of Labor (the “DOL”) promulgated in 1977 had elaborated on the circumstances in which the exemption would be available.  Much has happened since 1977, and there have been recent comprehensive legislative and regulatory proposals to address the level of fee-related disclosure available to fiduciaries and plan participants and beneficiaries.  On the regulatory side, the DOL recently made extensive revisions to the compensation-related information that plan administrators are required to report annually on the “Form 5500,” and has previously issued proposed regulations that would affect the disclosure of fees charged in connection with participant-directed “401(k)” and other plans.  Following its 2007 release of a controversial set of proposed Section 408(b)(2) regulations, the DOL has now issued long-awaited interim final regulations under Section 408(b)(2) requiring increased disclosure of compensation in the case of certain services to pension plans.  Under the new regulations, where they are applicable, an arrangement for providing services to a pension plan will be treated as “reasonable” only if the service provider discloses to the plan specified compensation-related information.  Notwithstanding the major changes from the 2007 proposals, and arguably reflecting the urgency with which the DOL views these issues, the new regulations are not in reproposed form, but rather are interim final regulations.  The effective date of the new regulations is, however, generally delayed until July 16, 2011.  (It is noted that the new regulations do not apply to “welfare” plans, and that future regulations are expected that would address welfare plans.  The new rules also do not apply to individual retirement accounts and similar arrangements.)  Once the rules become effective, they will apply both to future arrangements as well as to arrangements then already in place.  A failure to meet the requirements for the Section 408(b)(2) exemption could cause the payment of compensation to a provider of services to an employee benefit plan to be a prohibited transaction under ERISA and the corresponding provisions of the U.S. tax code.  The consequences of a prohibited transaction can be extremely significant, including, for example, punitive excise taxes, the possibility of fee disgorgement and other potential liabilities on the service provider.  Thus, it may be critical that fiduciaries and other service providers subject to the new rules be in compliance with the new regulations, once they are applicable.  In a guest article, Andrew L. Oringer, a Partner at Ropes & Gray LLP, and Steven W. Rabitz, a Partner at Stroock & Stroock & Lavan LLP, provide a sampling of some of the issues that may be of particular interest to fund sponsors.

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