Over the last few months, the most common questions asked by clients . . . and most of my work . . . have been about three issues:
The DOL’s new fiduciary proposal . . . not surprising.
Capturing rollovers from retirement plans. Again, not surprising because of the large amount of money coming out of plans and in light of the attention being given to rollovers by the SEC, FINRA, DOL and GAO.
The use and allocation of revenue sharing in 401(k) plans.
I will be writing about the first two points in the future, so let’s focus on the third one now.
For about 20 years, mutual funds have paid revenue sharing to 401(k) recordkeepers for services provided to the mutual funds. That includes 12b-1 shareholder servicing fees, 12b-1 distribution fees, and subtransfer agency fees. The view was that the money was paid for services to the mutual funds . . . and only incidentally involved the plans. However, that is changing—at least partially because the 408(b)(2) regulation treated those payments as compensation to the recordkeeper for services to the plans. Because of that change, there is a growing perception that the revenue sharing payments belong to the plan, and not to the provider.
Regardless of those perceptions, the DOL’s position, and the 408(b)(2) regulation, treat the payments as compensation to recordkeepers for their services related to the plans and their investments. As a result, if the total compensation from revenue sharing exceeds the reasonable cost of recordkeeping services, the plan sponsor has a fiduciary obligation to be aware of that and to recoup the excess compensation for the benefit of the participants.
The “new news” is that some providers and some plan sponsors are allocating all of the revenue sharing back to the participants and then charging participants’ accounts for the recordkeeping costs. Why? The general answer is because it is seen as being fair. The more detailed answer is that fiduciaries have a duty to oversee the use of revenue sharing by the recordkeeper and, when they delve into the matter (in order to understand the issues and fulfill their fiduciary responsibilities), the fiduciaries often determine that the equitable allocation of revenue sharing, and then proper allocation of plan costs, produces a result that is fair and that manages the fiduciary risk.
That raises the obvious question . . . what fiduciary risk am I talking about? The risk is that there is no guidance from the DOL on the proper use and allocation of revenue sharing. In other words, plan sponsors, advisers and ERISA attorneys are operating in a vacuum. We are making educated guesses about what will ultimately happen in terms of DOL guidance or ERISA litigation. When “walking on thin ice,” it is often preferable to take a relatively conservative position. In this case, the conservative position is to allocate the revenue sharing back to the participants.
To give you an example, think about a large plan where 50% of the participants’ money is in revenue sharing mutual funds, 40% of the participants’ money is in non-revenue sharing mutual funds, and 10% is in a company stock fund (that does not pay any revenue for recordkeeping). In this case, the 50% of the participants in the revenue sharing mutual funds are carrying the cost of the whole plan. Expressed slightly differently, half of the participants are in the plan for free, because the other half are paying the cost of recordkeeping. If we assume that the half of the participants in the revenue sharing mutual funds are paying higher expense ratios, then the problem becomes obvious. Not only are those participants paying for the plan, but they are bearing a financial burden to do that.
A similar case could occur where some of the participants (probably high-compensated ones) are in stock brokerage accounts, while the rank-and-file employees are in mutual funds that pay revenue sharing. The brokerage accounts aren’t paying anything to support the plan, while the rank-and-file employees are bearing the full cost of the plan.
The fundamental question is, how should your plan sponsor clients be positioning themselves in light of the lack of DOL guidance and the potential risk?