Plan Sponsor Series 6: 401(k) Fees Paid Through Revenue Sharing - A Shell Game?

Originally published by Lance Reising on March 18, 2018.

Does your 401(k) plan utilize a fee payment system known as revenue sharing? Whether you are a plan participant or especially if you are a plan sponsor, you should know. If you are a plan sponsor, you are required to know as a plan fiduciary. If you get nothing else from our newsletter today, please find out if you do not know. As a Registered Investment Advisor we are at a disadvantage because we are required to disclose all fees, regardless of the source. Of course, that is why we can reduce or eliminate much of your personal liability. This not necessarily true for banks, brokerages, and insurance companies, so let's see why.

What is revenue sharing? The most concise description we have seen is from Greg Carpenter, CEO of Employee Fiduciary: "Revenue sharing is the practice of adding additional non-investment related fees to the expense ratio of a mutual fund. These additional fees are then paid out to various service providers - usually unrelated to the fund company managing the fund. Why is this controversial? Mutual fund returns are reported net of fees, so the money collected from investors and paid out to other parties is not explicitly reported to investors, it simply reduces the net investment return of the fund. Because investors don't see the fees being deducted, the true cost of the fees charged is often overlooked when calculating the total cost of plan services."

The practice of revenue sharing evolved with the 401(k) industry as a way of efficiently making payments between multiple service providers to a plan. Many could argue that the practice actually helped to make 401(k) plans popular because of this operational efficiency and it allows for the payment of fees by the participants through deduction of fees before reporting of fund returns.

Laws requiring greater fee transparency have been in place for several years and it has become clear that the use of revenue sharing can circumvent the law and its intent. While it is still allowed, regulators have discussed banning the practice in an effort to allow more transparent competition to work to lower plan expenses.

Here are downsides:

• Insurance company plans may contain complicated wrap fees which are effectively hidden. If you sponsor a plan from an insurance company, are you aware of this "standard" but often hidden charge?
• It can provide a means for advisors and providers to act in their own interest at the expense of their client's.
• It allows for a wide array of share classes for the same mutual fund, only with different commission structures.
• The complicated nature of revenue sharing has caused most plan sponsors to not fully understand how revenue sharing works. They are required to constantly monitor who is getting paid by whom, from which mutual fund, how often, and how much. That gets very complicated and opens the plan sponsor to a possible breach of their fiduciary responsibilities.
• This fiduciary responsibility is very time and resource consuming if it is to be properly monitored by the plan sponsor.
• Revenue sharing may not be equitable to participants because the fees they are charged can be unequal depending on the funds they have chosen.
• The guidelines for completion of Form 5500 allow for revenue sharing to obscure the true fee and cost structure of plans. For instance, many Form 5500's for plans show zero administrative and/or advisory fees being paid because they were paid out from plan assets through revenue sharing. The fees are there; the providers do not work for free, but they do not disclose their fees clearly like a fiduciary is required to do.

As we have discussed before, litigation in the retirement plan business is now a major issue. This is an important reason why retirement plan executives and fiduciaries should know and understand their revenue sharing arrangements so they can document that no excessive fees are being paid. This entire issue can be avoided in two ways: 1) Recapture revenue sharing, or 2) eliminate revenue sharing. The easiest way is to build a fund lineup with investment choices that do not pay revenue sharing.

As Michael A. Hart writes in the National Law Review: "A significant advantage of a plan's investing in funds that do not pay revenue sharing is that it eliminates revenue sharing altogether and, therefore, eliminates the fiduciary's obligation to monitor it. It is not easy to monitor revenue sharing. While Plan Service Providers are generally obligated to disclose revenue sharing arrangements to plan fiduciaries under U.S. '

Department of Labor regulations (see DOL Regulation § 2550.408b-2(c)), they typically only make a general disclosure of the revenue sharing arrangement, and plan fiduciaries do not normally receive a detailed accounting of the actual amounts of revenue sharing being paid to the Plan Service Provider."

At Investor’s Choice 401(k) we disclose all fees in a simple and transparent way because we are always fiduciaries. It is one of the main reasons behind our philosophy of using ONLY low-cost index funds and ETF's in our suggested fund lineup and in our high-performing managed portfolios which do not contain revenue sharing. Contact us if we can help you determine whether or not you are under a revenue sharing arrangement. You need to know.

Wondering if you have revenue sharing in your current 401(k)? Contact us here for a complimentary plan review.