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401(k) Revenue Sharing: |
Pension and Retirement Memo |
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In late 2006, a law firm in St. Louis filed class action suits against several of America's largest corporations. The plaintiffs allege that these corporations had breached their fiduciary duties with respect to their 401(k) plans because those plans engaged in "revenue sharing" and paid excessive fees. The targeted employers included Bechtel, Boeing, Caterpillar, International Paper, Fidelity Investments, Kraft Foods, United Technologies, and Principal Insurance. These suits triggered a food-fight in the 401(k) world. Employers, plan providers, administrators, and mutual fund companies are battling with each other and class action lawyers over who is getting paid for what. Congress and the US Department of Labor have weighed in, and more plaintiffs' lawyers are ready to join the fun. Why not? With trillions of dollars in 401(k) plans, this food-fight over fees is drawing a lot of attention. If you are an employer with a 401(k) plan or a participant in a 401(k) plan, pay attention. Background 401(k) plans were introduced in 1978. In thirty years they have become the centerpiece of the private sector's retirement system. They are popular with employers because employees pay for a large portion of their retirement. In most plans, participants invest in mutual funds selected by the employer. 401(k) plans have many moving parts and players. The employer customarily uses a "plan provider," which is a consulting or administration firm. The plan provider designs, implements, and operates the plan. The plan provider also offers the mutual funds for plan investments. Under ERISA, fees paid to those providing services to plans must be "reasonable." What is "Revenue Sharing?" The following description of "revenue sharing" is admittedly over-simplistic. "Revenue sharing" is a practice by which mutual fund companies "share" the money they make from 401(k) plans with others who provide services to those plans. Revenue sharing is common in so-called "bundled" plan arrangements. A 401(k) provider will package, or "bundle," into a single product all plan documents, mutual funds, record keeping, and administrative services required for 401(k) operations. "Bundling" is convenient, one stop shopping for the employer. The employer customarily pays a very reasonable fee to the provider. The fee is reasonable because it does not cover all the costs of running the plan. Instead, the mutual funds in the plan pay some of the money they make to the other players, including the provider itself. The employer and participants do not know about the fee sharing. I have heard employers claim they pay only $1,000 per year in administrative expenses to run a 50 participant 401(k) plan. Annual plan expenses run much more than that, so the other expenses are probably being paid through revenue sharing. If someone sells you gas at a buck a gallon, you know you're paying the true cost some other way. The fees being shared are called "soft dollars" by investment pros and "kickbacks" by plaintiffs' lawyers. It depends upon your point of view. The fee sharing may go on at several levels. Revenue sharing is not limited to "bundled" products. It is a practice widely used in the 401(k) business. When a 401(k) plan engages in "revenue sharing," the fees are expressed as "basis points." A "basis point" is one one-hundreth of one percent. So, if a mutual fund pays the plan provider 15 basis points per year, the provider would receive .15% (i.e, .0015) of the assets of the plan. Not much, you say? Fees from "basis points" add up year after year and increase as the plan grows. In the example above, that's $1,500 per year on a $1 million plan, $15,000 per year on a $10 million plan, and $75,000 on a $50 million plan. When revenue sharing is practiced, there may be 1 to 2 percentage points involved, or 100 to 200 basis points, being paid out each year. Why All the Fuss? Revenue sharing is a hot topic now because: 1. Employers don't know about it. Revenue sharing fees are not disclosed to the employer or participants. In fact, the current IRS Form 5500 does not require disclosure. 2. It is extraordinarily difficult to find out exactly how much is being paid through revenue sharing. You have to dig through the fine print and jargon in the mutual fund prospectus. Even if you can find the explanation, you may not understand it. 3. The numbers can be enormous. Even at 1% per year, those 100 basis points add up to serious money in the multi-trillion dollar (and growing) 401(k) industry. There may be no volume discount on fees even as the plan grows in value from year to year. 4. Plan participants pay for "revenue sharing" fees and they don't know it. The fees are netted out of investment performance and reflected in lower rates of return. In some cases these hidden fees may put an additional 2% per year drag on plan returns. At the recent Congressional hearings on revenue sharing, it was pointed out that a 1% increase in annual fees will reduce a participant's overall retirement benefits by 20%. 5. It is unclear whether revenue sharing, per se, violates ERISA. Revenue sharing is a part of the fabric of the 401(k) business, and the Department of Labor has never questioned it. However, in those class action lawsuits revenue sharing's legality is being challenged. Congress and the DOL Congress held hearings on revenue sharing about a year ago. It was great theater, a times better than Congress's hearings on steroids in baseball. It pitted "fearless crusading legislators standing up for the little guy" against "greedy" plan providers and "Wall Street sharks." (See http://hr.cch.com/news/pension/032007a.asp). For example, a witness from the financial services industry defended continued nondisclosure of revenue sharing because it would "confuse" plan participants, and the amount of money in revenue sharing couldn't be accurately calculated anyway. He really said that. The Department of Labor responded by issuing proposed regulations on fee disclosure. Hearings were held on these regulations about a month ago. The preamble to these proposed regulations is instructive and worth reading. It reflects the DOL's struggle in dealing with the massive, complex, and diverse 401(k) distribution system. You may find these regs on the DOL website on the attached list. What to Do If You Are an Employer There are four steps you should take to determine if there is a problem of excessive expenses. First, appoint someone in your organization to monitor plan expenses. Second, determine what fees are, in fact, being charged to plan participants and whether those fees are being disclosed. How do you do that? Ask the plan provider and read the mutual fund prospectuses. The U.S. Department of Labor has a model fee disclosure form that you can send to your plan providers. (See the attached list for the website). And remember, you can always "shop around" for other plan providers. Third, determine whether these fees are reasonable and competitive. Fourth, carefully document your review. In any claim brought by participants for excessive fees, the procedures you have documented will be given great weight. What to Do if You Are a Plan Participant If you are a participant, read the plan disclosure information, such as the summary plan description and the mutual fund prospectuses. Scrutinize your account statements. Ask your employer and plan administrator if the plan engages in revenue sharing. More Information There is a lot of information about revenue sharing on the internet. Google "401(k) revenue sharing". Attached is a list of websites you will find informative.
401(k) Revenue Sharing Websites
General Overview McHenry Report CPA Journal Retirement Blog Fiduciary Advisor Aon Advisors Morgan Lewis Reish Lufton Nat. Law Journal http://www.kilpatrickstockton.com/publications/downloads/SteveSacherArticle.pdf Littler http://www.littler.com/presspublications/index.cfm?event=pubItem&pubItemID=17994&childViewID=246 Am. Benefits Council Dept. Notice DOL Prop. Regs. DOL Model Fee Disclosure Form:
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© 2008 Eugene Parrs |
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