Michael DiCenso, National Practice Leader, Gallagher Retirement Services, explained to attendees at the PLANSPONSOR National Conference that revenue sharing is a sharing of operational profits between two parties, usually under a written agreement. Direct revenue sharing is a hard-dollar expense, either basis points or a per-head fee paid from a mutual fund company to a provider, or from a provider to an adviser or consultant. Indirect revenue-sharing or soft dollars can be expense arrangements for reimbursement or for advertising, or can be undisclosed additional compensation.
Bill Talmage, Institutional Consulting Director, Graystone Consulting, a business of Morgan Stanley Smith Barney, added that fees that make up revenue-sharing include fees for distribution of the fund, sales and marketing fees, finder’s fees, 12b-1 fees, and a whole list of other components.
Steve Smith, VP, Sales and Corporate Plans Market Leader, Diversified Investment Consultants, said an example of hidden costs relates to using a stable value fund. Plan fiduciaries will never really know what are the costs and fees for that general account product by the insurance company because the general account captures all assets from what the insurance company is doing. There are no explicit fees, the insurance company may provide a net rate, but it could be yielding up to 250 basis points in fees. Smith said plans may want to take that product out of picture because it makes fiduciaries’ job of determining reasonableness of fees difficult.
In addition, Smith said fiduciaries should look at fees for proprietary funds. The provider is getting fees on its proprietary funds on top of fees for recordkeeping or administration. For ancillary services, such as retirement planning services, IRA rollover services, advice, managed accounts, the provider may say there is no fee, but if the service pushes participants to proprietary funds, the provider is getting a fee. If the plan’s default fund is proprietary, the provider is also getting paid for that.If using an adviser or consultant, Smith suggested plan sponsors find out how they get paid. Ask if they have arrangements with service providers. If so, it could limit providers plans can use and it could mean they’re paying higher costs.
What to Do about Revenue-Sharing
DiCenso said ERISA 404 requires plan fiduciaries to ascertain whether recordkeeping fees are reasonable, and 408(b)(2) requires they ascertain whether provider fees are reasonable. Fiduciaries can’t determine that if they don’t know about revenue-sharing arrangements. They need to know who the arrangements are benefitting, make sure written agreements are in place, and benchmark the revenue-sharing payments to the marketplace to make sure they’re appropriate.
David C. Kaleda, Partner, Alston & Bird LLP, said ERISA does require fiduciaries to act as if they have expertise, and hiring people with expertise is not a bad idea. However, he said, it’s all about procedural prudence - fiduciaries have to show that they thoroughly researched and the reasons why they decided fees are reasonable, and that they regularly look at fees. They should document decisions.
According to Kaleda, revenue-sharing is not necessarily bad, what’s bad is if the Department of Labor comes in and finds no process for evaluating whether revenue-sharing is going on and whether it is reasonable. “It may be perfectly prudent, but if you’ve never looked at it, or haven’t documented that you looked at it, you’re argument will be hard to prove,” Kaleda told attendees.
To the point that revenue-sharing is not necessarily bad, Smith advised attendees not to go overboard with their reasonableness measure. “You want your provider to be profitable, not go out of business,” he said.
Talmage suggested that asking providers to establish ERISA accounts to dump revenue-sharing dollars to pay for services from this account, and if the account has a surplus at end of year, spreading it among participants, offers a good approach for full disclosure and transparency. However, he contended a commission rebate back to participants in specific funds is best practice.
Kaleda warned that ERISA or recapture accounts should be set up appropriately, that it allows sponsors to have access to the funds and it is only used for any service that can normally be paid with plan assets. The accounts cannot be used for paying employer contributions.
If sponsors don’t want to or providers can’t set up an ERISA account, Kaleda suggests they look at different share classes; some pay 12b-1 fees and some don’t.Audio of the panel discussion is available here.