Revenue Sharing Still Unresolved Issue

February 27, 2004 (—Orlando, Florida— The revenue sharing that goes on between fund companies and brokers will be targeted by reform and will result in less soft dollars and more hard dollars, as well as trustee-directed revenue sharing accounts, said Marcy Supovitz, of Boulay Donnelly & Supovitz Consulting Group, Inc.

The practice of “revenue sharing” involves fund companies making cash payments to brokers and other intermediaries for distributing mutual funds.   Through these revenue sharing agreements, the intermediaries serve as a marketing and distribution channel for the mutual fund company (see  Fee For All).  

The widespread revenue sharing compensation practices in mutual fund firms have left the US Securities and Exchange Commission (SEC) wondering if investors are properly informed.    The SEC began its investigation into revenue sharing arrangement between brokerages and mutual funds in April 2003 and found the practice to be fairly common.  Indeed, the SEC  found fund advisors sometimes reward brokers for featuring their funds by directing brokerage trades to them and provide increased support to that broker over another (see SEC: ‘Revenue Sharing’ Rampant in Mutual Fund Sales ).  

However, commonality only raises questions for the SEC in how investors are informed about possible conflicts of interest that might occur when a broker is paid to favor certain mutual funds over others, sometimes called pay-to-play schemes.   Discussion continues over whether or not investors lose money through these schemes, or if these fees offset other charges by brokers, thereby benefiting investors.

At the recent American Society of Pension Actuaries (ASPA) 401(k) Sales Summit in Orlando, Florida, Supovitz said that four major types of fees often brought into the discussion: 12b-1 fees, sub-transfer agency fees, finder’s fees, and management fee rebates.   Supovitz said that the fund companies are trying to phase out the finder’s fees, enforce increased standards for the sub-transfer agency fees and decrease the management fee rebates.   Additionally, Supovitz suggested that the fund companies would implement share class restrictions by plan size (see also What You Don’t Know Can Hurt You ).

Supovitz agreed with others at the conference and said that there are likely to be mandated disclosure of fees and revenue sharing agreements, but went further in suggesting that participant statements might also include fee reporting, so it is not only disclosed to the plan sponsor, but participants as well.

While the revenue sharing arrangements are not a new phenomena, many remain confused about their purpose and composition.  Plan sponsors seeking clarity on the issue should consider the following”

  • 12b-1 fees are service fees paid by a mutual fund to a broker or recordkeepers out of the fund’s assets to cover distribution expenses such as advertising and marketing the funds to new investors, as well as paying for shareholder service expenses. 
  • Sub-transfer agency fees are part of the “other expenses” outlined in the prospectuses which represent a portion of the fund transfer agent compensation set aside for shareholder recordkeeping and accounting services. These are exactly the types of services provided by third-party administrators in most defined contribution arrangements.   These fees can be both variable and negotiable, as well as being either asset-based or flat fees.
  • Finder’s fees are a common practice whose payments do not come from fund assets, and are not disclosed via the prospectus.   These fees are paid from the fund company to the broker-dealer, and are sometimes disclosed in the prospectuses.   While rates of payment vary somewhat, it is quite common for the finder to receive a check for roughly 100 basis points of the first $1 million in assets delivered, with a declining fee scale after that.
  • Management fee rebates are highly negotiable fees, not disclosed in prospectuses, paid by the fund companies to major 401(k) distributors.