SEC Probes DC Revenue Sharing

July 4, 2004 ( - Government regulators are apparently delving deeper into the use of revenue sharing arrangements by 401(k) plans.

>McHenry Consulting has issued a  client alert  detailing a new sweep examination underway by the Securities and Exchange Commission (SEC) targeting “industry compensation practices in the distribution of defined contribution retirement plan products and services.”   Included in the alert was a list of twenty-five questions sent to mutual fund companies by the SEC over the past several weeks – questions that, according to McHenry, “delve deeply into the who, what, why, how and “how much” of retirement product compensation.”  

>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 ).  

Positioning Positions?

>Specifically enumerated in the request letter sent to fund companies are the SEC’s intention to examine “the reimbursements, rebates, subsidies and other payments that mutual funds and their advisors make as part of their participation in defined contribution plans.”   Additionally, according to text from the SEC letter included in the McHenry alert, “The examination will also review how DC Plan Payments are disclosed and whether Funds that directly or indirectly make larger DC Plan Payments receive different positioning in DC plans than those who pay less.”

>In fact, one of the twenty-five questions bluntly says, “State whether increased direct or indirect DC Plan Payments result in initial selection for, or different placement in, a sponsor’s retirement plan.”  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.  Emeryville,  California-based McHenry issued a controversial report in 2001 on revenue sharing practices in the industry ((see  Fee For All).    

>Plan sponsors should also be aware that the SEC has asked the fund companies to provide details regarding contact information, assets, and DC plan payments made to the "top twenty-five DC plans" where a DC plan payment was made during the examination period, and has asked for that the amount of fees paid for calendar years 2002, 2003 and 2004 (through April 30).

>Among the other questions are requests for information on:

  • Copies of standard DC plan payment agreements
  • Whether or not DC plan payment agreements are made pursuant to a written agreement, and if not, the circumstances in which a written agreement is not employed
  • The method of determining such payments
  • The factors considered when evaluating whether to enter into a DC plan payment agreement
  • Language used in fund prospectuses or statements that refer to DC plan payments
  • a sample of all materials used to describe DC Plan Payments, including but limited to materials provided to consultants and prospective clients, including examples of marketing materials and responses to requests for proposals
  • the name and title of the three executives most familiar with DC Plan Payments

>Since September 2003, the SEC has proposed 16 separate reforms for the mutual fund industry, including an amendment to Rule 12b-1 prohibiting the practice of directed brokerage, and greater disclosure of policies on granting "break-point" sales discounts to some fund investors (see  SEC Looking To Wrap Up Fund Reform)

>More recently, the SEC, which has drawn criticism from some quarters for its slowness in responding to the mutual fund trading scandal, has also probed the relationship pension funds have with investment consulting firms, including a request for information from a number of different pension consultants, asking for information regarding the practices, compensation arrangements and disclosures in providing services to defined benefit and defined contribution plans (see  SEC Looks At Consultant, Pension Fund Relationship ).