June 2010, Newsletter:

Revenue Sharing in 401(K) Plans

 

The concept of revenue sharing relates to the transfer of asset-based compensation from brokers or in­vestment managers to other service providers. Revenue sharing paid to consultants who advise 401(k) plan fiduciaries has been identified by the Department of Labor ("DOL")  and the Securities and Exchange Commission ("SEC") as a particular concern because of the potential influence such compensation may have on a consultant's investment recommend-ations, although neither the DOL nor the SEC have found revenue sharing arrangements to be per se illegal. On the other hand, lawsuits filed in relation to revenue sharing arrangements have alleged that such arrangements breach fiduciary duties and result in prohibited transactions.

 

  Here's how a revenue-sharing arrange-ment  works. An employer tells a record-keeper or adviser to establish a 401(k) plan with a certain number of mutual funds and services. The record-keeper or adviser collects a percentage from the expense ratio paid to fund managers or from a per-employee charge called an ``investment offset.''

  For example, if there is a  charge of 0.75 percent annually for a fund. From 0.10 percent to 0.50 percent may be paid back to the record- keeper or adviser for plan administration, advisory, auditing, communication and other services.

 

 

 

 

Plan fiduciaries have an obligation to act for the exclusive benefit of plan participants and beneficiaries, a duty to act prudently, and to avoid prohibited transactions. With respect to investment fees and expenses, plan fiduciaries may not pay  more than reasonable compensation for services  and, since investment fees and expenses may have a significant effect on investment returns, plan fiduciaries; fiduciaries need to consider those fees and expenses when selecting the plan's investment options.

Whether fee adjustments are possible, and how the fees are redistributed through revenue sharing arrangements can be difficult for plan fiduciaries. Therefore, the DOL has created a model plan fee disclosure form that can be used to assemble, assess and evaluate plan expenses. Model Fee Disclosure Form. The DOL, on the other hand, has recognized that this information is not always avail­able and has proposed regulations that would compel fee and conflict disclosures.  These proposed regulations would require service provider contracts to in­clude language compelling the disclosure of the service provider's compensation and conflicts of interest, and make the service provider liable for excise taxes under the prohibited transaction rules for a failure to meet these disclosure obligations.

 

In a statement issued by the DOL, the DOL announced that the DOL and SEC have formalized an information sharing agreement.  In an effort to pro­tect the retirement assets of American workers, the primary goal of the agreement is to improve investigative and enforcement activities, as well as the over­sight of investment advisors and other members of the investment community. In order to achieve the goal of the agreement, both agencies have reserved the right to transfer information to criminal law enforcement authorities.

 

Lawsuits have alleged that revenue sharing payments are plan assets, and that the revenue sharing arrangements breach fiduciary duties under the Employee Retirement Income Security Act ("ERISA")  by failing to disclose to participants all revenue sharing payments and result in prohibited transactions. However, ERISA and the DOL regulations do not require or compel the detailed disclosure required to report on revenue sharing arrangements and payments to plan participants, and the failure by a plan fiduciary to disclose such information has been found not to be a breach of a fiduciary duty.

 

Two recent cases, Hecker and Wal-Mart,  are illustrative of the differing attitudes the courts take in such cases. See, for example, the Notes on Hecker v. Deere posted by Stephen Rosenberg in the Boston ERISA and Insurance Litigation Blog. See comments on the Wal-Mart case at Eighth Circuit Reinstates ERISA Case Against Wal-Mart

 

In light of the increase in excessive fees and revenue sharing lawsuits, plan fiduciaries should seriously consider disclosing revenue sharing information to plan participants and document  decisions to make investment options available involving revenue sharing.

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