In the traditional trust environment, the trustee has the fiduciary duty to act only in the sole interests of the beneficiary. In keeping with this, transactions that generating revenue for the trustee are deemed “prohibited transactions.” Simply put, trustees cannot engage the trust in any transaction which benefits the trustee. This eliminates a commonly abused conflict of interest problem from the pre-trust law days.
Investment Advisers operating under the Investment Advisers Act of 1940 (“40 Act”) have always been under this same fiduciary standard. At its inception, ERISA also held its fiduciaries to this same standard. The 40 Act contained an exemption for companies where investment advice was ancillary to its main business. On the ERISA side, the DOL has promulgated opinions which allow for certain exemptions from the prohibited transaction rule.
This is how revenue sharing, including 12b-1 fees, came about.
Over the years, we’ve seen financial service providers take this molehill of an exemption and create a mountainous industry. Vendors have used this tactic to hide fees; thus, enabling them to sell “low-fee” 401(k) solutions to unsuspecting plan sponsors. So great is this pandemic, even the mighty Vanguard, oft viewed as the purest of mutual fund companies, has been sullied by the scarlet “RS” of revenue sharing. Now, to borrow a quote from the movie Giant, it’s “too big to kill.”
Many industry experts believe plan sponsors should avoid revenue sharing arrangements, thinking these indirect fees more often than not suck the growth out of the assets of retirement plans. The DOL, however, continues to permit these otherwise prohibited transactions.
But what the DOL did last week may have effectively killed revenue sharing.
By sticking to its guns and not backing down to industry demands, the DOL’s new Fee Disclosure Guidelines will reveal the wizard behind the curtain. And many 401(k) plan sponsors might not like the tricks that magician has been up to. As early as this summer, both plan sponsors and plan participants will finally see the true cost of their retirement plan.
Some may accept the level of these fees.
Others may suffer sticker shock when they realize their “free” plan isn’t free or their “low-cost” plan isn’t truly low cost. And for those surprised by the actual costs, they’ll be looking for an explanation.
They need look no further than revenue sharing and, to a lesser extent, 12b-1 fees (according to a recent ICI study, only 1 in 10 plans still use funds with 12b-1 fees). Clearly, this practice will no doubt anger at least some 401(k) plan sponsors. What will their response be? Will they shoot the innocent messenger who has the unlucky duty of being the first to inform them of this debacle? Will they simply fire all those involved in revenue sharing? Or will they be convinced (by someone with a clearly vested interest) to stay the course because “everybody does it?”
But there’s a greater question: If you can’t hide the fees anymore, what’s the purpose of revenue sharing? With fee disclosure, revenue sharing becomes no different than automatic fee deductions, which many plans already use to pay their vendors. And, since some plan sponsors may prefer to pay fees directly rather than have the plan pay them, revenue sharing (which requires the plan to pay the fees) becomes less desirable. To paraphrase Ronald Reagan, whose birthday we celebrate this week, don’t be stunned if revenue sharing ends up in the ashbin of history.
It is the intention of the DOL to expose revenue sharing to the light of day. Like so many other blood-sucking creatures, revenue sharing just might not survive exposure to sunshine.