(May 19,2008) "Capping" 401k Revenue Sharing: Record-keepers Block Rebates To Participants |
As Congress and the Department of Labor consider expanding expense disclosure to participants in the nation's 401k plans, the issue of "revenue sharing" payments between investment firms providing services to these plans, such as mutual funds and record-keepers, is being hotly debated. The mutual fund industry (which may well have invented the theory that too much disclosure can be harmful to investors) is arguing that as long as investors know the total expenses they are paying in their 401ks, how those fees are divvied up amongst the plan services providers is irrelevant. The industry says, "It's like buying a car. Consumers are told the sticker price of the whole car and make their decisions based upon that information, not based upon the price of all the various components."
The example the mutual fund industry offers is telling because, of course, there are uniquely high fiduciary duties that apply to protect retirement plans that don't apply to the car industry (i.e. ERISA) and we doubt anyone seriously believes applying the ethics of the car industry to 401ks would enhance retirement security for the nation's plan participants.
Another fault in the industry's position is that 401k plan participants under current regulations never really do know the total costs related to their plans. The expense ratio of the mutual funds and certain administrative cost may be disclosed (at best), but other significant fees, such as brokerage, are not. So, keeping with the car analogy, participants do not even know the sticker price of the vehicle.
Why, if total 401k plan costs are disclosed already (which they aren't), is the mutual fund industry so opposed to disclosing revenue sharing? What could investors learn from the disclosure of revenue sharing that is of such concern to the mutual industry? Anything? The answer is a lot and the regulators and legislators in Washington who are allowing the industry to shape the debate are missing the point. Here's the real story:
The largest 401k plan record-keepers, who also manage mutual funds, in 2004 decided to put an end to aggressive revenue sharing (or discounting) by non-proprietary mutual funds by "capping" the amount they would allow these non-proprietary funds to pay 401k plans they record-kept. In 2004 letters were sent to all the mutual fund companies that regularly participate in the major 401k platforms indicating that the record-keepers were "waiving" their right to collect additional revenue sharing payments. That is, even though these 401k plan record-keepers had negotiated contracts that allowed them to collect greater revenue sharing from non-proprietary mutual funds on behalf of 401k plan participants the record-keepers told the funds to keep the money. The money would not be passed through to the 401k plan participants to whom it rightfully belonged.
Why would the largest record-keepers do this? As mentioned above, revenue sharing is a form of discounting. Mutual funds disclose in their prospectuses certain fees that are included in an expense ratio and then agree secretly to rebate some portion of those fees. Those rebates, termed "revenue sharing" can be substantial and were growing. Some funds offer as much a 1% revenue sharing. Large 401k record- keepers that are asset managers were faced with a dilemma or conflict of interest. If other non-proprietary mutual funds agreed to rebate or discount half or more of their fees to 401k plans, plan sponsors (assuming they were aware of the availability of revenue sharing-which is often not the case) would demand that mutual funds affiliated with the record-keeper offer comparable discounts.
So, using their status as record-keeper to further their own self-interests, and without regard to their 401k plan clients, the record-keepers decided to secretly "cap" the amount of revenue sharing other mutual funds offered on their platforms could pay. By "capping" what other funds were allowed to pay, the largest fund groups (that are also record-keepers) capped the amount they would be required to rebate. In other words, the need to sustain high money management revenues trumped these financial firms obligations as record-keepers to 401k plans.
The results of this 2004 action were immediate and massive. 401k plans that had been receiving 50 to 100 basis points in revenue sharing from non-proprietary funds were cut to a maximum of 25 basis points for fixed income funds and a 35 basis point maximum for equity funds. Proprietary fund revenue sharing was cut to lower but comparable levels. The declining cost of investing in mutual funds through 401k plans came to an abrupt halt. One can view this capping of revenue sharing as a counter-offensive to the Spitzer-led assault on mutual fund excessive fees that began the previous year.
What will 401k plan participants gain from disclosure of mutual fund revenue sharing amounts? Investors will learn that the revenue sharing their plan receives from the mutual funds it offers may not be the lowest available. Participants will be able to see clearly whether the revenue sharing their plan receives has been "capped" as a result of heretofore concealed industry conflicts of interest. Participants will learn that some of the nation's largest 401k record-keepers, all of whom dispute that they have any fiduciary duty to plans, have put their own business interests before those of plan sponsors and participants.
What will 401k plan participants gain from disclosure of mutual fund revenue sharing amounts? Simply put, the cost of 401k plans will be cut in half.
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