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Under ERISA, No Padding Profits with Revenue Sharing

Under a recent Department of Labor (DOL) directive, revenue-sharing arrangements between mutual funds and advisors to employee benefit plans are likely to remain in place. However, they will no longer be used to pad profits

Under a recent Department of Labor (DOL) directive, revenue-sharing arrangements between mutual funds and advisors to employee benefit plans are likely to remain in place. However, they will no longer be used to pad profits.

In an effort to snuff out potential conflicts of interest, the DOL said in an advisory opinion Monday that broker/dealers, banks and asset managers cannot accept revenue-sharing payments from the funds in a client’s employee retirement plan unless those payments are offset by lower management fees.

About half of the banks and b/ds that manage midsized retirement plans have already begun “offsetting” revenue-sharing payments over the past few years, according to Louis Harvey, president of financial services rating firm Dalbar. But this directive will accelerate the movement in that direction, he said. “Anyone who is not doing offsetting today, will start doing it.”

It is hard to know just how much extra compensation b/ds get from the mutual funds in 401(k) plans, because these deals are never disclosed anywhere, said Harvey. But it could be anywhere from an additional 20 to 100 basis points, analysts posited. Meanwhile, deducting these payments from management fees is an accounting nightmare, said Don Trone, president of the Foundation for Fiduciary Studies.

“This puts the onus on plan administrators and record keepers and investment advisors to account for all the sources of revenue to demonstrate that it was not a variable compensation arrangement,” he says.

One thing the directive should remedy is the tendency for 401(k) plan providers to offer funds from just one fund company, which then pays for that privilege in turn, said Morningstar fund analyst Russel Kinnel. “The provider may have an incentive to choose funds from one shop to save money, but that just doesn’t make sense from a risk perspective,” he said. “Many big fund companies like Putnam, Fidelity and Janus have had problems that can hurt a number of their funds across the board,” he said.

The DOL, which oversees all things related to employee benefit, retirement and health plans, has taken a different tack on revenue sharing than the SEC, which only requires that b/ds offer full disclosure of their revenue-sharing agreements with fund companies. Few expect the DOL’s advisory opinion to influence the SEC’s thinking on the matter. “For them to turn around and say it’s fundamentally wrong at this point would be highly unusual,” said Dalbar’s Harvey.

The DOL issued the advisory opinion Monday in the form of a letter to Bloomington, Ill.-based Country Trust Bank. At issue is the high standard of fiduciary care required of anyone who provides advice on an employee retirement plan. Fiduciaries are expected to handle client assets with as much or more care as they would their own. Explicit responsibilities include monitoring and preventing artificial inflation of expenses.

There remain some differences of opinion in the industry over who is and who is not a fiduciary. Registered investment advisors are required to act as fiduciaries, but what exactly that means for them has not been clearly spelled out, said Benjamin Poor, an analyst at Boston-based Cerulli Associates. “There’s always been this school of thought within the DOL of a higher standard for ERISA,” said Poor. ERISA stands for the Employee Retirement Income Security Act, the legislation that governs employee retirement plans.

In fact, a spokeswoman for the DOL says there is a difference between ERISA and fiduciary requirements. “The SEC’s jurisdiction over fiduciaries is different than ours,” she said. “It’s not applicable to the same audience. Ours apply only to employee benefit plans and health plans. The SEC’s apply only to mutual funds and financial institutions.”

Meanwhile, some retirement plan providers do not offer explicit advice on the plans. They only prove trustee and custodial services to the assets. Will they be held to the same standard? Poor said the DOL might need to issue further guidance on the subject.

“That’s the funny thing about the DOL. It issues a lot of advisory opinions,” he said. “Often there is further explanation of those opinions down the road. Other b/ds will look for clarification, describe cases they have as related to this advisory opinion. They may ask, ‘What if I’m not a fiduciary?’”

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