Perhaps, but that's not the way the 401(k) industry functions. Record keeping companies have typically marketed their products assuming that some or all of their fees would be paid by revenue sharing from the funds within their client's plans. Companies sponsoring plans have become accustomed to the concept that there are few billable costs for the plan. Sam, as a participant, and his employer, as the sponsor, may have never paid a direct fee related to the 401(k) plan.
Many have argued that this arrangement is meaningless to participants since the same 1% is assessed either way. But those people seem to be losing ground to the critics, who say that the menu of available funds within a 401(k) plan are too influenced by whether the fund shares revenue with the pay-to-play record keeper. If the broker or advisor servicing the plan expects to receive the 12b-1 fees as compensation, this can further eliminate options that might otherwise be available. It might also mean even more expensive share classes (R shares) are used to pay all of the various parties.
Figure 3 again examines our hypothetical investment in Bond Fund Class A, this time including a look at the sister funds-Class Admin, Class Inst. and Class R-with differences in their overall pricing structure. R shares, a relatively recent class, are funds often offered at much higher expense ratios to generate greater revenue.
The "Institutional" class is virtually identical to the Class A version except that it has less than half the overall cost and there is a significant difference in the revenue sharing. While Class A generates 0.45% (nearly half the operating expenses) in revenue for the record keeper, Class Inst. generates only 0.10%.
This is a dramatic disparity in revenue by percentage, one that is amplified many times over when 401(k) plans with millions in assets shift to different share classes. A $10 million investment in Bond Fund Class A generates $45,000 in revenue sharing while the same investment in Class Inst. generates only $10,000 in revenue.
A federal judge recently ruled that energy company Edison International violated its "duty of prudence" by using retail funds when the company could have used available institutional versions instead. There is not, as of yet, a litmus test to determine what amount of fees is appropriate. We will have to wait and see what the SEC, the DOL and Congress come up with as the final answer to this question.
In the meantime, it may be wise for advisors to examine their current practices in anticipation of coming changes.
Here are some guidelines that may be useful for advisors and their clients:
Be straightforward about the universe of funds available through the record keeper. Don't promise to screen the entire universe of funds if, in reality, the record keeper/revenue requirement limits it to a few hundred.
Calculate the annual revenue sharing and commissions (if applicable) being produced by the plan and share these results with the plan sponsor.
Benchmark the all-in fees of the record keeper to see if they are within a reasonable range of the competition's.
Avoid offering the most expensive share classes of the investments to generate excess revenue.
Given the ramifications of pending regulatory activity on advisors' revenue and liability, those professionals servicing qualified plan clients should know exactly where their practice stands on revenue sharing. Given the added costs and potential for lower returns with funds that share revenue, it's even more important.
Marshall J. Cobb, CRSP, is founder and president of Cobb Retirement Solutions, LLC, a fee-only firm offering qualified plan analysis and oversight to corporations and organizations. Based in Houston, he can be reached at 713.660.9605 or [email protected].