There is a cost for 401(k) revenue sharing

A few days back, I wrote an article about how plan sponsors can prepare for the new 408(b)(2) fee disclosure regulations. A representative from a third party administrator (TPA) said that they enjoyed my article, except my snarky comments about revenue sharing kind of ruined it.

I guess my comments regarding revenue sharing were a bit sarcastic, but I thought accurate. While revenue sharing payments from mutual funds to TPA to help defray the costs of administration of a plan sponsor’s plan is legal, it remind me of a kickback because only some mutual fund companies pay for it and only some of their mutual funds pay it (also it may depend on the mutual platform that the plan uses as well as its size). I guess the term kickback has a negative connotation to it, but isn’t that what revenue sharing is. The mutual fund paying the sub t/a or 12b1 fee is telling the plan sponsor or financial advisor or TPA (or all three) that if you use my fund, it will help lower the cost of administration. Again, totally legal in the 401(k) industry, it would certainly be illegal in other industries. Ask the disc jockeys who got implicated in the payola scandals of the 1950’s (yes, Dick Clark is still alive) whether what they did was illegal.

Again, I have no problems with revenue sharing if it’s fully disclosed. My problem is that there is a silly notion that revenue sharing is some sort of free money that mutual fund companies distribute that helps lower a 401(k) plan’s plan expenses. The revenue sharing is not free money because plan sponsors are already paying that money through a mutual fund’s expense ratio.  Low expense ratios such as index mutual funds or exchange traded funds can’t afford to pay revenue sharing when the revenue sharing payment is almost as much if not more than their expense ratio. It should be noted that when it comes to fee disclosure regulations, the expense ratio of mutual funds does not have to be disclosed (since they should already be by looking at a prospectus). Since plan sponsors and their advisors never take that cost into mind when discussing plan expenses, they then develop this crazy notion that revenue sharing is some sort of “free” money. It isn’t. I contend that plans that use revenue sharing are not cheaper when it comes to plans that don’t. I don’t have any empirical proof, but it’s just a hunch.

One theory that many people have in the industry is that fee disclosure will put pressure on 401(k) fees and plan expenses, so many mutual fund companies will be forced to slash the revenue sharing they distribute to lower their fund expenses, which may have the negative outcome of less 401(k) money into these funds. We shall see.

Again, I have nothing wrong with the use of revenue sharing as a legal method for plan expenses, but let’s call a spade a spade. Let us not pretend that revenue sharing doesn’t cost the plan sponsors any money.

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4 Responses to There is a cost for 401(k) revenue sharing

  1. Pingback: There is a cost for 401(k) revenue … – The Rosenbaum law Firm PC | law firm new york guide

  2. Chris Christie says:

    I generally agree, but revenue sharing really costs participants, because it indirectly lowers their returns; it is not usually a cost for plan sponsors. Plan sponsors, as a fiduciary, are requried to make sure plan’s expenses are reasonable. Revenue sharing is a part of plan expenses.

    Revenue sharing has additional aspects that are not as well known known. If one follows fee litigation, one knows that what appears to be the same mutual fund can have institutional and retail versions (and possibly other versions), with different fee strutures, which in turn allows for different revenue sharing. In addition, some plans are actually offering plan participants, probably unknowingly, clone mutual funds. These mutual funds appear to be the same mutual fund as the one that reports its earnings in the newspapers, but has different expense structures than what is reported in the prospectus and thus slightly different returns. The different expense structure is often intended to allow higher revenue sharing.

  3. Spot on, Ary. Let’s also not pretend that revenue sharing doesn’t come from participant account balances; it does. You’re right, there are no free lunches.

  4. 401k plan says:

    I really like this post. It is sharing good information.

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