…And another thing on 401(k) Revenue Sharing

I am a big fan of the free flow and exchange of ideas.

My post on the cost of revenue sharing that I also featured in one my newsletters has spurred some really interesting debates and I just want to my views more transparent because I think there was a misunderstanding of what I was trying to say.

There is nothing illegal about revenue sharing payments. Starting in April 2012, providers who receive such payments will have to disclose that to plan participants. As long as the plan providers such as a third party administration firm is using it to offset plan expenses or a broker is using a 12b1 fee to get paid, everything is fine.

My issue is two fold. First off, revenue sharing payments are not free money. Some mutual funds pay it, some don’t. Revenue sharing payments come from fund expenses that mutual funds companies charge. A Vanguard index fund or exchange traded funds that charges 5 to 15 basis points, doesn’t pay 25 basis points in revenue sharing payment to a TPA because they can’t afford to. But another mutual fund that is actively managed that charges 150 basis points can.

Second, people complain that I likened revenue sharing payments to kickbacks because kickbacks are for illegal purposes. Revenue sharing payments are legal because they haven’t been made illegal.  However, in the 1950s, payola were payments made to disc jockeys to play specific songs, not all songs. It was made illegal under Federal law. So while revenue sharing payments aren’t exactly kickbacks because they are legal, they can be used as a form of bribery. As defined in Wikipedia, “Bribery is a form of corruption, is an act implying money or gift given that alters the behavior of the recipient.” So how are revenue sharing payments a form of bribery? I have seen it when the TPA states to a plan sponsor and their advisor that if they use any fund they want, their cost for administration will be x. But if they use a select list of funds, the cost for administration will be x-y. Since plan sponsors and most advisors only care about bottom line cost (which the plan participants actually pay most of the time), the select list of mutual funds is often chosen. Again, the TPA (at least almost all of them) don’t care which funds are selected because they’ll get paid either way. However, the plan sponsor and their advisors don’t understand that the revenue sharing payments come from fund expenses. So if a plan sponsor and their advisor is steered to a specific group of funds because they pay revenue sharing, it is akin to a bribe. Again, nothing illegal about that, yet.

With apologies to those who were offended, I am very transparent and I expect others to be transparent as well. So when I was in law school and I wasn’t picked for the tax clinic because my name wasn’t picked out of a hat (yes, literally). I wasn’t upset my name wasn’t picked out of a hat; I was upset that they never said picking names out of a hat was part of the clinic selection process. They made students believe that there selection was based on merit or interest in tax. So with revenue sharing, tell it like it is. It’s a payment that is funneled from the fund company to the TPA to offset plan expenses that was originally funneled from plan participants to the mutual fund company in the form of management expense fees. It’s just a rebate, not free money.

I always say honesty is the best policy, so let us not pretend that revenue sharing payments isn’t a way to steer money to specific mutual funds with the illusion that plans are getting something for free.

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2 Responses to …And another thing on 401(k) Revenue Sharing

  1. Mims Hillis says:

    Worse than the “feeling” of a kickback/bribe is the tangible reduction in return that is inherent in mutual fund revenue sharing. For detail about this reduction (which we call “friction”) go to http://www.fiduciaryblog.com/2010/09/friction.html So instead of free money or even a rebate, one might describe revenue sharing as only a partial rebate. Furthermore, the unrebated portion has not only the obvious immediate negative effect, but it actually negatively affects a participant’s return forever because the non refunded money is not in his account and is therefore unavailable for any future compounding of earnings/gains.

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