The Rosenbaum Law Firm P.C. Blog

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.

The latest edition of my newsletter geared towards financial advisors can be found here.

My latest JDSupra.com article can be found here.

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.

My latest newsletter can be found here.

Advisors ask me all the time of the role of education in participant directed 401(k) plans. Participant directed 401(k) plans that are governed under ERISA §404(c) offer the plan sponsors liability protection based on a participant’s gains or losses on their account when they direct their own investment.

There have been so many misconceptions that plan sponsors and advisors have had concerning ERISA §404(c) plans. They had this belief that if they just give a mutual fund lineup and some Morningstar profiles to plan participants that they are exempt from liability. ERISA §404(c) protection is about following a process and Morningstar profiles is just not enough education to give to plan participants. On the flipside, education to participants doesn’t have to amount to an MBA education.

I think an effective education component to ERISA §404(c) plans should include enrollment meetings where the characteristics of the plan are discussed, as well as the investment options, and offering the building blocks of financial education to assist participants to get a better understanding on how to choose investments.

Advisors that may have issues in offering education should always consider using some of the online resources out there such as rj20.com and smart401k.com.

In addition, written materials such as plan highlights and some Morningstar profiles should always be distributed.

Also while many advisors dislike, one on one meetings to participants should always be offered. While most participants will probably shun such meetings, they should always be offered to those that want them because as we know, every participant has a different financial goal and need.  One on one meetings offer participant individualized attention on asset allocation and fund choices; it can be an effective means of educating plan participants more than what a general enrollment meeting can offer. It can help participants understand how retirement plan assets relate to their other assets as part of a comprehensive financial plan.

Advisors should always look at education as liability protection, because offering participant education help a plan sponsor minimize their liability under ERISA §404(c). While I always stress education as important part of the fiduciary process, it’s not about achieving a specific result from participants directing their own investments. Offering participants educations is like the old proverb, “You can lead a horse to water, but you can’t make him drink.” So no matter how great the education component is, there is no guarantee that it will help plan participants achieve a better financial result because like they say, there is no guarantee in life, except maybe death and taxes. The participant who put all his money into a mid-cap fund because he considers it the “average of the market” may still do so even after getting education at the enrollment meeting and through one on one meeting. As with most things with retirement plans, it’s about following a process and not guaranteeing a result.

My latest JDSupra.com article can be found here.

A revised edition of my very first JDSupra.com article can be found here.

When it comes to technology, people cling on to some old technology because of their fondness for it either because it represents their youth or because they don’t want to change with the times.

I laugh how many new albums (I still like to use that term) are not only released in digital format, but CDs, and records. I have never been an audiophile and never will be, I’ll never understand why my father’s business partner had to travel to England to get a digital audio tape recorder (it was banned here for copyright issues). But I grew up as a child in the 1970’s and I hated records. They were too big, they were hard to play, and they scratched too easily. Same with VHS, give me Blu-Ray. My $2,000 ($2,000 in 1985 money) Apple IIe was no match for my $800 HP laptop.

When it comes to retirement plans, we do have one retirement plan for the single employer market that is sort of like a record or a VHS tape and that’s a money purchase plan. Money purchase plan is a defined contribution plan that is also a pension plan, so it has a specified contribution in the plan that has to be made every year. For multi-employer (union) plans or some governmental plans, money purchase plans are alive and well as they have replaced defined benefit plans. For single employers, money purchase plans were made obsolete in 2002 when the Internal Revenue Code was amended to increase the deductibility limits on profit sharing and 401(k) plans.

Prior to 2002, the limit on contributions that plan sponsors could deduct on their tax returns was 15% of compensation for profit sharing and 401(k) plans (which are profit sharing plans). That 15% limit did actually include salary deferrals (which made no sense since it was employee money). The deductibility limit for money purchase plans was 25% of compensation. So plan sponsors had a money purchase plan for the full 25% limit (or higher than 15%, whatever they could afford) or they had paired plans such as a money purchase plan for a 10% contribution of compensation and a 15% discretionary contribution under a profit sharing plan.

As soon as EGTRRA changed the limits in 2002 and allowed for 25% deduction limits (which no longer included salary deferrals), I remember merging the money purchase plan into the paired profit sharing plan or converting the stand alone money purchase plan into a profit sharing plan for our clients.

So the point is that unless the plan is designed to benefit union employees or because there is some contractually mandated money purchase plan contributions, I can’t find a reason why employers would keep them, especially if they sponsored both a money purchase and a profit sharing plan. Perhaps some plan sponsors have multiple plans to benefit different groups of employees (many law firms do that), but there is no reason why a money purchase plan shouldn’t be converted into a profit sharing plan.

I came across one plan sponsor with a money purchase, profit sharing, and 401(k) plan, all benefiting the same group of employees.  What was really apparent to me is that they had a third party administrator(TPA) who thought it was more economical for the TPA for the plan sponsor to have 3 plans, instead of just one.

So I would advise plan sponsors to look at money purchase plans that they may still have, as well as financial advisors to look at prospective clients that have. Perhaps there is a legitimate reason to still have a money purchase plan, but perhaps not.

For my first year of law school, I had a renowned criminal law professor. He had a penchant for ties and an odd love for Melrose Place (I was a Dallas guy myself). For his final law exam, the fact pattern for the final exam was based on Melrose Place. I thought I did particularly well and I think I got a B+ (for some reasons, our law school didn’t have minus grades).  I jokingly said that there was no rhyme or reason how he graded his exams that he just threw the exam down the stairs and he would assign a grade based on the step it hit.

When it came to working for a particular third party administrator (TPA), I remember we had a fee for clients terminating our services that we never disclosed nor was ever there a set fee. Our conversion guru would simply go down to our Chief Operating Officer and get a de-conversion fee quote that could be $1,500, $2,500, or $5,000 or anything he felt like. He could quote it based on plan size, whether he liked the advisor or not, or because his stock portfolio wasn’t doing well that day.

There is something to be said about plan providers charging direct fees that the plan sponsor and their advisor could understand and gauge. Even with fee disclosure regulations eventually being implemented one of these days, I believe that some providers will still have fees that plan sponsors will have a tough time understanding what the fees actually are.

I was busy drafting a new service agreement for a West Coast TPA so that they could comply with the fee disclosure regulations (cheap plug). The agreement was easier to draft because their fees were rather straightforward. They had a base fee, a per participant head charge, and an asset based fee.

I was reading a sample fee disclosure agreement for a TPA that one of the insurance company providers have been sending out. This sample was put out by some pretty reputable ERISA attorneys and to tell you the truth, reading the agreement gave me a headache. The agreement, unlike most agreements drafted by ERISA attorneys was written in English. What gave me a headache was the different reimbursements that the TPA may be getting from this insurance company. Special programs, special allowances, and special sauce. It’s sort of like Dean Wormer’s “double secret probation” in Animal House. It’s short on details because the TPA has no idea what they will get in these special programs, but scout’s honor, they will use 100% of these special payments as an offset to the fees charged.

I am a very direct person (which works well with clients, financial advisors, and TPAs I work with; managing partners of law firms, not so much), so I like knowing how much in fees that my client might be paying when they sign an agreement with a TPA. I know eventually that a plan sponsor will knopw how much a TPA working with this insurance company will charge, but I think clients should get direct fee quotes.

I remember when the Enron debacle happened that I never would have invested in Enron because I could not state what Enron did for business in one sentence. The same with TPA fees in their agreements, I would be wary recommending a TPA where I couldn’t directly state what their fees would be. But that’s just me.