The Rosenbaum Law Firm P.C. Blog

When I was working for that third party administration firm (TPA) that I always mention, I remember being asked by our conversion specialist to review a plan amendment being drafted by an outside ERISA attorney. It took quite a bit of time to determine what this ERISA attorney was trying to do with the matching provision amendment was trying to do. Rather than draft the amendment in simple language that a plan sponsor, the TPA, and their auditor could understand, the ERISA attorney took what could have been a simple amendment and turned it into the second coming of the Magna Carta. Instead of using simple language, he was using that mid 1970’s language that I call ERISAese. I told the conversion specialist that while the amendment was legal, “good luck in administering it correctly.”

When it comes to retirement plans, I believe less is more and I always say: “Keep it simple, stupid.” I am not trying to say retirement professionals are stupid, I’m just using the term to describe that retirement plans are difficult enough without trying to cloud with more legalese language that no one administering or reviewing the plan can understand. I was taught in law school to write in simple English if possible and my 12 years in the business is that not only should keep it simple if you can, but less is more.

The best TPAs, financial advisors, and ERISA attorneys are those that can take these difficult concepts in retirement plans and explain it in English. The best actuaries are those that almost any English speaking adult could understand, albeit that actuarial equivalencies and mortality tables are a language their own. As professionals in the retirement plan business, we don’t need to confuse the clients to justify our fees. Our professionalism and attention to detail in how we help administer retirement plans is enough. Retirement plan clients depend on us to get them through the difficult process of administering a retirement plan, so operating a belief to keep things as simple as possible makes their lives easier.

The same can be said about retirement plan financial advisors. Why offer 28 mutual funds in a fund lineup, when about a dozen will suffice. Large fund lineups on participant directed 401(k) plan depress participant deferral rates because participants become confused when the Plan has 5 different large cap funds and 6 different bond funds.

The latest issue of my newsletter, Retirement Plan Advisors Advantage can be found here.

While my career was shaped by working at a third party administration (TPA) firm that was less reputable when it came to actual plan administration and fee disclosure, I have been fortunate enough to work with several TPA firms since.

I work with several TPAs because every TPA has its own niche, expertise, and pricing that may not be the complete fit for every single client out there. As stated before, I stick to non-producing TPAs because I want their focus on plan administration. As noted before, I shun payroll companies because their compliance end isn’t very good.

Having worked for TPAs for 9 years, it’s a thankless job. It’s difficult, highly technical, and very little margins. I worked for a non-producing TPA years ago and our business was sold off to Ascensus because we weren’t making any money. People complain when things go wrong, but there are very few instances where you get compliments for a job well done.

Since I left the TPA world in 2007, I have to say that my overall experience with my client’s TPAs has been wonderful.  Any issue that may come up from time to time is easily rectified and the full fee disclosure that these good TPAs provide is a breath of fresh air from what I was exposed to.

I don’t want anyone to suggest that all my views about TPAs are only negative. My negative experience working for one is actually a positive experience because I can pick the good TPAs from the bad ones.

In the coming years, I hope to meet more TPAs out there because good TPAs are like baseball cards. You just want to collect them.

For further details on picking out the good TPAs, check out my article here.

As any of you are aware, the bulk of my career was spent working as an ERISA attorney for a couple of third party administration (TPA) firms including one that has truly inspired my work since I left the TPA world.  

Most of my criticism of the 401(k) industry is a result of the horrors I saw working there and the horrors I found about after I left. They were a producing TPA that didn’t fully disclose all their fees and I left in 2007 because I thought the future was full fee disclosure and the people that ran the company would never change with the times. Like crack, they became addicted to a very potent drug called revenue sharing.

This TPA had been making the news for all the wrong reasons. Years after I left, the Department of Labor started to investigate them for a nefarious relationship between the TPA and the auditing firm they referred work to, for the plans that required independent audits.  It was discovered that the two men who had owned the TPA and managed it after selling it to Focus Financial Partners were the trustees of the auditing firm’s 401(k) plan. It was also discovered that the staff accountants from the auditing firm were on the TPA’s payroll. Which of course, begs the question as to who the participants were in the auditing firm’s 401(k) plan?

Why would a TPA go through the whole trouble of starting an auditing firm to produce audits that were not independent? Perhaps to hide poor administration or hidden fees. This TPA never disclosed revenue sharing payments and their parent company insisted that they do so. So in 2008, they invented a fee that never existed before to justify their act of pocketing revenue sharing.

Needless to say, the TPA has been hemorrhaging clients since the story broke and the two men who ran the company were put out to pasture. It was just announced that the TPA was merging with a fellow TPA from the Focus Family, in order to bury their name.

I am glad they buried the name because that name in the 401(k) industry stood for hidden fees, poor administration, and apparently, fraudulent audit reports.  I am also glad that 70+ employees there will still be gainfully employed because they should no longer suffer for the apparent illegal acts of two men.

Payola, is the illegal practice of payment by record companies for the broadcast of recordings on music radio, in which the song is presented as being part of the normal day’s broadcast.

A kickback is a return of a part of a sum received often because of confidential agreement or coercion.

In the 401(k) industry, revenue sharing is a compensation practice in which money is paid to plan providers out of 401(k) investments by the managers of these investments. Revenue sharing may also include 12b1 fees and sub t/a fees. Many fund companies pay revenue sharing fees in a variety of amounts and many mutual fund companies don’t pay them. Many third party administration (TPA) firms and plan advisors herald the use of revenue sharing producing funds because these payments are supposed to be used to offset administrative expenses, which are usually borne by the plan participants.

Prior to the implementation of the fee disclosure regulations in July 2011, it is still possible that TPAs and plan advisors may not inform plan sponsors in the amount of the revenue sharing amounts received and what they are used for. I used to work for a TPA that actually pocketed the revenue sharing fees without disclosure and then invented a fee to justify the pocketing of those fees.

So if you look at the definition of payola and kickback, are revenue sharing payments that much different? Revenue sharing payments are an incentive for TPAs and plan advisors to steer 401(k) money to the funds that pay them because they are used to offset administrative expenses. Since some fund families pay them and some don’t and some pay more than others, how is it not a kickback or like payola? The only reason I find is that the Department of Labor and Congress hasn’t found the practice to be illegal.

Friends that I have the industry say that I’m too hard on the revenue sharing practice and that I should keep in mind that this practice saves participants money because they typically are the ones who pay for the administration of their 401(k) plans. Without revenue sharing, my friends state that plan participants would lose more of their account balance to fees.

The problem with that argument is that there is a hidden cost with the selection of revenue sharing producing funds which negates their savings. The hidden cost is the actual selection of these revenue sharing producing funds. Since these funds pay revenue sharing to plan providers, they certainly have to be recouped in some fashion. Revenue sharing payments are not “manna from heaven”, they are probably reflected in the fund’s management expense ratio. Low cost mutual funds, index mutual funds, and exchange traded funds (ETFs) typically don’t pay revenue sharing because of the low fee and transparency of these investments. Add in the fact that more than 70% of mutual funds fail to meet the benchmarks that index funds and ETFs almost meet, and then you see where I’m going. Revenue sharing payments may actually induce TPAs, plan advisors, and plan sponsors to pick funds that are more expensive and underperforming to funds that don’t pay them. That would negate the benefits of these payments. So the hidden cost may be the lost opportunity to invest in a low fee fund that may produce a greater return that would more than compensate for the extra plan fees (since these funds pay no revenue sharing fees).

Here is another hidden cost, increased liability. A TPA I know states their fee and then states that their fee is lowered by the selection of “select” funds, as selected by the plan custodian. The selection of mutual funds for a participant directed ERISA §404(c) should be done in conjunction with the plan’s investment policy statement (IPS). Does an investment policy statement state that whether a mutual fund pays revenue sharing is a part of the criteria for its selection? I don’t recall seeing revenue sharing mentioned in an IPS. Is my legal theory that farfetched? Maybe, but probably would survive a motion for summary judgment.

My friends in the industry will state that my views will be made obsolete by the fee disclosure regulations because plan sponsors and eventually plan participants will know all the fees behind the administration of their plan and all revenue sharing payments received. I disagree, because I believe that plan participants and sponsors will only be concerned with the bottom line as to the net expense of plan administration. While they will know the revenue sharing payments, they will fail to understand the lost opportunities by using revenue sharing paying funds.

While I am not proposing that plan sponsors and advisors avoid revenue sharing paying funds, I want them to understand that many fund companies don’t pay these fees and using these funds may actually cost them more to use in the long run than if they stuck with an index fund or ETF.

Chutzpah is a Yiddish word for audacity or nerve.

To see how to use chutzpah in the 401(k) industry, consider the following: chutzpah is an employer providing a 401(k) plan as an employee benefit and having the employees pay for it.

With elections just around the corner, I could just see this negative ad.

“There are two ERISA attorneys named Ary Rosenbaum. One invests in exchange traded funds (ETFs) for his personal investing. The other one claims that ETFs will only be a niche player in the 401(k) plan business. Ary Rosenbaum, he thinks ETFs are good for him and not for your 401(k).”

ETFs are slowly getting more traction in the 401(k) business and I don’t think it’s a bad thing. I just don’t think that with the way the 401(k) industry is run that ETFs will ever get major play as a suitable 401(k) plan investment.

I liken the whole ETF vs. mutual fund debate in 401(k) plans as a format war. As you know, a format war is when there is a competition between mutually incompatible proprietary formats that compete for the same market. We saw a format war between Blu-ray and HD DVD for high definition DVD technology, but the most remembered format war is VHS vs. Betamax for video tape dominance.

As most people don’t remember, Betamax was actually the better technology. VHS won the format war because its originator, JVC licensed its technology to competitors which lowered the price for VHS video recorders (VCR) while Sony was the only purveyor of Betamax VCRs. The other major difference was that VHS offered two hour recordings on its tape while Betamax only offered one hour. The lesson of this format war is that many times, the inferior product will win.

The reasons that I believe that ETFs will only be a niche player because the 401(k) plan business is dominated by the mutual fund industry. The 401(k) daily trading platforms in the way it operates, strip many of the benefits of ETFs namely because it won’t let participants buy ETFs throughout the day (unless they have a self directed brokerage account) and since participants pay the bulk of 401(k) fees, it will add substantial fees to what is a financially transparent product. ETFs’ main strength is its low fees and fee transparency, these are drawbacks in an industry where fees are still hidden and mutual fund companies pay revenue sharing fees to third party administration firms that remind me of payola and kickbacks. Let us also not forget that many of the daily 401(k) trading platforms are dominated by mutual fund companies like Fidelity, Schwab, Nationwide, John Hancock, American Funds, and ING, companies who would lose out if ETFs became a more dominant form of 401(k) investment. Do you think these companies have any interest in lowering the fees for ETFs when they allow the trading of their mutual funds for free? I highly doubt it.

Do I think ETFs are a proper form of 401(k) investment? Absolutely. While I think more choice in 401(k) investments is better, the pessimist in me thinks that ETFs will still remain a niche player. Perhaps IShares will start its own daily trading platform for 401(k) plans which might be a game changer. Unless something as seismic as that takes place, I think mutual funds will still dominate this format war. Just remember, the best product doesn’t always win.

The IRS finally released their 2011 cost of living adjustment limits for retirement benefits, which can be found here. Except for an increase in the saver’s credit and Roth IRA phaseouts, there were no changes. The 402(g) limit for deferrals is still $16,500. Catch-up is still $5,500 and the 415 limit for defined contribution plans is $49,000.