The new DOL conflict of interest rule is grabbing headlines but it should also result in the end of the practice of revenue sharing by defined contribution (DC) plan sponsors. Here’s why.
The DOL rule is focused on eliminating situations where fiduciaries, or parties that have some discretion, have the opportunity to put their interests ahead of their clients. The situation is acute when one investment will pay that fiduciary or broker more than another one even if the investment is suitable. So levelizing fees eliminates that conflict.
Revenue sharing includes the practice of money managers “sharing” a portion of the fee they receive from investors in their funds with third parties like the plan’s advisor and record keeper. It’s a way to have participants in the plan pay the costs rather than have the company write a check.
So what’s wrong with revenue sharing? Let me count the ways:
- Transparency – It makes it harder to determine who gets paid what with a spiders web of direct and indirect compensation. The DOL’s fee disclosure rules 408b2 and 404a5 promulgated in 2012 were meant to help but some providers have made their disclosures hard to understand.
- Conflicts – A money manager desperate for placement in a DC plan may be willing to pay the record keeper more than others putting the record keeper, advisor and even the plan sponsor in a difficult situation. Index funds, which pay little or no rev share, are gaining traction at the expense of active funds so these active managers losing market share are more likely to do what they can to get placement. Advisors that get level compensation are not affected but record keepers are put in a situation where they are tempted to put in a fund that pays them more rev sharing. And if you don’t believe me, just look at whether funds that pay more getter more placement.
- Fairness – A participant using index funds that pays no rev share gets a free ride at the expense of the participant in active funds that pay more to make up the deficit. Is that fair?
To allow mutual funds to adjust to the various needs of different clients, they have created different share classes ranging from A Shares to six classes of R (for retirement) shares as well as institutional shares that pay no or little rev share. This complicated system forces plan sponsors to constantly negotiate to make sure they are getting the right share class which has been the subject of many lawsuits. The fees paid under rev sharing are anything but level.
But the real reason to abolish rev sharing is that technology allows record keepers to eliminate the practice of rev sharing by, first, determining how much each participant should pay to run the plan and secondly, then charging each account according. Plans still have to determine whether the fees are reasonable for the services provided but at least the fee is clear and everyone pays a fair share eliminating potential conflicts, just like the DOL rule.
Learn how a plan sponsor attending a TPSU program benefited from eliminating rev sharing using institutional shares. And ask your record keeper and advisor if it makes sense for you.
