The term “revenue sharing” refers to revenue paid from a mutual fund to another company – typically a record-keeper, for certain administrative functions performed for the fund. The revenue is usually passed along, in part or in whole to a number of service providers. These amounts may or may not be disclosed under current rules.
Within the world of retirement plans which are governed by ERISA, allocating revenue sharing should be considered a fiduciary function and must be reviewed in the context of a fiduciary process.
For example, is the actual decision to use revenue sharing a fiduciary decision in of itself? And how is that decision being made in many cases today?
Should plan sponsors select investments that have revenue sharing in order to help pay for the cost of the plan? Or, should plan sponsors make it a policy to select only funds with no revenue sharing?
If funds with revenue sharing are selected, how are the funds selected and who monitors the revenue sharing?
If revenue sharing is used to pay for plan costs, and each fund has a different amount, then, some participants who select funds that have revenue sharing will actually be subsidizing the plan costs for others who select funds that don’t have revenue sharing, or that have less revenue sharing.
When Fiduciary Duties Cross Paths with Revenue Sharing
All of these scenarios dictate the need for a fiduciary process and decision making system by the plan sponsor.
Remember that the plan sponsor owes a duty of loyalty to the plan participants and so must discharge its duties under the exclusive purpose requirement. ERISA describes these duties as follows:
“A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and:
(A) for the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries;
and
(ii) defraying reasonable expenses of administering the plan.”6 [Emphasis added.]
Clearly, revenue sharing is a part of plan expenses. So, simply selecting a list of funds, all with random amounts of revenue sharing, without a prudent process to determine it the amounts are reasonable, and if other possible solutions exits, would seem to be a breach of the aforementioned requirements.
ERISA actually states how such duties should be exercised...“with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”
The DOL goes on to describe the steps for satisfying the prudent man rule as
A. to give appropriate consideration to facts and circumstances that it knows or should know are relevant to the particular investment
or investment course of action involved and then
B. to act accordingly, i.e., make a decision based on the information that the fiduciary has gathered and analyzed.
The prudent man rule also requires a duty to monitor, which in this context should mean that as fees, services and technology changes, the plan should review their impact and weigh accordingly.
And finally, prohibited transaction rules are important in this context. Without an exemption to the prohibited transaction rules, ERISA provides that plans can enter in to reasonable arrangements with service providers as long as no more than reasonable compensation is paid.
What have the Courts Said?
We have some guidance on how the courts might interpret issues regarding fiduciary decisions and processes regarding reasonable plan expenses. In Tibble v. Edison International, the court considered the process of selecting of investments by the plan and whether or not the plan could have selected lower cost investments. The court described the plan’s failure as follows:
Defendants have not offered any credible explanation for why the retail (Emphasis added: more expensive) share classes were selected instead of the institutional share (Emphasis added: lower cost) classes. In light of that the fact that the institutional share classes offered the exact same investment at a lower fee, a prudent fiduciary acting in a like capacity would have invested in the institutional share classes.
The case against Wal-Mart is still in play, but the same issue is at hand; why did the plan offer more expense retail funds (retail funds generally have high revenue revenue sharing) when it could have offered lower cost institutional shares (generally without revenue sharing).
DOL Guidance
The DOL has provided a 4 step guide on the allocation of revenue sharing;
Obviously, merely accepting a fund list from a vendor and accepting their disclosures about revenue sharing, is not nearly enough to fulfill these steps.
A 6 Step Practical Guide
Conclusion
The decision to use revenue sharing should be considered a fiduciary decision, and must not be taken lightly. If plan investments do include revenue sharing, a prudent process should be used to evaluate the revenue, monitor the revenue, adjust it as needed, and credit it, or account for it in a manner that weighs the needs of the participants, while eliminating conflicts.
William Kring, CFP, AIF, is chief investment officer and accredited investment fiduciary for 401k ProAdvisor, a full service retirement plan manager and registered investment advisor with the SEC. Kring and his team assist ERISA retirement plans in meeting their fiduciary responsibilities through fiduciary consulting services, monitoring, reporting services, and investment management. For comments or questions, email to This e-mail address is being protected from spambots. You need JavaScript enabled to view it