Though many advisors and some record keepers are moving away from revenue sharing, its use is still rampant in the defined contribution world. Just as we once moved away from advisor commissions to asset-based pricing to take on co-fiduciary status, it may be time to move away from revenue sharing for the sake of transparency.
When 401(k) and 403(b) plans started in the 1980s, they were managed by institutional consultants and providers using investments like separately managed accounts, which did not have revenue sharing with fees paid by the employer, just like they did with their pension plan. Besides, who would want a percentage of the assets of a 5,000-employee plan sponsor with no or limited assets?
All that changed in the 1990s when mutual fund providers like Fidelity offered investments with 12(b)(1) fees—not only could employers shift the cost to employees, but the record keeper also usually only offered proprietary assets. At the time, Fidelity went mostly direct, but other firms like MFS, Putnam and American Funds started distributing through advisors, followed by insurance providers using annuities.
Though the alphabet of mutual fund share classes was and is confusing, they were more transparent than the annuity wrapper, where the advisor could dial up their compensation for each plan. Advisors using A shares got a 1% bump every time they switched funds plus the normal ongoing 25 basis points, while others using C shares got 1% annually. The commissions that insurance providers paid were mind-blowing, causing some broker/dealers to consider limiting compensation.
Much of this began to change with the move to fiduciary status in the 2000s led by fi360 founder Don Trone and espoused by legendary ERISA attorney Fred Reich, who shocked the advisory world when he postulated that any advisor that recommends or even blesses an investment is a fiduciary. Which, in turn, meant that they could not be paid out of plan assets unless the fees were reasonable and the compensation was level.
Problem solved, right? What could be the trouble if the fiduciary advisor is paid a level and reasonable fee with no incentive to recommend or select one investment over another?
The issue was and remains transparency. Led by California Congressman George Miller in the 2000s, there was a move to more transparent pricing highlighted in 2008-09 during the Great Recession as 401(k) account balances dropped precipitously, with participants, plan sponsors and the media asking who was getting paid what and how, culminating in a famous 60 Minutes segment with then PSCA Executive Director David Wray.
Eventually, the DOL issued fee disclosure rules in 2012 with providers required to divulge fees to sponsors and to participants in forms 408(b)(2) and 404(a)(5), respectively. The problem is that most of these forms are difficult, if not impossible, to read and understand. The industry also moved from existing share classes to R shares, which has only extended the problem as few, if any, plan sponsors and almost no participants understand how they work.
It’s sad, if not laughable, when providers say that an R4 share may be more advantageous than a share class with less revenue sharing. The industry has created a labyrinth of share classes that plans and advisors must navigate.
Not to mention that share classes have led to many ERISA lawsuits, where plans did not use their leverage to get a cheaper share class or offered so many funds, like some universities, that they lost that leverage.
Participants in index funds pay less of the cost of plan administration and advice than others in active funds that might pay higher revenue sharing. No one thinks that’s fair.
When the archaic revenue sharing is explained in English, not by reading confusing and complicated 4018(b)(2) forms, plan sponsors get angry and wonder why, leading them to think their vendors are trying to hide something.
TPAs are ahead of the game as most are paid directly, not through revenue sharing, while advisor compensation is moving toward flat fee plus additional costs for selected services. A flat asset charge for all services may lead a plan sponsor to ask if they get a discount if they do not want or need everything.
Here’s an idea—move to zero revevenue share investments, whether a mutual fund or CIT, and have each provider, record keeper, advisor, investment manager and TPA disclose in plain language what they will charge for the services they provide? The employer then decides whether to pay directly or have participants pay fairly.
It’s time to move from outdated, opaque and complex revenue-sharing schemes to transparent and understandable pricing for all vendors, fiduciary or not, and to advisors acting as stewards, not rules based fiduciaries.
