By: Brant Grifﬁn – August 22, 2013
Revenue Sharing Revisited
The last several years have witnessed numerous industry developments relating to the revenue derived from qualified plan investments. Against the backdrop of 2012’s DOL fee-disclosure regulations, revenue sharing and its affect on the way plan fees are paid, has received its share of national media attention, mostly negative.
As background, revenue sharing is the portion of a plan investment’s expense that is available to offset plan fees. These payments come in the form of 12b-1 arrangements, shareholder and administration service fees, or similar credits. This compensation is intended to offset the plan provider’s costs of services such as plan administration, statement delivery and staffing functions.
Plan payments are often directed into a real or virtual account frequently referred to as an “ERISA Account” or “ERISA Budget Account.” Specific provider agreements vary, but typically the sponsor will direct the qualified plan expenses of consultants, attorneys or other service providers to be paid from this source. Any remaining revenue in the account can be allocated to the plan’s participants.
DOL Advisory Opinion – Revenue Sharing as a Plan Asset
In July 2013, the DOL delivered an Advisory Opinion in reference to a plan administered by the Principal Life Insurance Company (Principal). The letter described Principal’s practice of capturing investment revenue sharing payments and establishing an ERISA Budget Account for its plan clients.
The Advisory Opinion concluded that Principal’s receipt of plan investment payments in a non-plan account, and often maintaining a bookkeeping record of the payments, did not warrant the treatment of the revenue as a plan asset for purposes of ERISA. However, the opinion noted that any revenue payments that were eventually paid into the plan (such as remaining revenue after plan fees are paid that is directed to participants) would then become plan assets.
The identification of “plan assets” is a critical distinction as it activates ERISA rules relating to trust requirements and prohibited transaction regulations as well as the identification of plan fiduciaries. The latter mandating an elevated code of conduct.
Recent Case Law – Tibble v. Edison
The Court of Appeals recently ruled that fiduciaries must choose investment share classes that provide the best value for their plans. In the case of Tibble v. Edison, the court found that Edison’s plan fiduciaries acted imprudently by choosing more expensive retail share classes of the plan’s mutual funds instead of cheaper institutional share classes offered for those same investments. The court ruled that fiduciaries must factor all the available share classes into their decision-making process.
The court’s decision focused on the reasonableness of investment expenses in light of the plan’s collective purchasing power. Thus, plan sponsors must ensure they make decisions based on the different share classes available their plan’s investments. Since mutual funds frequently have multiple share classes, fiduciaries must be diligent to ensure they understand that different share classes may be offered and evaluate which provide the best value for the plan and their participants given its plan’s size. In light of Tibble v. Edison, fiduciaries now have the increased responsibility of choosing share classes that provide the most value to plan participants.
As revenue payments from plan investments often vary from fund to fund, different investments can subsidize plan costs in varying amounts. When looked at in a different light, one participant that allocates his savings to investments that produce larger plan revenue payments will be subsidizing more plan costs than another participant who selects investments with lower revenue producing amounts (like some passively managed index funds).
Should one participant with an identical account balance as another participant, offset more plan costs solely because of how they allocate their savings among the plan investments? This may be problematic, especially if it is found that more non-highly compensated employees (HCEs) are invested in larger revenue producing investments. This could potentially be found to be an ERISA violation if the non-HCEs are shouldering a larger proportion of the plan’s costs. As case law surrounding this issue evolves, it is entirely possible that future court decisions may find this arrangement discriminatory and unreasonable.
The potential for inequality, stemming from Tibble v. Edison and other recent plan fee cases, have led some plan sponsors to change the way their plans are paid for. Some organizations are moving to a payment arrangement where
each plan participant would pay an identical amount by equalizing the plan’s investment revenue. Alternatively, some sponsors have evaluated an arrangement where participant accounts are charged directly for plan costs and the investments do not include revenue sharing at all.
Plan revenue sharing has received its share of attention over the years, and the DOL’s fee disclosure regulations have again highlighted this controversial plan arrangement. Due to the volume of litigation surrounding this issue, fiduciaries should be well versed in the recent developments surrounding revenue sharing and regularly review industry best practices in managing this plan feature. Despite the criticism, revenue sharing is an economic reality for most qualified plans, performing a critical role in how plans are paid for – and it’s not likely to go away any time soon.
Yale Professor Sends Accusatory Letter to Plan Sponsors
Yale Law School Professor Ian Ayres has sent a shocking letter to over 6,000 retirement plan sponsors implying that they have potentially violated their fiduciary duties by maintaining plans with above average costs. In the letter, the Professor threatens that his study will be published in spring 2014 and call out the plans identified as having high plan fees. Further, he states that his findings will be disseminated to the news media and popular social media outlets. The letter reminds plan sponsors that “fiduciary duties are the most stringent imposed by the law, and require administrators to act solely in the interest of the plan participants.”
Plan sponsors should be aware that the study’s findings may be inaccurate. There are a few important deficiencies in the claims made by Professor Ayres, including:
- The study uses data from 2009 that may no longer accurately represent what a plan pays and does not illustrate whether the sponsor is paying some or all of its plan fees.
- The study does not factor qualitative plan data including unique plan services provided to the plan. This is critical in the determining if the plan is paying a reasonable amount for the services provided.
- The study does not factor the complexity of the plan design and resulting costs.
The tone of the letters is shocking. The implicit accusation of fiduciary impropriety made by Professor Ayres raises obvious concerns among plan sponsors. Due to the recent DOL plan and participant fee disclosure regulations, many companies are hypersensitive to any suggestion that its plan may be inefficiently priced.
Nonetheless, companies that have received the letter (and truly all plan sponsors) are advised to address the issues raised within the letter even if they feel such claims are wrongly asserted. This event is an opportune time for fiduciaries to review this critical element of fiduciary oversight that mandates plan fees are reasonable in view of the services provided.