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Will 401k Plan Sponsors Wonder: Doth the 12b-1 Industry Protest Too Much?

November 09
01:30 2010

The SEC 12b-1 comment period officially ended last Friday with a flurry of high profile letters from large industry associations. The overwhelming response from these groups: change hurts, keep the status quo.

717899_27521117_blood_hand_stock_xchng_royalty_free_300Oddly, the common thread among these disparate groups involves the use of 12b-1 fees in retirement plans. The Investment Company Institute claims “The current use of 12b-1 fees in the retirement plan context is clearly not the functional equivalent of a front-end sales charge.” The American Society of Pension Professionals & Actuaries (ASPPA) warns the SEC to “not undermine the success that servicing and administration arrangements have fostered for participant-directed retirement plans.” Additionally, both the Council of Independent Recordkeepers (CIKR) and the brokerage industry’s Spark Institute came out against the proposal. Again citing “non-distribution costs” in retirement plans, the Spark Institute asked the SEC to raise its proposed limit from 25 basis points to 75 basis points.

The clamor over how one squeezes the toothpaste of retirement plan fees might cause the typical 401k fiduciary to wonder if the industry might be protesting too much. For example, even the ICI’s own September 2010 report “The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2009” shows 73% of plan assets do not use 12b-1 plans and only 8% of the plan assets have 12b-1 fees in excess of the proposed 25 basis points. The ICI does not point to this fresh report in their SEC comment letter, but rather cites this quote from a year-and-a-half report it commissioned from Deloitte Consulting, “Defined Contribution/401k Fee Study” (Spring 2009): “While the median plan’s ‘all-in’ fee was 0.72% of assets, median fees among plans with less than $1 million in assets were 1.89% of plan assets and for plans with more than $500 million in assets, the median ‘all-in’ fee was less than 0.50%.” The ICI even referenced the following fact from the U. S. Department of Labor’s Employee Benefits Security Administration, Private Pension Plan Bulletin, Abstract of 2007 Form 5500 Annual Reports, (June, 2010): “it is important to remember that small plans represent the majority of 401k-type plans and more than 8 million people actively participate in these small plans.” While neither of the references cited in the ICI’s comment letter spoke specifically to 12b-1 fees, the more recent (and omitted) report did.

Ed Ferrigno, Vice-President (Washington) of the Profit Sharing/401k Council of America told Fiduciary News although the 12b-1 issue affects only a small amount of total assets, it remains unknown how many of the smaller plans – and how many total employees – might be affected by 12b-1 fees.

Mike Alfred, CEO and Co-Founder of BrightScope, a 401k plan rating company, is not surprised to hear industry groups are questioning the SEC’s proposal. “These groups are just trying to defend the underlying economics of their members’ businesses,” he says. Alfred also supports Ferrigno, and points out “large plan sponsors with any sophistication are completely out of this [12b-1] game already. They’re not interested in carrying unnecessary fiduciary risk.”

And fiduciary risk is really what it’s all about to the 401k plan sponsor and fiduciary. Blaine F. Aikin, CEO of Fiduciary360, offer three significant concerns all plan sponsors and fiduciaries must mull over if involved in a potential 12b-1 fee situation. “With respect to the receipt of 12b-1 fees by a service provider to an ERISA plan, there are a number of important considerations. First, if the service provider is serving in a fiduciary capacity, the fiduciary (under ERISA Section 406(a)(1)) must not engage in a transaction that ‘constitutes a direct or indirect…furnishing of goods, services, or facilities between the plan and a party in interest, such as an investment advisor; [or] transfer to, or use by or for the benefit of, a party in interest or any assets of the plan.’  Thus, a fiduciary must exercise extreme caution to avoid a prohibited transaction if they receive 12b-1 fees. The Frost Letter provides an example of how this can be done as it addressed a situation where the fees were used entirely to offset expenses that would have otherwise been incurred by the plan and no extra compensation flowed to the fiduciary.”

“Second,” says Aikin, “plan sponsors have a duty to understand (1) whether service providers are receiving compensation from such sources as 12(b)(1) fees, (2) the amount of such compensation, and (3) ensure that the total compensation paid to each of the service providers is fair and reasonable for the services provided.”

“Finally, non-fiduciary service providers are generally permitted to have conflicts of interest, often without proactive disclosure. This places a special burden on plan sponsors to be especially vigilant in investigating and evaluating fees paid to non-fiduciaries in order to meet the duty described in the second consideration above.”

Readers might wish to reference the Prudent Practices for Investment Stewards and Prudent Practices for Investment Advisors handbooks published by Fiduciary360 (fi360), paying particular attention to Practice 4.5.

Although a few groups like fi360 did submit a comment letter in support of the SEC’s proposal, Alfred expresses concern about the general lack of groups or organizations supporting investors that might counter the service providers. “There are a handful of organizations you would expect to do more in this area. In general, investors are not well represented in Washington DC. There are, however, a number of investor advocates working in both the Education & Labor committee in the House and the Aging Committee in the Senate,” he said.

The question remains (and in keeping with our Shakespearean motif), is the 401k defense of 12b-1 fees much ado about nothing? “It probably has been 8 years since I came across a plan with 12b-1 funds in it,” said Terrance Power, President of American Pension Services of Clearwater, Florida. His firm manages $350 million in qualified (50-1000 life) plan funds, including multiple-employer plans. Power’s firm bills directly and he sees many TPA firms doing the same. He acknowledges 12b-1 fees might be an issue for very small plans.

Ferrigno says, “If the rule goes through, it’s clear the fee collection methodologies for some plans will have to change. The question is ‘What will the impact be?’” Roger Wohlner, a financial advisor with Asset Strategy Consultants in Arlington Heights, Illinois echoes this. “At the end of the day, it is the overall fund/plan expenses that matter most. I hope that if the 12b-1 fees are eliminated that this doesn’t lead to some sort of solution that is worse and less transparent to sponsors, participants, and consultants.”

Still, other regulatory actions may force 12b-1 fees – and any similar alternative – out into the open. The DOL is now requiring per account expense reporting. Both the DOL and the SEC are in the process of redefining “fiduciary.” It’s not clear if the Frost Opinion will stand in light of the DOL’s proposed new definition of fiduciary. Fiduciary News placed a call with the DOL for comments on this matter but the department did not respond prior to the deadline.

One thing is clear – many providers are able to serve the 401k market with direct billed asset based fees. Whether fees are direct billed or via 12b-1, they are still asset based fees. Some feel portions of the 401k service industry want to retain 12b-1 fees because such fees make it easier for those providers to hide their compensation. These people feel daylighting such fees might actually drive 401k expenses lower by exposing a fiduciary risk some 401k plan sponsors have, to date, remained unaware of.

Alfred bluntly sums up this feeling when he says, “It just takes time for the rest of the marketplace to catch up.”

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

1 Comment

  1. Stephen Winks
    Stephen Winks November 09, 19:22

    The consumer has no lobby like ASPPA/CIKR/SPARK and is relying on the SEC to protect their best interests. The question is does the SEC know any better? It is telling that 73% of plans do not avail themselves to 12(b)1 fees, only 8% of 12(b)1 plans have fees in excess of 25 bps and there is a massive conflict of interest in advisers who render advise accepting 12(b)1 compensation which precludes the fiduciary standing of the adviser–all points conveniently left out of industry comment letters. The thought that the industry would seek fees of 75 bps is obscene. Hopefully the SEC can see through these self serving and misleading industry comment letters that clearly are contrary to the best interests of the investing public.


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