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A Brave New World for 401k Plans Sponsors without Conflict-of-Interest Fees

A Brave New World for 401k Plans Sponsors without Conflict-of-Interest Fees
April 05
01:37 2016

Like many veteran financial professionals, Neil Maxwell, Founder and CEO of Maxwell Wealth Planning, Inc., located just outside of Denver Colorado, got his start selling products. He found it quite revealing. Maxwell says, “In my previous career in the business I got to learn about 12b-1 fees on an intimate level. I worked at Edward Jones for a short while where they had the lawsuits over ‘revenue sharing’. [Ed. Note: “Edward Jones Agrees to Settle Host of Charges,” Wall Street Journal, December 21, 2004). I also used to work at PwC as a part of their financial education practice.”

Although today he owns his own Registered Investment Adviser and gladly accepts being bound by his fiduciary duty to his clients, during the era part of his career Maxwell regularly sold products with 12b-1 fees. “The reason they were recommended at the time is because those were the funds that the companies that I worked for told us to sell (and we got compensated in one way or another for selling them that were above and beyond what other funds would pay us. Sometimes the extra compensation was in the forms of trips or bonuses.”

With the DOL poised to release its Conflict-of-Interest (a.k.a. “Fiduciary”) Rule and the SEC committed to targeting 12b-1 fees, it appears 12b-1/revenue sharing fees may soon be consigned to the dustbin of history. It’s not surprising, therefore, to see many advisers singing the praises of the true Fiduciary Duty, i.e., always acting in the best interests of the client. If the DOL stays true to its word and retirement savers are saved from conflict-of-interest fees, what will this brave new world look like? Robin Solomon, a Partner with Ivins, Phillips & Barker, a tax and benefits specialty law firm in Washington D.C., says, “Generally: The elimination of revenue sharing and 12b-1 fees would be a significant paradigm shift away from today’s bundled fee arrangements. Record-keepers would have to rethink how to market and sell their services. Plan sponsors and participants would have to adjust their expectations for a different fee model.”

In reality, the world may not change as much as one might think. Already, many advisers have spurned these conflict-of-interest fees. “We do not recommend funds that contain 12b-1 fees or revenue sharing payments,” says Paula Friedman, Managing Director, Employer Retirement Plans at McLean Asset Management Corporation in McLean, Virginia. “We believe in fee transparency and use low-cost investments that do not contain revenue sharing with our clients. Our firm is compensated through a fixed-dollar fee, asset-based fee or a combination of the two. Any fees paid by plan assets (participant accounts) are clearly shown as a line item on a participant’s statements. We also encourage the use of providers that charge based on the number of accounts instead of the size of plan assets. By separating provider compensation from the cost of the investments, we are able to offer our clients flexibility in how they want to pay plan fees. Some choose to pay fees directly at the company level and others choose to apply them to plan assets.”

For those who have participated in business models based on 12b-1 fees and revenue sharing are often the most adamant when it comes to eliminating them. Maxwell says “12b-1 fees and ‘revenue sharing’ are slimy,” says Maxwell. “It’s about time that the industry starts paying attention to these ‘gray areas’ that have plagued the business for so long. It’s like setting up the rules of the game to give the large broker dealers the advantage over the individual investor, which is the opposite of transparency. This is what happens when a culture values profitability above all else, which is why I now own my own company so that I can follow my own moral compass rather than that of a large sales organization. Make no mistake, if an ‘advisor’ is selling you funds that have these fees associated with them, then that ‘advisor’ is a sales person and is not looking out for your best interests ahead of their own. The scary part is that the sales representative may in fact not even know or understand the ramifications of their recommendations (yes, even the ones that make a lot of money with ‘successful’ practices).’

A Brave New World for 401k Plan Sponsors

It’s quick to conclude a world without conflict-of-interest fees represents a logical extension of the hoped-for ramifications of the 2012 401k Fee Disclosure Rule. “Under the new paradigm,” says Solomon, “fees would be more transparent. Plan sponsors would negotiate with record-keepers for a fixed fee per participant. Fixed fee arrangements tend to be less profitable for record-keepers than revenue sharing models (in which fees generally increase as the plan grows in size). As a result, record-keepers may try to raise other fees to compensate for this lost income.”

Indeed, one of the biggest complaints about the 2012 Fee Disclosure Rule deals with its lack of template and how “hidden” fees, while technically “disclosed,” remained hidden in a maze of small print and extremely long URLs. Without conflict-of-interest fees, there would no longer be anything to hide. Friedman says, “Plan sponsors would have an easier time assessing fee reasonableness if they could plainly see what each provider charges. By removing the option for 12b-1 and revenue sharing payments, there will be a reduced reliance on which investment options are selected for use by the plan, since pricing will not be based on anticipated revenue sharing payments. As more sponsors become informed and educated, provider fees will be more aligned with the services performed for the plan, instead of the size of plan assets. This is already happening with many of the smaller, independent providers we work with.”

Smarter plan sponsors aren’t waiting for the DOL to mandate the elimination of conflict-of-interest fees. Class action lawsuits have proven the potential fiduciary liability 12b-1 fees and revenue sharing hold. “I have seen a number of clients who have already evaluated whether revenue-sharing fees remain appropriate, and in a number of cases clients have decided to eliminate this category of fees,” says Benjamin L. Grosz, a benefits and tax attorney at Ivins, Phillips & Barker in Washington, D.C. “Some have raised concerns about the cross-subsidization issues that can arise when revenue sharing varies significantly across different plan investment funds. For these plan sponsors, the world has already changed.”

Those plan sponsors who discover they continue to have exposure to conflict-of-interest fees may need to research alternative providers of, at least, alternative compensation methods to existing providers. Grosz says, “For plan sponsors that currently offer funds with 12b-1/revenue sharing fees, the elimination of such fees or the replacement of such funds will result in the need to find alternate sources of payment for certain vendors (e.g., recordkeepers). As plan sponsors have generally already moved toward the best practice of recordkeeping contracts with headcount-based fees (as opposed to asset-based fees), the elimination of revenue-sharing will require plan sponsors to decide whether they will impose/increase periodic fee assessments against participant accounts to cover reasonable plan expenses, or if they would rather pay these costs themselves. Both approaches may be appropriate, with employee relations and other HR considerations tending to drive this decision. Additionally, these fee structure changes (and related unbundling of fees) may lead to greater fee transparency for plan sponsors and fiduciaries. To the extent any 401k plans currently have unreasonable compensation arrangements with vendors, this provides them with an opportunity to revise and adopt an appropriate fee arrangement, as well as greater impetus and alertness to do so.”

A Brave New World for 401k Plan Participants

One of the options Grosz mentions is the company absorbing any fees that had previously been paid through 12b-1 fees or revenue sharing. “Participants might be fortunate if their company decides to pay for some of these services directly instead of imposing/increasing a direct participant assessment,” he says. “In this case, participants will come out ahead financially.”

Removing these embedded fees will have an immediate impact on the investments of employees. “For most participants, the elimination of revenue sharing and 12b-1 fees would be good news,” says Solomon. Under a bundled fee arrangement, revenue sharing payments are taken directly from the fund’s investment return. These revenue sharing payments may be invisible to the participant, but that doesn’t mean they’re free. Under the new paradigm, record-keeping fees would be more transparent. Some participants would notice that record-keeping fees appear as a new line item on their quarterly benefit statements – but in most cases this fixed fee would be lower than the ‘invisible’ revenue sharing alternative.”

An additional benefit includes more explicit disclosure. In the end, this may help better educate plan participates as to the true nature of the service providers. Friedman says, “The current participant fee disclosures don’t provide the breakdown of provider compensation that is paid from investment balances. Instead, the disclosures focus on total investment costs, leading participants to believe that the fund managers are receiving all of the compensation. If participants became aware of how provider compensation was paid from their account balances, I believe that many would question what services they received in exchange for the fees. This is especially true for smaller companies where the owners have the majority of the plan assets and therefore absorb most of the plan fees. Heightened awareness would eventually trigger a review of the plan fees and potential provider changes.”

Still, it’s not wise to believe in a static analysis. Moves begat counter-moves. We’ll leave it to the refugee from the conflict-of-interest business model to issue a stern warning. “If a company is used to making a certain level of profits then the chances are that they will find another way to do it,” says Maxwell. Theoretically, individual participants should be paying less in fees as a result.”

Interested in learning more about important topics confronting 401k fiduciaries? Order Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada. His new book Hey! What’s My Number? –  How to Increase the Odds You Will Retire in Comfort is available from your favorite bookstore.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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