The case for clean shares in retirement plans

They demystify how DC plans work, but resistance remains strong

Sep 1, 2018 @ 6:00 am

By Fred Barstein

When the topic of 401(k) and 403(b) revenue sharing comes up, advisers get very vocal about why we should be moving to institutional or clean shares. Along with greater transparency, clean shares demystify how defined-contribution plans work for plan sponsors and employees. They also eliminate many potential conflicts of interest.

I have never met a plan sponsor who has read and understood their 408(b)(2) disclosure forms. When revenue sharing is explained, the usual reaction is at best confusion and at worst suspicion the DC industry is trying to pull a fast one.

Though fund companies are creating more and more clean shares, many are resisting giving up revenue sharing altogether. Why? How did we get to a situation in which one party (fund companies) is paying the freight for another party (plan sponsors and participants) to a third party (record keepers) for services rendered? And why is this situation fraught with danger?

When 401(k) plans started in the 1980s, predominately at larger companies, participants paid investment management fees for separately managed accounts that did not include 12(b)(1) or sub-transfer agency fees. Plan sponsors paid the record keeper and the TPA directly, just as they did with their pension plan.

To attract smaller employers to 401(k) plans in the 1990s, Fidelity introduced retail mutual funds into the mix, shifting the record-keeping and administrative costs to participants through revenue sharing. Though the move seemed like a panacea that created hundreds of thousands of 401(k) plans that might not have been started otherwise, there were inherent problems.

First, clients had to use Fidelity funds. Second, most plan sponsors did not conduct proper due diligence to learn exactly how much employees were paying.

Insurance companies jumped in, offering a lineup of investments from many fund companies while charging a wrap fee to cover expenses, further obfuscating the process and leaving the door open for adviser fee abuse.

Capitalizing on the fiduciary movement, in the mid-90s 401(k) specialists used fee disclosure and cost savings to attract clients.​

Responding to the demand for nonproprietary funds, mutual fund record keepers either exited the market to become pure defined-contribution investment-only providers, or they started charging outside investments revenue-sharing fees. If the costs to run a plan are embedded in expense ratios, it is only fair that outside fund companies should remit a portion of their 12(b)(1) or sub-TA fees to the record keeper.

Not only did DCIOs not resist paying revenue sharing to fund companies, many embraced it, willing to pay more to get better placement. That's why many fund companies are resisting the move to all clean shares. They would lose leverage by relying on the quality of their investments almost exclusively.

Vanguard is the only DCIO that does not pay revenue sharing because the demand for its investments is so strong.

In the retail 401(k) and 403(b) market, record keepers have the most power, especially with smaller plans served by broker-dealers and advisers. Because DCIOs have limited direct access to plan sponsors, they must rely on record keepers and advisers to represent them. Eliminating revenue sharing diminishes their leverage over their distribution network.

Though DCIOs complain about the growing demands for marketing support from providers and advisers, most would resist their elimination for the same reason they resist clean shares.

But the market is moving toward more fiduciary transparency even with the demise of the DOL's conflict-of-interest rule. Plan sponsors are starting to realize that allowing fund companies to serve as the paymaster on behalf of employers and their employees can create conflicts, even if plan sponsors are able to figure out the exact payments. And the argument by fund companies about share-class optimization further complicates what should be a simple solution.

Imagine if all parties knowingly paid each vendor for its services directly, and vendors were forced to compete solely on the value of their services.

Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University.

0
Comments

What do you think?

View comments

Upcoming event

Nov 19

Conference

New York Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Most watched

Events

Finding innovation in your firm

Adam Holt of AssetMap explains how advisers understand they need to grow, but great innovation may be lurking right under your nose.

Events

Finding your edge from Tony Robbins

Guru Tony Robbins has helped a lot of people, but armed with his psychology Financial Advisor Josh Nelson has helped his practice soar.

Latest news & opinion

Tony Robbins loses role with RIA amid charges of sexual misconduct

String of allegations costs the self-help guru his gig as chief of investor psychology at Creative Planning.

SEC sets June 5 date for vote on Regulation Best Interest

Commission adds new item to agenda: Interpretation of broker guidance that qualifies as advice

House passes SECURE retirement bill with massive bipartisan support

The measure allows small employers to band together to offer plans and raises the RMD age. Another provision eases use of annuities in 401(k)s, which critics say goes too far

10 IBDs with the most annuity revenue

Here are the independent broker-dealers that brought in the most annuity revenue last year.

DOL sets date to propose new fiduciary rule

The regulation, expected in December, likely will be contoured to the SEC's new advice standards.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print