DOL fiduciary rule will nudge 401(k) advisers to zero-revenue-share fund lineups

Retirement plan advisers are likely to use 401(k) investment funds that unbundle revenue-sharing payments from their cost because of the new Department of Labor fiduciary rule.
The DOL rule exposes advisers receiving variable compensation, such as 12b-1 fees and commissions, to greater compliance requirements and litigation risk. Experts believe advisers will try to mitigate that risk by using funds that strip out such compensation.
“Fiduciary advisers are moving or thinking of moving to zero-revenue-sharing lineups as a direct result of the new conflict of interest … rules,” Marcia Wagner, principal at The Wagner Law Group, said.
In zero-revenue-share funds, participants only pay the investment management expense. Other fees, such as the adviser and record-keeping fee, would be billed as separate line items, paid in a hard-dollar or asset-based arrangement.
Plan advisers will have to comply with the Best Interest Contract Exemption (BICE) — a provision of the regulation imposing the additional hurdles — in order to receive variable compensation. However, compliance with the BICE isn’t required if an adviser’s 401(k) fees are level, which would preclude receipt of 12b-1 fees, Ms. Wagner said.
“The DOL rule is saying you have to have levelized compensation,” Sean Deviney, head of the retirement plan group at Provenance Wealth Advisors, said. “It means don’t take up-front money and don’t have different investments where you’re just collecting 12b-1 fees, because that doesn’t make you level. For an adviser to go to this model, it’s just kind of a no-brainer.”
Revenue sharing — which involves directing a portion of a mutual fund’s expense to pay for certain plan services — has been the traditional way to pay for plan services.
Nearly 52% of defined-contribution plans used revenue sharing to pay at least a portion of plan administrative expenses in 2015, according to the consulting firm Callan Associates. That trend is on the decline, though — 67% used revenue sharing in 2012.
At the same time, share classes of mutual funds stripping out revenue sharing payments, such as R6 shares, have been “growing like wildfire,” according to Chris Brown, founder and principal of Sway Research, an asset management distribution research shop.
For example, in 2015, 72% of assets held in the various “R” share classes were in those share classes that strip out a 12b-1 fee. By comparison, it was 56% in 2012.
Fee-disclosure regulation handed down by the Labor Department in 2012 and ongoing lawsuits targeting excessive 401(k) fees, which many times cite revenue-sharing payments for being too high, have contributed to this greater push toward fee transparency, advisers and other industry watchers say.
Some also consider it a best practice because it’s more equitable to participants. Participants investing in funds with higher revenue-sharing fees that are bundled in, effectively subsidize plan costs for others in lower-cost funds.
The DOL rule will likely accelerate the trend to unbundling revenue sharing.
“The DOL is going to promote advisers to do that, or do it faster,” Mr. Brown said of adopting zero-revenue-share funds in plan menus. Early results from an annual survey Mr. Brown is conducting of advisers specializing in retirement plans indicates more than half of advisers anticipate switching to such a model.
The trend will likely accelerate mainly among brokers rather than registered investment advisers, because many RIAs have already begun moving away from revenue sharing, according to Jania Stout, practice leader and co-founder of the Fiduciary Plan Advisors group within HighTower Advisors.
Of course, there are ways to achieve level compensation for an adviser without adopting a lineup of zero-revenue-share funds, but they could potentially prove more complicated.
“It’s just cleaner to go to zero revenue share and layer on that [advisory] fee, rather than try to levelize compensation with different revenue-sharing percentages in all the different funds,” Ms. Stout said.
In that scenario, an adviser would determine the amount of revenue necessary to pay for plan services, and match funds for the plan with the requisite revenue sharing expense (within the parameters established by an investment policy statement, of course).
Using a zero-revenue-share lineup could prove administratively simpler, according to Mr. Deviney. As plans get larger and capable of negotiating fee reductions for services, doing share-class conversions to achieve cost savings could be difficult, whereas plans with zero-revenue-sharing lineups wouldn’t have to do such conversions, he said.
Also, it often — although not always — works out that plans can achieve a lower net cost by using such mutual funds, Ms. Stout said.
However, advisers’ decisions don’t exist in a vacuum — the plan sponsor needs to be on board with the decision to switch to a zero-revenue-share investment lineup. And sometimes plan sponsors are loathe to move forward due to concern for participant backlash.
“Most of the time our clients did not take our recommendation the first time around,” Ms. Stout said. “There’s this fear if you start being more transparent participants will get more upset because they’ll see all the fees.”