The Tibble v. Edison International case brings some interesting issues to light.
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In this column last month, I wrote about the case of Tibble v. Edison International, the first 401(k) excessive investment fee case to go to trial that resulted in a judgment. I thought that it might be of interest to expand on that discussion of this case since it has generated so much commentary.
Revenue-Sharing Isn't Necessarily Good for Plan Participants
Some of this commentary has centered on the notion that Edison, the plan sponsor, had the "Duty to Ask" about the availability of institutional, lower priced mutual fund investment options for the Edison 401(k) plan. I posed the question last month why Hewitt Financial Services, one of the largest and most prestigious investment consultants in the land and an investment advisor to Edison, would have ever let Edison continue to offer retail, higher priced mutual funds in a multi-billion dollar 401(k) plan? I suggested that before imposing any Duty to Ask on Edison, it might be more appropriate to first impose on Hewitt the "Duty to Tell" Edison that burdening plan participants (and their beneficiaries) with such higher costs was entirely unnecessary.
In earning its fees, what other "investment advice" could Hewitt offer Edison that would be of more importance to participants? Surely it couldn't be noodling with the Edison staff over the (past) performance of the plan's investment options. While the return on investment options is important, it's also an entirely random variable over which no one has any control. It's much more beneficial to plan participants for a plan sponsor (and its advisors) to work to manage the risk and reduce the costs of a retirement plan's investment options--both of which enhance return and therefore leave more money in the pockets of plan participants.
Doing away with revenue-sharing in a retirement plan is one good way to reduce the cost of the plan's investment options. For the sake of simplicity to illustrate a concept, suppose a plan has just one mutual fund investment option. It has an annual expense ratio of 1.25% (or 125 basis points), and included in that number is 0.50% (or 50 basis points) of revenue sharing. Now suppose that the same mutual fund was available--without revenue-sharing--with an annual expense ratio of 0.75% (75 basis points). The plan's record-keeper is now out 50 basis points of revenue-sharing fees but since this is America it cannot work for free so it must be paid something.
One possible alternative is to directly bill the plan sponsor with an invoice for record-keeping services of 50 basis points. Another possible alternative is for the advisor to suggest to the sponsor that the record-keeping fee of 50 basis points be wrapped into the expense ratio of the fund and be fully disclosed to the plan participants. But if the advisor is truly worth its salt, it will advise the sponsor to shop the market for a record-keeper that will work for a fully disclosed fee that is tied directly to fully disclosed services performed. And the sponsor will probably find that it will be able to get a record-keeper to work for less--say, 25 basis points--than for more--50 basis points.
And that's why revenue-sharing isn't good for plan participants: when it's present, the expense ratio of a plan's fund investment option is often kept artificially high because there's no breakout of the record-keeper's costs plus its profit. But when a fund with no revenue-sharing replaces a revenue-sharing laden fund, something remarkable happens: the true cost of revenue-sharing for plan participants is isolated and exposed to the sunlight. When the cost of revenue-sharing--including the record-keeper's "excessive" profit--is unlocked from a fund's expense ratio, record-keeping costs are driven down. This is due primarily to the profit portion of the record-keeper's costs going from "excessive" to "reasonable" which is a result of market competition. That result is much better than a plan sponsor and its advisor guessing about the true cost of record-keeping and other services. It's also much better than having a court attempting to guess after the fact a plan sponsor's motives concerning revenue-sharing.
Revenue-sharing, of course, is perfectly legal--even when it's not disclosed. At present, plan service providers are under no requirement to disclose costs to plan sponsors even though, under section 404(a) of the Employee Retirement Income Security Act of 1974 (ERISA), sponsors have the fiduciary duty to know what those costs are in order to determine whether or not they're "reasonable" in relation to the services for which they're expended. (This is the great "disconnect" in the ERISA statutory scheme that I've written about in previous columns.) But even when 408(b)(2) is fully implemented, guess what: sponsor will still have the duty to determine whether or not costs are reasonable in relation to services. So the game remains the same.