In my experience, most 401(k) fiduciaries— like plan committees— have not focused on properly allocating the revenue sharing received by their plan’s recordkeeper. In fact, it is possible that many plan fiduciaries are not aware that their recordkeepers are receiving revenue sharing from the investments, while others may assume that the recordkeepers are handling the matter properly . . . and perhaps also assume that it is not an issue of concern for plan sponsors. Those are dangerous assumptions.

As background, recordkeepers receive revenue sharing (such as sub-transfer agency fees and administrative services fees) from most of the mutual funds used by 401(k) plans. In most cases, the recordkeeper collects those amounts and either takes them into account in setting its fees or, alternatively, directly offsets them, dollar for dollar, against a stated fee. In some cases, the recordkeeper deposits the revenue sharing into an expense recapture account in the 401(k) plan and then pays its fee—as approved by the plan sponsor—from that account. That is an example of full transparency.

However, this situation is even more complicated than that. That is because different mutual funds pay revenue sharing in different amounts. Assume, as an easy example, that a 401(k) plan had only two investments. The first investment is in an actively managed mutual fund (Fund A) that invests in equities and has an expense ratio of 1% per year (or 100 basis points). Assume the other investment is an S&P 500 Index Fund (Fund B) with an expense ratio of .20% per year (or 20 basis points). In this hypothetical, the first fund pays one quarter of a percent (or 25 basis points) per year in revenue sharing to support the operation of the 401(k) plan, while the second mutual fund does not pay revenue sharing—because its expenses are so low. Finally, assume that half of the participants are invested in Fund A and half in Fund B. In that case, the participants who invest in the first mutual fund are paying all, or substantially all, of the expenses for operating the plan, while the participants who invest in the second fund are not paying anything for the operation of the plan. Is it fair . . . or even legal . . . for half of the participants to be charged for operating the plan, while the other half are not? That’s the question.

Another common example would be when one of the investment options is a company stock fund, which pays little, if anything, for the operation of the 401(k) plan.

While 401(k) industry insiders have been concerned about this issue for several years, it is just now emerging as a legal issue for plan sponsors.

There are a number of considerations (which we will address in future articles), but the point of this article is that the allocation of revenue sharing is a fiduciary responsibility and that, therefore, plan sponsors and their committees must engage in a prudent process to determine the proper allocation. That process, and the resulting decision, should be documented.

Source: The Report to Plan Sponsor