This oversight in allowing for only partial disclosure will, as I mentioned in Part I, lead to the creation of even more investment share classes that will be used for the exclusive purpose of burying expenses into the already complex language of a fund prospectus. This result is best summed up by Quinn’s First Law: “Liberalism always generates the exact opposite of its stated intent”. (Syndicated Radio talk show host, Jim Quinn, WPGB, Pittsburgh, PA). My adaptation of the above would be to substitute “Liberalism” with “Government regulation”. To further explain, my illustration in Part I compared an arrangement where administrative costs were paid in full by non-disclosed revenue sharing, with another arrangement wherein investment expenses were substantially less, with a corresponding requirement to disclose all fees deducted from the account. My point was to illustrate that a typical investor will look at a full disclosure statement with scrutiny, even though the total cost may be less than that of an all-inclusive “expense ratio”.

Although this illustration was meant to show the difference in two separate approaches (revenue sharing vs. net investment expense plus add-on fees), the reality is that rarely would a participant be faced with the choice between the two. Generally, the employer sponsoring the plan makes the decision as to how the fees will be paid and all investments within the plan are similar in structure. It is this reality that led to the promulgation of regulations under §408(b)(2) which requires all service providers to a plan to disclose all fees to the employer sponsoring the plan, including revenue sharing payments. My comments thus far have been aimed at the participant disclosure regulations under §404a-5 and how these regulations will not accomplish their primary objective. The 408(b)(2) regulations, however, are much needed as every Plan Sponsor/fiduciary to a plan must know and understand the fees and expenses that are being paid by the plan and as equally important, to whom the expenses are paid. A recent article written by attorneys Fred Reish and Bruce Ashton of the law firm Drinker Biddle explain these regulations and the importance thereof, quit succinctly.

Riddle me this, if a service provider (mutual fund company, insurance co, etc.) can and must inform the employer of revenue sharing payments used for plan administration, then why can’t the same information be passed on to the participants?

Let’s look at another reason why many in the service provider space fight the revenue sharing disclosure issue. In most cases, the inequities of allocating revenue sharing at the participant level can be significant. In an open or semi-open architecture arrangement, it would be possible to have 2 investment options in the same plan, one of which pays revenue and the other which does not. In most cases, service providers “underwrite” the cost of services by estimating the total revenue sharing payments that will be received. Assuming the revenue is enough to pay the total administration cost, those investing in higher revenue generating investments would subsidize those in the lower cost, lower revenue generating investments. For example, if Investment A with a total expense of 1.05% allowed 0.50% revenue sharing, and fund B with an expense of 0.18% allowed 0% revenue sharing, investors in fund A would be subsidizing administrative costs for both participants.

The practical reality is that many providers either have a set menu of revenue producing alternatives or they estimate participation in the revenue generating funds to determine an adequate level of revenue sharing to cover administrative costs. Some require a certain level of proprietary investments, stable value or target date funds, knowing that the revenue will be generated. When a plan sponsor pushes back and demands further usage of low revenue funds, it causes the uncomfortable scenario of the provider “re-quoting” their fee.

In fairness, some providers have embraced this inequity by assessing an add-on fee to those funds that do not generate a sufficient amount of revenue. This methodology can be found with certain non-registered investments such as insurance company separate accounts, collective trusts and group annuities. The next step in the evolution of the open architecture daily valuation environment will be broad adoption of this practice.

In the final segment of this article, I will address some creative strategies to counter some negative consequences that may develop among an informed employee population.