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Will 401(k)s Abandon Revenue Sharing?

A recent ruling by a U.S. District Court may accelerate moves away from the practice of revenue sharing within 401(k) plans. This will make it easier for participants to figure out how much they are paying for their plan—and to whom.

“This could be a landmark case,” says Lori Lucas, leader of consulting firm Callan Associates Inc.’s defined-contribution practice. “It definitely has revenue sharing in the cross hairs.”

Revenue sharing involves using a portion of the investment-related fees participants pay to cover the costs of a 401(k) plan’s administrative expenses.

Why should participants care about revenue sharing? For one thing, you may be able to avoid paying for administrative costs entirely if you stick to low-cost index funds, which pay little to no revenue sharing. Moreover, some fear that revenue sharing can create conflicts-of-interest. After all, plan sponsors and administrators may have an incentive to pick funds that pay more in revenue sharing, instead of those that are the best investments.

Issued in late March by U.S. District Court for the Western District of Missouri, the ruling is the latest in a string of cases involving 401(k) fees. It stands out, in part, because it was decided in favor of 401(k) investors, says Ms. Lucas.

In Tussey vs. ABB, Inc., U.S. District Judge Nanette K. Laughrey ruled that ABB, Inc., a manufacturer of power plant equipment, violated its fiduciary duties to its 401(k) plan when it agreed to pay Fidelity, the plan’s recordkeeper, “an amount that exceeded market costs” … “in order to subsidize the corporate services provided to ABB by Fidelity,” for items including payroll administration. In other words, the court found that ABB’s 401(k) plan participants were effectively subsiding payroll and other services the company purchased from Fidelity.

The court also took ABB to task for replacing the Vanguard Wellington Fund with the more expensive Fidelity Freedom funds in its 401(k) lineup. The court said ABB had done so in order to generate more in revenue sharing and to save the plan from having to defray such expenses itself.

The court also said ABB violated its fiduciary duties when it “failed to monitor recordkeeping costs” and negotiate rebates for the plan from Fidelity and other investment companies. It found fault with ABB for selecting “more expensive share classes” for various investments in the plan—again, allegedly to boost revenue sharing payments to Fidelity and keep the plan’s outlay for administrative expenses low.

The court ruled that ABB must compensate its 401(k) plan for losses related to these decisions, to the tune of $37 million.

The ruling, says Ms. Lucas, may cause employers to shy away from using revenue sharing arrangements to cover 401(k) administrative costs. Instead, 401(k) plans may gravitate towards charging participants separate and fully disclosed fees to cover investments and administrative services.

The ruling comes just before a July 1 deadline for mutual-fund firms and other 401(k) administrators to disclose to employers details about the fees they are charging to run 401(k) plans. Under the new rules, 401(k) administrators must then disclose details of plan fees to the employees eligible for these plans. When revenue sharing occurs, the disclosures must say so.


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About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.