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By Marcia S. Wagner, Managing Director, The Wagner Law Group

The recent case of Tussey v. ABB, Inc. provided the plan sponsor a costly lesson in the fiduciary obligations that apply to negotiating recordkeeping costs and its implications for selecting the investment funds for a 401(k) plan. Financial advisors should consider obtaining explicit direction from the plan sponsor on the extent to which revenue sharing payments are to cover plan administrative costs.

Effect of revenue sharing on fiduciary procedure

The central issue in the ABB case was the compensation of the plan's recordkeeper under a revenue sharing arrangement, a common industry practice. The Court held that the fiduciary process required by the DOL includes (i) calculating the amount earned by the recordkeeper from revenue sharing, (ii) knowing the market for comparable services (i.e., benchmarking), and (iii) evaluating the recordkeeper's compensation in light of service quality. Unfortunately, the ABB defendant did none of these things.

The Court emphasized that while revenue sharing is not disallowed per se, neither is it automatically permitted under the relevant facts and circumstances. The plan sponsor's failure to monitor the recordkeeper's revenue sharing payments made it impossible to satisfy its fiduciary duty. Monitoring only an investment's expense ratio is inadequate for this purpose, because it does not show the actual revenue flowing to a service provider.

Hard Dollar Fees vs. Revenue Sharing

The recordkeeper in the ABB case had initially been paid with a per-participant hard dollar fee, but its compensation eventually shifted to a revenue sharing arrangement. ABB argued that this shift resulted in a more progressive allocation of expenses, because participants with larger accounts bore more of the costs. However, there was no evidence that these participants actually selected investments with higher revenue sharing. The Court found there was a failure to evaluate the implications of how recordkeeping fees were ultimately borne by each participant.

Influence of Revenue Sharing on Investment Selection

The recordkeeper in ABB had, in fact, demanded a fee arrangement that would be revenue neutral. Since ABB had to pay hard dollar fees to achieve this neutrality, it had an interest in minimizing its own costs. This conflict of interest resulted in ABB's selection of investment options with higher revenue sharing payments for the recordkeeper. For example, ABB was faulted for replacing a low-fee index fund with a target date fund that paid higher revenue sharing without con­ducting a proper analysis of the two investments. The Court held that a failure to conduct any meaningful analysis of the funds' cost structure violated the sponsor's ERISA fiduciary duty.

Lessons Learned from ABB Case

  • Advisors should ensure that their plan clients understand that record­keeping expenses, including hard dollar fees and revenue sharing, must be monitored. ABB failed in this regard, because it never calculated the revenue sharing received by the recordkeeper.
  • Advisors can help plan clients analyze 408(b)(2) compensation disclosures and remind them that reviewing fund expense ratios alone will not be adequate.
  • Advisors should ensure that the provisions of governing plan documents (e.g., IPS) are followed. In ABB, the plan sponsor ignored explicit IPS requirements to seek rebates from revenue sharing payments to offset plan administration costs.
  • Advisors should counsel their plan clients not to be swayed by low costs alone, as a recordkeeper's service quality and qualifications must also be considered. The DOL does not automatically equate the lowest fee with a prudent decision, or the highest fee with an imprudent decision.
  • Where the plan is big enough to possess economic leverage, advisors should encourage plan clients to seek rebates to the extent the recordkeeper receives revenue sharing through the plan's funds or any other form of asset-based compensation.

As needed, they can help them submit a request for proposal (RFP) to potential providers for a change. The key word is "reasonableness"—plan sponsors should never hire a provider simply because it is the cheapest, and fees should always be evaluated in light of the services provided. If a plan sponsor does not understand or appreciate its responsibilities, advisors should remind them of their fiduciary duty to protect the plan from unreasonable fees. 408(b)(2) will be turning up the heat on plan sponsors, and smart advisors will help protect their clients by creating a paper trail that shows the plan sponsor reviewed the fees, benchmarked the plan as needed, and made any changes necessary to avoid potential litigation.

Improve Financial Literacy of Participants

The Participant Disclosure Rules impose a new fiduciary duty on plan sponsors, requiring the delivery of a wealth of information to participants. The required disclosures must provide a side-by-side comparison of the plan's investment options, including performance and benchmark information, as well as detailed information concerning the plan's fees and expenses. But perhaps the most difficult obligation imposed on the plan sponsor is the fiduciary requirement that these disclosures be written in a manner calculated to be understood by the average plan participant. Unfortunately, if the average participant in your client's plan "is financially illiterate, there is a good chance that these disclosures will not be understood.

Adding value

To help plan sponsors avoid a fiduciary violation of the Participant Disclosure Rules, advisors should:

  • Warn their clients of this average plan participant standard.
  • Talk with clients about increasing (or beginning) participant education meetings to ensure a plan's participants are financially literate. By delivering even a minimal level of financial education, plan sponsors will find it much easier to say that their disclosures are now calculated to be understood by the average plan participant.

Be Proactive Now

Plan sponsors will need help navigating the DOL's required fee disclosures and what it means for them and their plan participants. Instead of passively waiting to see how clients will react, smart retirement plan advisors should reach out to clients now to begin the discussions around benchmarking plans or setting up participant education meetings. By highlighting the fact that they can help them deal with the serious consequences of the 408(b)(2) Regulations and the Participant Disclosure Rules, advisors can show their ultimate value.

The Wagner Law Group prepared this article. BlackRock does not represent that the information is accurate and complete, and it should not be relied upon as such. The article is intended for general informational purposes only, and it does not constitute legal, tax or investment advice on the part of The Wagner Law Group or BlackRock. BlackRock is not affiliated with The Wagner Law Group. Prospective changes in applicable law or regulatory guidance under ERISA may affect the information presented in the article, and legal counsel should be consulted concerning the impact of any such changes.

The information contained in this material is derived from third-party sources deemed reliable, but BlackRock does not guarantee the completeness or accuracy of the information. The material is provided as an educational tool and should not be considered investment advice. BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. BlackRock is not engaged in rendering any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.

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