Revenue sharing related to retirement plan investments plays a central role in the financing of plan administrative services and sales compensation in the retirement industry. The bulk of this revenue sharing arises from mutual fund payments of 12b-1 fees and other service fees (such as sub-transfer agent fees) either paid directly by the mutual fund company to the plan and its service providers, or indirectly through vehicles like separate accounts in group annuity contracts.
All sorts of revenue sharing issues arise well beyond the disclosure of these arrangements which has been required by the new 408(b)(2) regulations. For example, one of the focuses of the ASPPA annual conference being held here in DC in the middle of hurricane Sandy is related to ERISA accounts and forfeitures, much of which arise because of these 12b-1 based revenue sharing programs; and revenue sharing continues to garner the attention of the DOL through its investigative activities.
I have noticed a curious perception with regard to all of this activity related to 12b-1 arrangements, which gives me some pause. There seems to be a growing sense of entitlement, that somehow plans are entitled to revenue sharing, that there is some sort of innate (and perhaps legal) right plans have to the 12b-1 and service fee payments generated under these programs. It seems that a plan’s "right" to revenue sharing is too often where the conversations begin, and even seems to be creeping into some of the DOL’s own approach to it.
I think it may be helpful to keep in mind the source and purposes of mutual fund 12b-1 and service fee programs, as it will help keep a healthy perspective when winding one’s way through these revenue sharing issues.
12b-1 is actually Rule 12b-1 to the Investment Company act of 1940, which establishes the manner in which the Board of a mutual fund company can establish and administer marketing programs which support the sales of mutual funds. The language of 12b-1 is telling. The rule applies:
“if it (the investment company) engages directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company, including, but not necessarily limited to, advertising, compensation of underwriters, dealers, and sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature.”
Note the absence of any language related to paying retirement plans for administrative services. Indeed, mutual fund companies have often taken the position that these 12b-1 fees can only be paid to broker dealers for their marketing activities, and often have issues with their shareholders (such as retirement plans) actually receiving these funds. This fear arises in part from the “discrimination” issues that ’40 Act companies face: mutual fund companies are prohibited from discriminating between its shareholders. They really cannot pay 12b-1 fees to some shareholders (plans) and not to others (individual shareholders).
The industry has devised all manner of machinations to address the problems raised by the actual structure of 12b-1 fees as marketing fees, and to address the discrimination issue. But they are, after all, machinations: 12b-1 fees are, in reality, fees paid to promote the marketing of mutual fund shares. How this then somehow worked to eventually serve as the basis of a crucial part of retirement industry is quite a story.
The basic notion remains, and is helpful to keep in mind when analyzing revenue sharing. 12b-1 fees are marketing fees payable to distributors and marketers of mutual fund shares. It is these marketers and distributors to whom revenue sharing rights arise; any plan rights to such payments are only derivative. These are not funds to which mutual fund shareholders (like 401(k) plans) are entitled. No plan has the right to demand the payment of these fees and, in actuality, their eventual payment to plans requires implementing some very interesting fictions.
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