For most 401(K) Accounts with retail share class mutual funds, the recordkeeping and administration fees of the plan are paid through “revenue sharing”. Revenue sharing is the padding of retail share class mutual funds with fees to pay for the Plan, paid by the plan participants. The difficulty of revenue sharing is the lack of transparency for the participants in seeing what they are actually paying for their investments.
Institutional Share classes of mutual funds do not have recordkeeping and administration fees (12b-1 Fees and Sub Transfer Agent Fees “Sub TA” fees) included in their expense ratios. As a result, the institutional class shares have the lowest annual expenses of any share class. With lower expenses comes better performance over time (i.e. no deductions for expenses). However, the mutual fund sponsors limit the types of institutional investors who can buy the shares. The minimum amount to invest is generally in the $1 - $2 million range.
Retail share class is akin to buying your diamond engagement ring at full retail. Institutional share class owners “know a diamond guy” and buy their ring at cost. Which would you rather do?
For those who don’t “know a guy” there is no choice but to buy at the full retail price. While participants who understand revenue sharing don’t necessarily like the program, up until now it has been a necessary evil that allowed workers to save for retirement and not be solely reliant on the social (in-) security system.
But what if you could purchase your investments at “cost” but instead were forced to buy at full retail markup? The employees at Edison International were in the exact situation, didn’t like it, and fought back. Their fight may change the playing field for all of us.
Participants of the Edison International 401(K) Plan sued their Plan Trustees for breach of fiduciary duty involving excessive fees in their Plan. Plaintiffs alleged that Edison added six (6) retail share class mutual funds to the Plan which had an institutional share class option. Both share classes invested in the same securities and were managed by the same fund managers. The only difference is the retail shares have significantly higher management fees (paid for by the Plan Participants) which the Plan Trustee used for revenue sharing and to cover the costs of the Plan. The Court found the Plan Trustees breached their fiduciary duty by not operating the Plan solely in the best interest of the Plan Participants.
Many experts believe that this case will have a strong and widespread effect on all 401(K) plans, big and small. The question should be: how do we protect our Plan and from a similar fate?
The first order of business is to determine who the fiduciaries of the Plan are. Is your Advisor a co-fiduciary of the Plan? Engage an Advisor that is with you in the trenches and has the same vested interest in the Plan as you do. Registered Investment Advisors (RIAs) have a fiduciary duty to act in the best interest of their client while a brokers’ only duty is to decide that the investments are “suitable” for the Plan. In my opinion, it would be a breach of that duty to place a client who qualifies for institutional shares in retail shares of the same fund.
Secondly, understand what the Investment Policy States expresses about the fees and funds of the Plan. This should be carefully drafted and used as a guide in all operations of the Plan.
Lastly, determine whether the investments chosen for your plan are `in the best interest of the participants”. Edison was found liable not because the investments it selected did not perform well, but because it selected pricier investments for its own bottom line (saving on the costs of the Plan) and not for the exclusive benefit of the participants. Ask your Advisor about the share class of the investments within your Plan. Surprisingly, institutional share classes may be available today for your Plan!
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