SEC and Revenue Sharing Enforcement

According to its September 6, 2012 press release, the U.S. Securities and Exchange Commission ("SEC") settled with two Portland, Oregon investment advisory firms for $1.1 million. At issue was whether investors were harmed due to the allegedly hidden revenue-sharing arrangements in place that may have resulted in a less than neutral basis for recommending certain funds. Neither party admitted or denied the regulator's charges. See "SEC Charges Oregon-Based Investment Adviser for Failing to Disclose Revenue Sharing Payments," September 6, 2012.

The issue of revenue sharing is unlikely to go away, especially with multiple regulators paying close attention now. The SEC had said that it plans to ask more questions about the independence, or lack thereof, that characterizes the relationship between professionals who give advice and the brokers and/or asset managers they use. Mr. Marc J. Fagel, Director of the SEC's San Francisco Regional Office, states that there will be a continued focus on "enforcement and examination efforts" related to "uncovering arrangements where advisers receive undisclosed compensation and conceal conflicts of interest from investors."

 The U.S. Department of Labor ("DOL") is likewise investigating whether revenue-sharing arrangements are being adequately disclosed. A few months ago, DOL settled with Morgan Keegan and Co. According to published accounts, monies will be returned to nearly a dozen pension plans by Morgan Keegan for having received a fee in exchange for recommendations it made about hedge fund vehicles. Morgan Keegan will also need to disclose whether it is acting as an ERISA fiduciary. See "Morgan Keegan settles with DOL over revenue-sharing accusations" by Darla Mercado (Investment News, April 16, 2012). 

Given recent court activity, more will be said later on by this blogger about when the practice of revenue-sharing could make sense and when there could be problems.

New Focus of ERISA Fee Litigation

According to Troutman Sanders ERISA attorneys Jonathan A. Kenter and Gail H. Cutler, the outcome of a recent 401(k) plan lawsuit known as Tussey v. ABB did more than force the sponsor to write a check for $37 million. It led to lessons learned about the need to regularly review record-keeping and investment management fees, negotiate for rebates if possible and adhere to documented investment guidelines. What it did not resolve was "whether the record keeping costs of a 401(k) plan may be borne exclusively by those participants whose investment funds enjoy revenue sharing...while participants whose accounts are invested in investment funds with no revenue sharing pay little or nothing."

In "The Next Frontier in Fiduciary Oversight Litigation?" (April 27, 2012) they suggest that courts will likely be asked to opine as to whether ERISA fiduciaries have justified prevailing revenue sharing arrangements, taking allocation and class-based fee levels into account. Their recommendation is to decide on a disciplined approach that makes sense rather than making arbitrary decisions. Allocation rules to consider include the following:

  • Apportion record keeping fees on a pro-rata basis so that each participant is only charged his or her "fair share." Credit any revenue sharing received back to the "funds or participants as part of a periodic expense balance true-up."
  • Levy the same record keeping fee for each participant. Allocate revenue sharing monies ratably "to all investment funds or participants."
  • Adopt a combined pro-rata and per capital allocation such that a record keeping fee would consist of a fixed amount and a variable amount. Imposing a cap on total fees could be included.
  • "Hard wire the allocation method in the plan document" so that how record keeping fees are charged becomes a settlor function versus a fiduciary task.

In 2007, the ERISA Advisory Council's Working Group on Fiduciary Responsibilities and Revenue Sharing Practices reviewed industry practices as a way to improve disclosure for 401(k) plan participants. One recommendation made to the U.S. Department of Labor thereafter was to categorize payments for certain professional services as settlor functions and thereby protect fiduciaries from allegations of breach. Another request was for clarification that revenue sharing is not a plan asset "unless and until it is credited to the plan in accordance with the documents governing the revenue sharing."

With ERISA Rule 408(b)(2) fee disclosure compliance just ahead, numerous questions remain. This had led litigators and transaction attorneys alike to comment that further lawsuits and enforcement actions are likely to follow.

Note: Interested persons can read "Final Regulation Relating to Service Provider Disclosures Under Section 408(b)(2)," published the U.S. Department of Labor in February 2012.