Revenue Sharing Restrictions

[Guest jmiskey]

We are a TPA for many retirement plans (mostly 401k). Many of the mutual funds we use pay revenue sharing. For plans which we receive large amounts of revenue sharing, we like to offer incentives to clients. Currently, we offer them reductions in our fees.

We have had clients ask about the possibility of allocating some of the revenue sharing to the plan and distributing it among participants. Someone once told me that it was not legal to allocate any of the revenue sharing to the plan, trust, or participants. They said that using to offset administrative expenses was the only way to offer anything back.

I have searched the internet in hopes of finding some sort of article discussing the restrictions on how revenue sharing may be used/allocated. I have found many articles which discuss what revenue sharing is, but none that discuss the legal restrictions on them. Can anyone help me?

Thanks.

[Jon Chambers]

The problem you face is that there are different types of revenue sharing, and different interpretations of what is legal. Generally, if the revenue sharing is structured as a commission (e.g., a 12b-1 fee), if the revenue sharing is rebated to participants, you have probably violated NASD rules prohibiting the rebating of commissions. Illegal? Perhaps, but not necessarily. If the revenue sharing is from the fund's OER, it's probably not a problem.

There are lots of arrangements out there. I've even seen revenue sharing rebated to the plan sponsor, ostensibly to offset their staff costs for plan administration. I've also seen commentators argue that "free" plan amendments are illegal, b/c they are settlor functions paid for (at least indirectly) with revenue sharing, which should be considered to be a plan asset, and plan assets can't legally be used to pay settlor costs. Due to the complexity of determining the revenue sharing source, different ways to apply the revenue sharing, and different ways to account for the sharing, it's very hard to make blanket statements about what is or isn't "legal".

I generally suggest that sponsors that want to rebate revenue sharing to participants would be better served by selecting low cost funds that don't offer revenue sharing.

[Guest jmiskey]

Thanks for the response.

Unfortunately, as TPAs, we really don't have as much say in the funds they select as their Investment Advisors and brokers do. Assuming that some of the funds they use offer revenue sharing, we are trying to use it to the benefit of the plan.

The different types of revenue sharing we have encountered are Sub-TA, Shareholder Servicing Offset, 12b-1, and Finder's Fees. Are these handled differently?

Perhaps a good follow-up question to ask is if other organizations do the same thing (that is use revenue sharing to the benefit of the plan), and how they go about doing it. How about it?

[MoJo]

A few years back the DOL issued a pair of Advisory Opinions on the fundamentals involved here. unfortunately, they did not encompass the variety of arrangements that can be , and have been, implements. The opinions centered around Frost National Bank's structure of rebates/offsets. Start there. Where I've seen excess revenue sharing, it typically 1) is used to reduce billables to zero; 2) it is used to pay other legitimate plan expenses (audits, legal, etc (as long as they are not settlor functions); 3) they are used to increase services (more days of education, custom materials, etc.); and then, maybe 4) used to increase participant benefits. I agree that the rebating of certain kinds of revenue would be an NASD violation, but generally, you can suck up the excess revenue rather effectively in other ways.

[Guest jmiskey]

So, it looks to me as if there is nothing written that explicitly restricts revenue sharing being put back in the plan. However, depending on interpretation, it may or may be a prohibited transaction and should therefore be avoided. Am I understanding this correctly?