Revenue Sharing question

An interesting question came up yesterday in a discussion with some other folks who are in the TPA arena.

Suppose you have a TPA whose engagement letter specifies that Revenue Sharing paid to the TPA by the investment firm will offset TPA billings to the Plan Sponsor. At some point, due to asset growth, the Revenue Sharing paid to the TPA starts to exceed the amounts charged, so is basically placed in a holding account with the TPA. The Plan Sponsor is fully informed of this, and as a fiduciary is still happy with this investment arrangement. The amounts accumulating in the holding account start to become substantial, and the TPA is uncomfortable with this, and wants to change things to (a) get rid of the accumulated amount, and (b) prevent it from accumulating in the future.

The gist of the discussion was that the TPA should issue a new engagement letter, so that the TPA would keep all future Revenue sharing fees, even if in excess of what would normally be charged. And the holding account will be used to offset fees charged in the future until it is depleted entirely, which will take, apparently, about 4 years. Plan Sponsor is apparently fine with this.

A couple of questions were kicked around, however, which were interesting, and I'm soliciting opinions.

1. Is there really any reason why a new engagement letter couldn't simply say that the TPA will keep the accumulated revenue sharing immediately, as long as the Plan Fiduciary doesn't have a problem with it? In other words, does it have to be allocated over the next (x) number of years until depleted?

2. What happens if the client leaves? Wouldn't this money go to the TPA anyway, as it certainly isn't a Plan asset, or anything "belonging" to the Plan Sponsor?

Seems to me that the solution proposed, while certainly reasonable, is more cumbersome than necessary? Anyone ever encountered a similar situation?

If I were addressing this scenario from a legal perspective first I would want to know what, if anything, the TPA's 408(b)(2) disclosures say about the prospect of the RS exceeding the agreed-upon fees.  

The information presented was that the disclosure did not address this issue. Whether this is accurate or not, I can't say, it was a discussion, and the actual disclosure was not presented. But for purposes of this discussion, let's assume it was not addressed.

3 hours ago, Belgarath said:

The gist of the discussion was that the TPA should issue a new engagement letter, so that the TPA would keep all future Revenue sharing fees, even if in excess of what would normally be charged. And the holding account will be used to offset fees charged in the future until it is depleted entirely, which will take, apparently, about 4 years. Plan Sponsor is apparently fine with this.

How can the plan sponsor be okay with this? Having the participants pay excess TPA fees beyond what is necessary and prudent is a problem. I would work with the investment advisor and the sponsor to eliminate (or at least reduce) the revenue sharing by changing the investment share classes to avoid the excess. The TPA can then attach an asset charge or a flat fee paid by participants. 

Having the participants pay excess fees (even if the sponsor is okay with it) via revenue sharing would not be the prudent route.

WCC - thanks. It so happens that I agree that there is something "strange" about all this.

This option you suggest (changing Revenue Sharing, or investments) was discussed, and the TPA said that this option was proposed to both the investment provider and the Plan Fiduciary, and the investment provider said that it wasn't an option for this particular program, whatever it may be. And again, the Plan Fiduciary has determined that this investment program is prudent, good, etc., etc...

Now, the Plan Fiduciary may be making a bad call on all this. BUT, I'm asking purely from a TPA point of view - if the Plan Fiduciary is ok with it (rightly or wrongly) do you see a problem for the TPA if the TPA keeps this "extra" money? The TPA has (supposedly) disclosed this in great detail, and even recommended that the Plan Fiduciary consider whether this arrangement is reasonable.

I haven't seen the various documents involved, for disclosures, etc., 'cause this was just a discussion and I'm not entitled to see those details, so I can't really give you anything more than what I've posted here.

Thanks again.

P.S. - I've tried putting myself "in their shoes" to think about what would be reasonable, and it scares the heck out of me, but I suppose I ultimately come down on the side of the TPA being able to retain the fees, where such arrangement has been fully disclosed and approved by the fiduciary. It just goes against the grain...

Is there/should there be a concern that if the totality of the compensation is unreasonable then the TPA is engaged in a PT? 

Is there any reason why any left over money in the ERISA bucket account is not allocated to the plan participants as earnings at the end of the year?  

Completely agree with Pam Shoup's comment. The TPA got what they contracted for during the period of the contract. The accumulated amount is a plan asset. Negotiation of a new agreement with higher fees going forward may be OK, but the decision to raise fees will need to have justification (e.g., bigger plan = more work) independent of the fact that the plan has grown bigger and can now generate more revenue sharing.

Pam and Luke... what if the left over money in the ERISA bucket is already in the TPA's checking account.  How does his money get back to the plan to allocate to participants as earnings.  Simple "dividend earnings" deposit?

I mean let's assume the total amount is "reasonable."  Perhaps the engagement agreement should just say "Our fees are equal to the revenue sharing."  The fiduciary signs it, and then that's that.  If they found it reasonable, then it is reasonable barring something completely obnoxious.  It is very difficult to assess what a reasonable fee is and therefore very difficult to determine what an unreasonable fee is.  I suppose it would likely be similar to the Supreme Court's ruling on profanity, meaning we would know it if we saw it.  There are some really pricey TPA's out there though.  Just because revenue sharing happens to exceed what your standard formula might be does not make it unreasonable.  Again barring something obnoxious, the onus is on the fiduciary.  I mean lets face it, in capitalism the goal is to get paid as much for your services as you can.  The check on our "greed" is the fiduciary oversight.  

chc93, obviously I have not reviewed the contract or any other relevant documents, so I am addressing really a hypothetical posed by Belgarath. But the mutual funds doing the revenue sharing are owned by the plan, so the revenue sharing amounts belong to the plan as well, subject to the right of the TPA to take the portion of them it is owed under its contract with the plan and/or plan sponsor. If, as I think the OP stated, the amounts so shared are (a) in excess of the amount the TPA is owed under its contract, and (b) in the possession of the TPA, the TPA can write a check to the plan.

This subject does make for interesting conversation, doesn't it? (Maybe only interesting to us ERISA geeks...) And it brings up some issues that weren't discussed - suppose the Revenue Sharing is paid directly to the TPA. Not to an "ERISA account" in the plan.  If, as asserted above this excess is a "Plan Asset", the moment the Revenue Sharing exceeds the TPA fees, does this make the TPA a Fiduciary? Is the TPA then responsible for investing the assets under Fiduciary standards? If this has gone on for several years, does the TPA then owe interest to all participants for those years? Etc., etc.

I'm inclined towards Austin's point of view - I fail to see that this is a Plan asset. But please, keep these comments coming! I'm going to pass them on to the folks who were involved in the original discussion.

12 hours ago, Luke Bailey said:

chc93, obviously I have not reviewed the contract or any other relevant documents, so I am addressing really a hypothetical posed by Belgarath. But the mutual funds doing the revenue sharing are owned by the plan, so the revenue sharing amounts belong to the plan as well, subject to the right of the TPA to take the portion of them it is owed under its contract with the plan and/or plan sponsor. If, as I think the OP stated, the amounts so shared are (a) in excess of the amount the TPA is owed under its contract, and (b) in the possession of the TPA, the TPA can write a check to the plan.

Luke, are you saying the revenue sharing is a plan asset simply because it originated from investments held as a plan asset?  For this argument, do we need to get more specific as to what we mean by "revenue sharing"?

For example, many providers have "TPA incentive programs".  All (or qualifying TPAs) receive an incentive from the provider based on the assets of the plans in the TPAs book of business.  Lets just make it easy and say 5 bps.  The provider collects 50 bps from the plan as its asset based fee.  The provider pays 5 bps to the TPA, which is properly reported.  Because of plan assets, the 5 bps paid to the TPA amounts to more than the total fees for the year per the service agreement.  Would you call the excess a plan asset in this situation?  

Is it different if the provider's incentive program is based on the specific investments (5bps on assets in class A, 7 bps on assets in class B, etc.)

Forgive me for stating the obvious here, but if the engagement letter doesn't address this, then it's a very bad engagement letter.  But in the absence of anything to the contrary, without a shred of doubt, the excess MUST be returned to the Plan ASAP and on a frequent basis (quarterly?).  I don;t think any other conclusion could be reached.  The TPA would just cut a check and deposit the money to a Plan suspense account to be reallocated or to pay other expenses, like an audit.

There is no way possible to say "yes I'm getting more than I am entitled to, but I'm holding onto it for the Plan and by the way I'll use it for cash flow purposes."

4 minutes ago, austin3515 said:

But in the absence of anything to the contrary, without a shred of doubt, the excess MUST be returned to the Plan ASAP and on a frequent basis (quarterly?).  I don;t think any other conclusion could be reached.

Are you saying that unless specifically stated otherwise, revenue sharing MUST be credited towards fees, and when all fees have been paid, excess MUST be paid to plan?

Let's say my IT Company charges me $5,000 a month for their services.  Due to a mistake I made, I paid them $6,000 a month.  You better believe I want my $1,000 back.

How is this any dfferent?  It should be even more so because as a business owner I'm not burdened by fiduciary status to myself.  A Trustee is.

I'm not a big fan of revenue sharing, but I'm struggling with the requirement part. I don't think I have seen many revenue sharing or incentive programs from a third party that even mention fees or expenses.  

Quick example:

Plan A contracts with investment company X to pay 50 bps in fees.  A also contracts with TPA Y to pay $4,000 in annual fees. 

Investment Company X pays all TPAs with at least $100,000,000 in combined plan assets a 5bps incentive.

Plan A has $10,000,000 in assets, and the fee collected by X is $50,000.

Y has more than $100,000,000 in total plan assets with X, so it receives an incentive of 5 bps from X.  

Under this scenario, must Y pay the plan $1,000 since it received $5,000 from X and its agreement with A was $4,000?

No, I don't think they do. I don't see how this can possibly be considered a plan asset. Very different from a plan where there is an "ERISA account" - the 5bps is being paid directly to the TPA by Investment Company X. Austin, would you feel differently if the engagement letter had clearly specified that any Revenue Sharing in excess of TPA fees charged to the Plan Sponsor would be kept by the TPA? If the Plan Fiduciary has done due diligence, and determined (rightly or wrongly) that the overall investment portfolio, expense ratio for the investment company, etc. is acceptable, then why should extra TPA profit be a problem? Granted that this is a bizarre combination of circumstances.

You can see why the initial discussion went round and round...not sure there is any perfect answer (other than to avoid this situation in the first place).

Belgarath, I agree.

I don't even think a service agreement has to state that TPA will keep excess revenue sharing, unless the revenue sharing is being payed to the TPA for the stated purpose of paying for fees.

In my situation, the plan has actually paid less than it had originally contracted for since the TPA has reduced its fees by revenue received from the investment company.  

2 hours ago, RatherBeGolfing said:

 

Here's a quick rundown on if/when they are plan assets

https://www.benefitslawadvisor.com/2013/07/articles/erisa-fee-recapture-accounts/dol-provides-guidance-on-erisa-fee-recapture-accounts/

Thanks - and the situation discussed doesn't fit into this category. It is a payment made directly by the investment company to the TPA - it is not an ERISA fee account or recapture account. Instead, the TPA, in its contract with the EMPLOYER (not with the plan) agrees that it will reduce the administrative charges billed to the EMPLOYER by the amount of any Revenue Sharing amounts received. And while as Austin points out the engagement letter, as apparently written, is weak in that it doesn't address the issue of Revenue Sharing in excess of normal charges, it still, IMHO, clearly would not belong to the Plan.

I interpreted the OP as saying that the TPA agreement had agreed upon fees (e.g., basis points and/or per account charge that was calculated separately from revenue sharing). There are then agreements between TPA, fund company, and plan providing that  rev share will be credited against TPA's total fees owed, and source of rev share is the shareholder servicing or related fees charged by the underlying funds against NAV. Turned out,  rev share exceeded the TPA's agreed upon fees. I think in that case, whether the rev share check from the mutual fund group goes to the TPA or the plan, the excess rev share (I.e., total minus TPA agreed fee with plan) is  a plan asset.

If the mutual fund family has an agreement to pay the TPA what is in effect a finder's or business aggregation fee, such as the 5 basis points example that several posts have raised, that is different. That amount is taken by the mutual fund company out of its revenue (what would otherwise be its profit) and spent on the TPA as a promotional expense. Of course, it should be disclosed to the plan fiduciary with authority to retain the fund family and the TPA. Of course also, if the TPA were a fiduciary it would be a "double dealing" PT under 406(b)(3) of ERISA, but the typical TPA is not going to be a fiduciary, so not a PT.

So, if it's not a recapture account, the revenue sharing deal is between the TPA and the provider.  The the TPA tells the sponsor (employer) that it will offset the plan's fees by the payment.

If that's right, the sponsor really has no say in the matter, except determining if it thinks the fee the provider is paying the TPA is fair given that the funds originally came from the plan.  The TPA would simple get to keep the difference between the payment from the provider and the offset fees.  What the TPA does with that difference is up to them--they can earmark it for future fees of the plan to the extend future payments fall short.  Or they can just pad the company's profits.  Or do a profit sharing to its own plan.  Or use the funds to add staff or technology.  The list is endless.

At least that's the way I see it.

I think the 408(b) Notice should outline the fees paid back to the TPA.  The Service agreement can say any revenue will offset fees.  But I don't think the SA needs to say what happens to a surplus.  If there is extra laying around and the revenue doesn't cover fees, the the TPA can discount the fee, using the slush fund.

Example:  

Slush fund:  $1,000

2019 Revenue:  $2,000

2019 fees:  $3,000

Invoice:

Fee: 3,000

Revenue sharing; (2,000)

Discount: (500)

Due:  0

BG5150, just to be clear, you are positing a situation in which the written contract between the TPA and the plan or plan sponsor says that the TPA will (a) be due a formula-derived amount from the plan based on its assets and participants, (b) separately receive from the mutual fund company a specified portion of the underlying funds' shareholder servicing and related fees , and (c) credit the amounts under "(b)" dollar for dollar against the amounts under "(a)," but implicitly or explicitly also provides that if the "(b)" amounts are greater, that is the fee?

The situation we were discussing was even simpler than that. There was no formula-derived payment/contract with/from plan. TPA was contracted solely with the Plan Sponsor for administrative fees. The contract/service agreement/whatever you want to call it specified that any fees billed to the Plan Sponsor would be reduced by Revenue Sharing paid to the TPA, if there is any.

TPA received Revenue Sharing from the investment provider - which the investment provider provided automatically - nothing the TPA asked for. Then, as discussed, at some point the Revenue Sharing exceeded the TPA's normal fees.

I see the question here as what did the TPA's 408b-2 fee disclosure say about this indirect compensation?  If it doesn't clearly disclose it and say the TPA keeps any amount in excess of their contracted fee and the TPA keeps the excess, in my opinion, the TPA is receiving indirect compensation that is not disclosed and their contract doesn't meet the requirements to be considered reasonable.  If the TPA contract is not reasonable, any direct or indirect compensation from the plan to the TPA would be a PT. That can be avoided by returning the excess to the plan.

I agree with Austin that this should have been addressed previously.  If the plan sponsor agrees to a disclosed asset based fee payment to the TPA for the same services rendered going forward, I think the TPA is ok.  But, the plan sponsor would have a potential problem with their decision that this fee arrangement is reasonable. 

I think I agree with most of the comments above, including that this is indirect compensation that must be disclosed under the 408(b)(2) regs. Would point out further that this might very well have been a PT, subject to the BIC exemption, had the DOL's fiduciary regs stuck. Given the apparently lucrative arrangement that the TPA has with the mutual fund company, it would be conceivable that the TPA might in fact influence the plan's decision regarding which fund family to use and its retention. That would have made the TPA a fiduciary under the withdrawn regs. And then receiving compensation from the mutual fund company would have been a "double dealing" PT under 406(b)(3), again subject to the potential application of the BICE labyrinth.

Of course the plan fiduciary selecting the TPA and the fund company should in theory fully understand the disclosed fees and the issues they raise. If not, this could be fertile ground for TPA and fund family competitors to go over the 5500 and point out to the plan sponsor something that it may not be aware of. (I understand, of course, that Belgarath's OP stated that the plan sponsor was fully aware of the situation and fine with it.) It is, of course, not uncommon for fee structures to become outdated as plans grow larger over time, and plans will often demand fee concession as the TPA's revenue for their plan grows.

So I do have a question - answer is not immediately apparent to me - let's suppose, as Kevin mentioned, that the 408b-2 disclosure from the TPA to the Plan Fiduciary did not adequately describe the arrangement. Is the PT (or potential PT) on the TPA or the Plan Fiduciary, or both? Or to really get into the weeds, suppose it was discussed with the Plan Fiduciary, but not put in writing? (I'm inclined to think this is likely to be meaningless, except perhaps in assessing damages in litigation, since the disclosure is required to be in writing...)

I think the TPA involved needs to talk to ERISA counsel...but this discussion has been very helpful to me as I haven't really thought about these issues much for several years.

P.S. - assume it is on the TPA, but not certain if applies also to Plan Fiduciary because Plan Fiduciary didn't adequately investigate or request more information, if disclosure wasn't specific enough...

Belgarath, our TPA firm does exactly what you have described here - we receive an "efficiency allowance (EA)" (ie, revenue sharing) from many of the large recordkeepers, and we apply that against our TPA fees to the client.  This money is not a plan asset.  It is simply the recordkeeper sharing a portion of their profits with our firm because of the fact that we have a relationship with them and we provide a service to the plan that the recordkeeper would have otherwise had to provide, if the plan were bundled rather than using a TPA.  The money is paid directly to our firm, usually monthly or quarterly.  It is never in an ERISA account, etc.  

In response to your question:  1. Is there really any reason why a new engagement letter couldn't simply say that the TPA will keep the accumulated revenue sharing immediately, as long as the Plan Fiduciary doesn't have a problem with it? In other words, does it have to be allocated over the next (x) number of years until depleted?   I would say that the accumulated revenue sharing should continue to be used to pay future plan fees until it is depleted, but that probably depends on the terms of your service agreement.  Our agreement with our clients specifically says we use ALL revenue sharing payments to offset our future invoices.  So I think that if we were to change the terms of the agreement in the future to where we were instead keeping the revenue sharing, we would still be obligated (at least morally) to honor the initial agreement regarding the use of any revenue sharing that had accumulated up to the point that we changed the terms of the agreement.

2. What happens if the client leaves? Wouldn't this money go to the TPA anyway, as it certainly isn't a Plan asset, or anything "belonging" to the Plan Sponsor?  Hopefully this has been addressed in the service agreement.  Ours states:  

Services already provided, but not yet billed, plus any contract discontinuance charges, will be reduced by any unused revenue sharing.  Because revenue sharing is not considered to be a plan asset, if any unused amounts remain, they will be forfeited. 

 Hope that helps

Thanks - I will pass all of these comments along to the folks involved. This whole discussion has been very interesting, and I thank you all for your opinions.

AKconsult, do you agree that this is indirect compensation required to be disclosed under the 408(b)(2) regs?

Do you think it makes sense for a plan fiduciary to agree to a fee deal in which the fees paid to the TPA cannot be reasonably estimated in advance and have only a known downside, not upside, and plan does not share in upside?

I agree that fees paid by the mutual fund company out of its revenue are not a plan asset, and therefore agree that there is no per se PT as long as the TPA is not a fiduciary (which I assume it has concluded it is not), but from an overall fiduciary perspective we all know that the shareholder servicing and related fees offered to be rebated by the fund company can be paid back into the plan to the extent they are not scooped up by the TPA.

17 minutes ago, Luke Bailey said:

do you agree that this is indirect compensation required to be disclosed under the 408(b)(2) regs?

Yes

18 minutes ago, Luke Bailey said:

Do you think it makes sense for a plan fiduciary to agree to a fee deal in which the fees paid to the TPA cannot be reasonably estimated in advance and have only a known downside, not upside, and plan does not share in upside?

Im not sure I see it that way.  The fees usually can and should be estimated.  Under 408b-2, I don't think it is enough to say "we get revenue sharing from many large record keepers".  I believe you need to specify where it is coming from and how much you estimate that you will collect (or the formula if an amount cannot be estimated).  I'm a bit rusty on 408b-2 though.  With that information, the fiduciary knows what the service agreement calls for and what the TPA expects in revenue sharing.  This is also a good argument against evergreen service agreements.

25 minutes ago, Luke Bailey said:

but from an overall fiduciary perspective we all know that the shareholder servicing and related fees offered to be rebated by the fund company can be paid back into the plan to the extent they are not scooped up by the TPA.

Sometimes easier said than done.  Id rather not deal with revenue sharing at allk to be honest.  On some plans, we have negotiated with the fund company to have them discount their fee by the revenue sharing amount, and have the employer pay the fee.  Less fees for the plan and the employer can deduct the expense.  You need a plan with a lot of assets in order to get the big guys to do anything but standard procedure though.

On ‎11‎/‎18‎/‎2019 at 8:17 AM, Belgarath said:

So I do have a question - answer is not immediately apparent to me - let's suppose, as Kevin mentioned, that the 408b-2 disclosure from the TPA to the Plan Fiduciary did not adequately describe the arrangement. Is the PT (or potential PT) on the TPA or the Plan Fiduciary, or both? Or to really get into the weeds, suppose it was discussed with the Plan Fiduciary, but not put in writing? (I'm inclined to think this is likely to be meaningless, except perhaps in assessing damages in litigation, since the disclosure is required to be in writing...)

I think the TPA involved needs to talk to ERISA counsel...but this discussion has been very helpful to me as I haven't really thought about these issues much for several years.

P.S. - assume it is on the TPA, but not certain if applies also to Plan Fiduciary because Plan Fiduciary didn't adequately investigate or request more information, if disclosure wasn't specific enough...

The PT would involve both the Plan Fiduciary and the TPA.  The fee disclosure rules include a way for a plan sponsor to get off the hook if a service provider doesn't disclose direct or indirect compensation received from the plan.  https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/fiduciary-responsibilities/fee-disclosure-failure-notice

From that web page:

Quote

 

In order for a service contract or arrangement with a retirement plan to be reasonable, covered service providers must disclose certain information about the services they will provide to the plan and the compensation they will receive, including indirect compensation from sources other than the plan. This information is needed in order for the responsible plan fiduciary (the fiduciary with the authority to cause the plan to enter into, extend or renew the service provider contract or arrangement) to understand the services, assess the reasonableness of the compensation (direct and indirect) received by the service providers, and identify any conflicts of interest that may impact the service provider's performance.

If a service provider fails to provide the required information, the contract or arrangement between the plan and the service provider is prohibited by ERISA, and the responsible plan fiduciary will have engaged in a prohibited transaction.

However, an exception (known as a class exemption) allows responsible plan fiduciaries who did not know that the service provider had failed to disclose some of the required information to avoid engaging in a prohibited transaction. To get this relief, certain conditions must be met. ...