Downloadable version (pdf) of this article.

Members of Congress, the Securities Exchange Commission (SEC) and the Department of Labor (DOL) have spent the past several years in on-again/off-again discussions regarding fees within 401(k) plans. The upshot of the debate is that requiring employers to document the fees charged against participant accounts might result in reduced costs for participants. How? Apparently all involved are hoping that shame will do the trick as no one is contemplating caps on fees. Employers must be gouging employees or why else would there be such a fuss - or so the logic goes.

Substantial legislative change in an election year is harder to find than $3 gas, and this year has not proven to be an exception. With Congress sidelined, the DOL has finally taken action in the form of a proposed regulation requiring uniform fee disclosure. This effort has been lauded in a number of publications that have leapt on the shame bandwagon and are now touting the significant savings that will soon be a reality.

While I am always in favor of complete disclosure, I have some problems with the path the DOL is taking. The primary issue is that, based on the proposed regs, most participants will receive a disclosure saying that they pay nothing in administrative costs. In reality that participant, along with all of the other participants, is paying 100% of the administrative costs of the Plan.

How can this be? I wasn't in the meeting but a funny thing must have happened on the way to the proposed regs as the DOL conveniently forgot to include any disclosure requirement for "soft dollar" revenue -- money the funds within a 401(k) plan pay back to the vendor servicing the plan in exchange for being included in the menu.

A full explanation of this practice can be found in previous articles (please see Revenue Sharing Part I, II, III) but for our purposes here, let's say that the operating expense of a given fund - which is required to be disclosed under the proposed regs -- is 1.00%. This 1.00% is what all participants within the plan pay to utilize the fund (this information is already available through another wonderfully complicated disclosure document: the prospectus).

The "soft dollar" revenue aspect of this arrangement is that the fund manager will pass (for example) half of the fees generated by the operating expense (.50%) back to the recordkeeper. If $1 million in plan assets is invested in this fund, the recordkeeper is receiving $5,000 a year back from the fund on an annual basis ($1,000,000 x .50%). Repeat this exercise for all of the funds within a 401(k) menu and its easy to see why there isn't an additional administrative fee charged to participants. The vendors are making all they need to provide administrative services for the plan from the soft dollar revenue.

While this may be news to you, soft dollar revenue sharing is not a secret. It's the cornerstone of the 401(k) industry and congress, the SEC and the DOL are well aware of it. It's also the main driver for what funds are available in your 401(k) plan, and how much they cost.

The question then becomes: why would the DOL propose a disclosure requirement that ignores soft dollar revenue sharing? It's a great question; one that I'm sure the mutual fund and 401(k) recordkeeping industry has already discussed at length with the DOL.

Getting back to the employers for a minute: there are assuredly employers out there who levy excess fees on their participants to reduce the check they would otherwise have to write to offer the 401(k) plan. That said, many (most) employers unwittingly participate in the soft dollar revenue arrangements because those arrangements were imbedded in all of the proposals they received from every vendor willing to provide administrative services. Many employers, by the way, do write six or seven figure checks to support their plans when they fund their matching contributions.

If shame exists in this situation, it falls primarily in the lap of the mutual fund and recordkeeping industry - perhaps with a bit to spare for the DOL. That said, if the proposed version of this disclosure becomes reality, none of those parties will have to worry as those expenses apparently don't count.

Marshall J. Cobb, CRSP, is president and founder of Cobb Retirement Solutions, LLC., an independent, fee-only firm offering qualified plan analysis and oversight exclusively to corporations and organizations. Cobb's first-hand knowledge as a veteran representative of retirement plan vendors beginning in 1990 gives him a unique perspective as he advises his clients. Cobb runs his virtual office -- based near Houston, Texas -- with employees and clients across the country.

For additional information on this Newsletter article, please contact: