Monday, March 20, 2006

Eyes of the Beholder

Revenue-sharing has become an integral part of the business of serving retirement plans and, while a growing number of advisors have moved (or are rapidly moving) to a fee-based model, many have clung to the former. And let’s be honest here – a large number of plan sponsors still prefer that model for the simple reason that it is easy (no invoices, no checks to write) and seems, on the surface, anyway – cheap (not physically writing a check always seems less expensive).

However, the revenue-sharing model is coming under heightened scrutiny – because it does tend to obscure the actual fees paid from the oversight of plan fiduciaries, because its basis of calculation – plan assets – does not always comport equitably with services rendered in exchange for those revenues (and sometimes that means it undercompensates for the services rendered) and because, when you take money from someone other than the person you are providing services to for providing those services, it can look like a bribe.

The most recent warning bell on revenue-sharing practices came in a recent case involving Nationwide, and its practice of putting together retirement plan menus with funds from which it “shared” revenue (see Nationwide ERISA Suit Survives Challenge). Now, one shouldn’t make overly much of this particular ruling – Nationwide asked the court to dismiss out of hand some charges related to the suit, and the court, looking at things from a standpoint most favorable to the other side (which they are required to do in these requests for a decision without fully hearing evidence) instead found that these were issues that deserved a fair hearing. Not good news for Nationwide’s legal team, but hardly a “loss,” either.

But in its opinion, the court raised some issues that, depending on their final resolution, could be hugely impactful. It suggested that Nationwide’s role in constructing the plan menu could constitute control of plan assets, for one thing – making it a fiduciary. It also said that one might plausibly find, under a “functional” approach, that the revenue-sharing arrangements – which, by their very nature, come from plan assets – might actually BE plan assets. And, the court also noted that, even if the revenue-sharing payments do not constitute plan assets, a Trier of fact could plausibly find that “Nationwide's service contracts constitute prohibited transactions.”

Once again, I should note that the court’s determination that there might be issues that require a trial to resolve does not constitute a resolution of those issues, nor does it suggest a probable outcome. However, one of the dangers of being too long “inside” industry practices is that you forget how those “common” practices look to the outside world, particularly when “explained” by opposing counsel (remember how shocked Congress was at the notion of a 12-day blackout in Enron?).

The Nationwide ruling is a reminder that it’s worth taking a regular look at your revenue-sharing practices – or your business practices, generally - through the eyes of an outsider. Before you’re forced to do so.

- Nevin Adams

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