Plan recordkeepers, facing challenges to their traditional revenue models, are looking for new revenue sources. These new sources pose legal challenges for the recordkeepers and practical challenges for plan fiduciaries.
A question for all you plan fiduciaries out there–is your plan being charged “infrastructure fees” by the plan recordkeeper? And do you even know what these fees cover or how much these fees cost your plan?
Don’t be surprised if the term “infrastructure fee” is unfamiliar to you— until recently, it appears to have been a carefully kept secret. However, some recent events have brought this term to light. And, the more we learn about this fee, the more we are reminded of the challenges facing plan fiduciaries in monitoring plan recordkeepers–and the different ways that recordkeepers can elicit (direct and indirect) compensation from employer-sponsored retirement plans.
On February 21 a lawsuit was filed against Fidelity (Wong v. FMR LLC et al). The suit describes fees imposed by Fidelity on mutual funds if such funds (i) sought to be offered to retirement plans using Fidelity’s recordkeeping platform (i.e., “shelf space”) and (ii) the funds did not otherwise produce sufficient revenue for Fidelity through more typical, disclosed fees (e.g., 12b-1 fees, service fees, sub-transfer agent fees and/or similar fees). (For a discussion of the kinds of fees typically imposed on employer-sponsored defined contribution plans, see this DOL brochure.) In effect, the infrastructure fee was targeted at low cost funds (such as indexed funds and other passive investment products) that do not generate “sufficient” revenue sharing for Fidelity–the very kinds of funds that plan fiduciaries are pursuing. Interestingly, the complaint states that the infrastructure fee imposed on a mutual fund was a percentage of that fund’s total assets under management (AUM), and was not based on the assets invested in the mutual fund through the Fidelity recordkeeping platform.
The complaint maintains that Fidelity should have disclosed these fees as “indirect compensation” received by Fidelity “in connection” with providing services to these plans, as required by DOL regulations. The complaint goes on to claim that Fidelity’s imposition of these fees–and failure to disclose them to plan fiduciaries — represents a breach of Fidelity’s fiduciary responsibilities and a prohibited transaction under ERISA.
Of course, a complaint reflects the plaintiffs’ characterizations of the facts and the law. Accordingly, it will take a while — and lots of legal wrangling–before we learn more about these fees and the legal implications of Fidelity’s approach to structuring and communicating these fees. So, stay tuned on this front.
Enter, the DOL.
On February 21 an article appeared in the Wall Street Journal describing a Department of Labor investigation into … Fidelity’s infrastructure fees. (“Government Probes Fidelity Over Obscure Mutual Fund Fees”). The article claims that the infrastructure fee is described in an internal Fidelity document reviewed by the Wall Street Journal. As described in the WSJ article, the Fidelity document acknowledges that Fidelity’s traditional business model is “broken” as investors pursue lower cost funds, rather than Fidelity’s traditional actively managed funds.
The WSJ article describes how Fidelity’s failure to clearly identify and disclose these fees creates potential problems with the DOL because of ERISA fee disclosure requirements. The article also discusses potential SEC challenges, because Fidelity’s characterization of these fees as “infrastructure” fees–and not distribution fees — could run afoul of SEC disclosure requirements.
Is Anybody Really Surprised?
Fidelity (and other bundled recordkeepers) are under pressure on multiple fronts. It is likely that downward pressure on recordkeeping fees is impacting the profitability of that business. And, at the same time, the move toward indexed funds, ETFs and other lower-cost investment alternatives is taking a bite out of asset management fees.
This blog has already described some of the different recordkeeper strategies for recouping declining revenue — from extra fees imposed on fund managers, plans and participants (Fee Compression: Fiduciaries Take Note) to concerted efforts to attract rollovers upon the occurrence of a distributable event (The Lure of the IRA and the Power of Inherent Conflict) to the sale of non-plan insurance and financial products (Unchecked Revenue: Show Me the Fees).
However, these latest revelations about Fidelity’s infrastructure fee serve as a stark reminder that plan providers’ quest for “opaque” revenue — revenue that is not identified in the bidding process or in annual fee disclosures — is ongoing and constantly evolving.
What’s a Fiduciary to Do?
It is important for plan fiduciaries to be cognizant of these trends–and the myriad ways that recordkeepers can seek to recoup lost revenue. More importantly, fiduciaries need to scrutinize multiple aspects of a recordkeeper’s service and revenue model in order to truly determine that the fees levied upon the plan and participants are reasonable. This fiduciary scrutiny is, of course, intended to obtain the best fees for employer-sponsored plans — and it must be emphasized that identifying the best fees can only occur in an environment where all recordkeeper revenue (both direct and indirect) is identified and understood: when fees are transparent and not opaque. Without the ability to identify all fees, fiduciaries are blindfolded in their efforts to meet their fiduciary responsibilities — not exactly a “prudent” approach.
No doubt, we will hear more about Fidelity’s infrastructure fees in the coming months. And, there is also no doubt that after the focus on these fees has subsided, we will learn about another recordkeeper’s revenue enhancement program.