Imagine waking up one morning to find the sun rising from thewest. That’s the situation 401(k) recordkeepers may soon find themselvesin (see “Will the DOL’s New Fiduciary Rule Redefine the Roleand Boundaries of Plan Recordkeepers?”FiduciaryNews.com, November 8, 2016).

The DOL’s new “Conflict-of-interest” (aka “fiduciary”) rule,combined with 2012’s Fee Disclosure Rule, acts as a one-two punchwhich will likely result in dramatic changes in 401(k) recordkeeperbusiness models.

Not that these changes haven’t already started. Let me offer twocontrary anecdotes as examples.

Years ago I was speaking with the president of a largerecordkeeping firm. He excitedly expressed how he had discovered a“new” pricing model that would be his firm’s golden goose. He hadjust switched his pricing model from a per participant model to anassets under management model. This not only made his billingeasier, it also offered an opportunity to increase revenues withoutan associated increase in plan participants.

When I asked how he could justify this when his firm’s costs andservices were directly related to participants, not on the size ofthe investment assets, he merely scoffed, “But everyone is doingit.”

Indeed, everyone was doing it – and they were doing it in a waythat didn’t require actual fees to come out of the plan (directly,at least).

In the mid-1990s, it became clear that the recordkeeper, evenmore than the plan’s custodian, was the focal point of planoperations.

Mutual funds quickly discovered that, in order to even beconsidered for the plan’s investment menu, it had to receive theblessing from the recordkeeper (and the custodian) that the fund“had the flexibility” to work with the provider’s chosen platform.To show this flexibility, funds had to pay for shelf space first byoffering the custodian a “platform fee,” and then by reimbursingrecordkeepers.

This recordkeeper reimbursement couldn’t come throughcommissions, since the recordkeepers weren’t acting as brokers.Furthermore, it was problematic for recordkeepers to be paidthrough 12b-1 fees since those were quickly being redefined as“adviser” payments and recordkeepers did not want to become subjectto the associated regulatory morass in becoming an adviser.

That left only two options. Initially, recordkeepers were paid“sub-transfer agent” fees. For those not familiar, mutual funds paytransfer agents to keep track of shareholders.

While some mutual funds, to keep fund operating expenses low,continue to act as their own transfer agent, the norm is for mutualfunds to contract with third party transfer agents.

In a very real sense (true today as much as it was true backthen), recordkeepers perform an identical role.

The problem with sub-transfer agent fees is that they are verylimited both in scope and in “fee reasonableness” range. To avoidthese obstacles, and to hide these payments from standarddisclosures, funds created a new type of operating expense:“revenue sharing.”

Like commissions, 12b-1 fees, and sub-transfer agent fees,revenue sharing is an asset-based fee. Because it is less defined,however, it is more fungible.

It became the preferred manner in which recordkeepers would getpaid. Because these fee payments are buried deep within fundaccounting statements, it gave the appearance the plan sponsors andplan participants weren’t paying anything for their retirementplan.

The 2012 Fee Disclosure Rule was intended to change that.Unfortunately, the DOL never came out with a standard reportingformat, and service providers were able to meet the letter of thelaw while avoiding the intent of the law. This is the situation wecontinue to find ourselves in today.

But then along comes the fiduciary rule, and all bets are off.The blurry line of “education” between recordkeepers and investmentadvice has been more precisely defined.

In addition, the definition of “fiduciary” has been broadened ina way that recordkeepers will find more difficult to skirt around.For these service providers, the Sun is sabout to rise in thewest.

Not for all of them, though. Let me relay this second anecdote.I was speaking to a different recordkeeper when I was doingresearch for my 2012 book 401(k) Fiduciary Solutions. He,too, was initially captivated in the 1990s by the business modelincorporating sub-transfer agent fees.

As he learned more, however, he quickly (and well beforeeveryone else) discovered the fiduciary liability associated withsuch a model. He then decided to build his firm using a flatfee/participant-based fee model. The firm grew so large he was ableto sell it for a tidy sum.

Who did he sell it to? Not a broker, but a bank that offeredtrust services.

He understood the meaning of “fiduciary” as it applied to therecordkeeping business and, in staying true to it, he profitedhandsomely.