The administration of a 401(k) plan requires a number of parties. These include a custodian to hold the plan’s assets, a recordkeeper to maintain plan and participant records and process distribution requests, and investment fund managers with whom plan assets may be invested. Sometimes employers engage each service provider separately, in what is known as an “open architecture” arrangement. Often, however, these services are purchased in a “bundled” arrangement, in which a single entity or a group of affiliated entities does everything.
The cost of providing these services typically is shared by the employer and plan participants. Participants may see their share of this cost deducted directly from their accounts, but more commonly administrative fees are assessed indirectly, as a component of the management fee (or “expense ratio”) charged by the investment fund providers.
When fees are paid indirectly, the investment fund providers often outsource administrative functions to third parties such as recordkeepers. Such functions may include maintaining shareholder records (i.e., a list of participants who own shares of the fund) and mailing prospectuses and other information to participants. The fund companies pay for these outsourced services in a variety of ways, carving off a portion of the expense ratio to do so. Such payment methods include “12b-1 arrangements.” Those arrangements, which are authorized pursuant to Rule 12b-1 of the Investment Company Act of 1940, allow fund companies to use fund assets to pay marketing and shareholder service expenses. Those 12b-1 payments must be disclosed on the mutual fund’s prospectus.
Fund companies may also pay for these services by “sharing” a portion of the revenue that they receive with those service providers. These revenue sharing payments are captured as part of the fund’s overall expense ratio, but are not included in the 12b-1 fees disclosed on the prospectus. Thus, they may be difficult to separately identify.