Why companies should never use a broker to “manage” their plan

A broker cannot legally provide advice or act in a fiduciary capacity.  Rather, a broker can only earn percentage-based kickbacks known as 12b-1 fees from mutual funds which creates a major conflict of interest because some mutual funds don’t have any kickbacks – which means a broker can only make money by recommending certain funds.  Only a registered investment advisor can act in a fiduciary capacity and provide actual advice because this type of advisor does not receive any kickbacks.  This short video also illustrates the difference:

Butchers v Dietitians Brokers v Advisors Suitability v Fiduciary:


This article further explains:

Conflicts of Interest Cost Retirement Plan Investors Billions:


•   By using affiliated mutual funds, brokers are not acting in the client’s best interest. This is the focal point of the fiduciary standard. Eliminate the conflicts of interest in terms of giving advice, and investors will immediately benefit.  It doesn’t mean eliminating brokers, it just means eliminating the claim that brokers are giving advice. They are not.  Advice requires a fiduciary duty.  Brokers don’t (and shouldn’t) have to operate under the regimen of a fiduciary duty.  Brokers don’t give advice.  They trade.

 Furthermore, many plan sponsors are actually under the impression that a broker somehow helps them meet their fiduciary responsibilities.  This is simply not possible, as a broker is not only not a fiduciary, but a party whose very existence inherently places plan sponsors at greater risk.

First, a broker can only get paid a percentage-based kickback that is deducted out of participants’ accounts, so if plan sponsors wanted to limit their expose to excessive participant fees by writing their broker a check, they would not be able to do this.  Second, a broker can typically only make money from more expensive actively managed funds (or index funds which are significantly more expensive that the least expensive available index funds such as the Vanguard Total Stock Market Index Fund – VTSAX – which has a cost of only 0.05%) which require significantly more monitoring than less expensive passively managed index funds.  This additional required monitoring makes an investment policy statement (a written description of a plan’s investment related decision making process) more difficult to follow.  Third, because a broker can only charge a percentage-based fee rather than a flat fee based on how much actual work there is to do, there is a greater chance that the broker’s fees will not be considered reasonable in light of the services provided.

Unfortunately, everyone still continues to falsely believe that a broker is “free” because the mutual funds pay the broker.  This belief isn’t true as explained below:

“The first form of revenue sharing, 12b-1 fees, is used for the cost of the sale, or distribution, of investments. The fee is deducted from the assets of the mutual funds and thus is charged directly to the participants invested in that fund. The fee is ordinarily paid to a broker-dealer as a part of the distribution of the mutual fund. However, for small plans funded with group annuity contracts, it may be paid to subsidize the recordkeeping costs.

The second form of revenue sharing, subtransfer agency fees (or sub-TA fees), are also deducted from the mutual funds’ assets. A mutual fund must maintain records of its shareholders and may properly pay for that service. Where an intermediary, like a record keeper, maintains those records, the mutual fund pays the record keeper for that service. Sub-TA fees are typically fixed fees on a per-participant basis or asset-based fees, or a combination of both. [Pozen, Robert C., The Mutual Fund Business. Boston: Houghton Mifflin Company, 2002.] The transfer agent also provides other shareholder services, such as administration, compliance, communications, and other operational services; the fees for these services, in the aggregate, are referred to as shareholder servicing fees.

The third form is that the mutual fund investment management firm, or an affiliate, may pay a portion of its management fee to a third party as a form of revenue sharing. For example, a mutual fund manager or affiliate may pay a bonus payment to a broker/dealer based on a specified sales goal or total volume of business retained. The source of this money is the fee for managing the portfolio of securities held by the mutual fund that is charged to the fund by the investment manager. Management fees are also charged directly to the mutual fund’s assets, thereby reducing participants’ benefits.”


“Mutual funds also may charge what are known as Rule 12b-1 fees, which are ongoing fees paid out of fund assets. Rule 12b-1 fees may be used to pay commissions to brokers and other salespersons, to pay for advertising and other costs of promoting the fund to investors and to pay various service providers of a 401(k) plan pursuant to a bundled services arrangement. Some mutual funds may be advertised as “no-load” funds. This can mean that there is no front- or back-end load. However, there may be a 12b-1 fee.”



Why most plans should not have an investment policy statement

An investment policy statement (IPS) is a written description of a plan’s investment related decision-making process.  While not required, the prevailing view is that any company offering a retirement plan should have this document in place because it will help provide protection from fiduciary liability.  In fact, the Department of Labor will regularly ask for this document in the event of a plan audit.

However, it is actually a bad idea for most companies to have an IPS because they likely will either not follow it or not sufficiently document the process.  The reason is that most companies have a large number of asset classes and fund choices, most of which are actively managed.  As a result, the process becomes extremely complicated to follow.  Here are some examples of questions that come up:

  1. Under what circumstances will the fund managers be replaced?
  2. What happens if the style of the fund changes?
  3. How should the performance standards of the fund managers be determined?
  4. How should these decisions be documented?

There are likely many more questions that companies need to answer, but the idea should be clear:  most plans are set up in a way that makes it extremely difficult to follow and document the steps in an IPS.   Consequently, it’s safer not to have one at all.

Uncovering the corruption, excessive and hidden fees, and conflicts of interest in the retirement plan industry