I found myself pondering how conflicts of interest under ERISA and the Internal Revenue Code arise in retirement plans — particularly when fiduciaries receive third-party compensation tied to investment decisions. Going beyond that, it is instructive to think about how these situations can trigger prohibited transactions and what plan sponsors should do to mitigate risk.
The most frequently cited conflict of interest appears to be in the revenue sharing arena. Revenue sharing is built into certain mutual fund share classes and that revenue can be given to the advisor as compensation when a participant contributes to that mutual fund.
There are share classes of mutual funds that may not include revenue sharing (typically, the institutional share class or the R6 class). What is baffling to me is why a 401k advisor would not opt for the lowest fee version of a mutual fund as offered on the record keeping platform.
As near as I can suss out, when a fiduciary (such as a registered investment advisor) accepts custodian revenue sharing in exchange for investing plan assets in certain funds (e.g., no-transaction-fee share classes), that arrangement can constitute self-dealing, which is a prohibited transaction under ERISA §406 and the Internal Revenue Code.
This applies whether the compensation is direct or indirect and includes typical revenue sharing arrangements that influence investment recommendations.
I can appreciate that an advisor might take over a retirement plan that has these types of share classes in it but wouldn’t it behoove the advisor to change that? Wouldn’t that be something the advisor would have brought up when they were talking with the plan sponsor about a possible take over of the plan?
Complicating things is that the prohibited transaction rules apply only if the advisor is a fiduciary under ERISA or the Code. If the advisor is not acting as a fiduciary, the revenue sharing issue still raises conflict-of-interest concerns, but a prohibited transaction liability may not attach. My view is that whether an advisor is a 3(21) fiduciary or a 3(38) or not a fiduciary at all, it is essential to follow the Prudent Person rule and Duty of Loyalty in making investment decisions.
Of course, nothing in the 401k world is ever as it seems. The rule, Prohibited Transaction Exemption 2020-02 can cure what would otherwise be a prohibited transaction — if all conditions are met:
- Impartial Conduct Standards — best-interest conduct, reasonable compensation, best execution, and no materially misleading statements.
- Full Disclosure — acknowledgment of fiduciary status and material conflicts, including custodian revenue sharing.
- Policies and Procedures — documented, implemented controls to adhere to best-interest standards.
- Annual Retrospective Review — documented compliance review and certification by senior management.
The thing I ponder is how to you prove impartial conduct? Would a court review every investment discussion that an advisor had with a participant? Does one look at the preponderance of where funds are allocated in a 401k?
My “Homework” for Plan Sponsors
- Assess All Revenue Sharing
Plan fiduciaries must understand whether any adviser compensation is tied to investment choices — including indirect or “soft” revenue sharing — as this creates a conflict the law forbids absent exemptive relief. - Require Transparent Disclosures
Sponsors should demand clear written disclosures of revenue sharing and conflicts before investment decisions are made, not after. - Evaluate Adviser Status and Compliance
Confirm whether external advisers are acting as fiduciaries under ERISA/Code and that they satisfy the exemption conditions if they receive conflict-creating compensation. - Document Process & Reviews
The prudent process — including how conflicts were identified, evaluated, mitigated, and reviewed — must be thoroughly documented in committee minutes and compliance files. - Consider Fee Offsets Where Appropriate
If exemptive conditions can’t be satisfied and third-party compensation is received, consider offsetting that compensation against the advisor’s fees to avoid prohibited self-dealing.
The Parting Glass
From a governance and risk-management perspective, sponsors cannot treat revenue sharing as a benign line item. Even “industry standard” arrangements that tie compensation to investment choices can expose the plan to prohibited transaction risk and heightened DOL scrutiny. Sponsors must adopt robust procurement and oversight practices, ensure advisers have no incentive misalignment, and insist on complete transparency before any recommendation. Failure to do so increases fiduciary liability exposure and undermines the duty of loyalty under ERISA.