Revenue sharing is an arrangement under which a mutual fund in which pension assets are invested pays a portion of its fees to the entity that services the pension plan. In Leimkuehler v. American United Life Ins. Co., 713 F.3d 905 (7th Cir. 2013), the Seventh Circuit held that the arrangement did not violate ERISA fiduciary duties (at least as implemented in the case at hand). The court provided a helpful explanation of what revenue sharing was in general, and how it fits into the context of the management and operation of a 401(k) plan.

Leimkuehler, Inc. operated a 401(k) plan for its employees. The plan contracted with defendant, AUL, to provide investment services.  One of the services AUL provided was the use of a group variable annuity contract, which enabled individual Plan participants to invest their 401(k) contributions in mutual funds. The investment is not direct, however. Instead, AUL puts all of the plan’s money earmarked for mutual fund investment into a separate account and uses those funds to buy the appropriate funds. Thus, instead of each participant having a separate account with each mutual fund, the whole Plan has a single account with each mutual fund. AUL performs administrative functions of tracking how much each participant invested with each fund, and calculating the value of the participants’ individual “accounts” (among other things).

The court noted that AUL has two ways of recouping the costs of its administrative work and potentially turning a profit. It can charge the Plan directly, or it can receive from the mutual fund company a portion of the fees that the mutual fund charges. The second option is known as “revenue sharing.”  The court noted: “As a general matter, expense ratios [mutual fund fees] and revenue-sharing payments move in tandem: the higher a given share class’s expense ratio, the more the fund pays AUL in revenue sharing. But there is a trade-off for the Plan: “It is also generally the case that the more AUL receives in revenue sharing, the less it charges plan sponsors or participants directly for its services.”

In addition to managing the money invested, AUL also played a role in selecting the universe of mutual funds, and the specific classes of those funds, in which participants could invest. It provided a menu of potential funds to the Plan trustee, who then selects which funds would be available to participants. AUL told the trustee what the expense ratio for each fund was, but not how much AUL would receive from each fund.

Viewed as the Seventh Circuit does, revenue sharing is a perfectly legitimate way of allocating the costs of pension plan administration. AUL is entitled to be paid for its services.  A process where AUL is given part of the fee that the mutual fund would otherwise keep, and then reduces the fee it would otherwise charge the plan, would appear to be a win-win. From that starting point, the court held that AUL did not violate any fiduciary duties to the plan.

First, the court rejected the argument that AUL’s role in selecting a menu of mutual funds and fund share classes from which the Plan would make the final selection does not make it a fiduciary. Particularly, it held that this pre-selection was not a “discretionary” act that would give rise to a fiduciary duty.

Second, though the court agreed that AUL was a fiduciary insofar as it exercised “any authority or control” over the management of the assets in the special accounts that were used to purchase mutual funds, it held that AUL did not violate that fiduciary duty. Thus, the plan did not allege that AUL had failed to credit participants with appropriate gains or income, or improperly withdrew funds. The selection of mutual funds and share classes was unrelated to the management of the accounts.

Third, the Department of Labor, which appeared as a friend of the court, had argued that AUL had the right to substitute or remove funds on its menu, and this power made it a fiduciary, even though it had never, in fact, exercised that power. The court found that accepting the DOL’s position would expand fiduciary responsibilities to entities that took no action with respect to a plan. In other words, AUL’s decision not to exercise its right to substitute funds was not an exercise of discretion sufficient to make it a fiduciary.