Gross-to-Net pricing versus
“Fee Normalization”
A superior new solution from BPAS
A presentation for Plan Sponsors, Trustees and Advisors prepared by BPAS
1
The concern of Congress and the DOL in proposed
fee regulations? It is impossible to be objective
when a provider is paid like this:
70
60
60
= Mutual
fund
revenue
sharing
(basis
points)
50
50
40
30
50
40
35
25
20
10
0
A
B
C
D
E
This “incurable conflict of interest” will impact:
 fund selection
 fund monitoring, recommendations over time
 participant education and advisory services
F
2
What is ‘gross to net pricing’ (a.k.a., the
ERISA budget approach) ?



A methodology for handling retirement plan fees
Has been in use since 1997 (initially contemplated in DOL
Advisory Opinion 15A to Frost Bank, which required a dollarfor-dollar offset of revenue sharing against the provider’s fee
schedule to eliminate any conflicts of interest)
The concept:

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
Most mutual funds feature various forms of “revenue sharing”
As plan assets increase, revenue sharing dollars also increase
At some point, revenue sharing may exceed the providers’
aggregate costs for servicing a plan
The concept: identify and isolate excess revenue sharing, then
allocate it back to the participants in the form of enhanced
earnings
Goal is to achieve more value for plan participants, maximize
wealth creation
3
What is the basic math used in
gross-to-net pricing (GTNP)?


Identify the total revenue sharing that is generated by a plan’s funds
(A)
Identify the total costs of servicing the plan (B)

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




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Recordkeeping fees
Clearing and custodial fees
Trustee or Advisory Fees
Fees for additional education services or communication tools
Other plan-eligible expenses (audit costs, legal fees, consulting, etc)
Note: Together, these amount to a considerably larger figure than plan
sponsors are used to seeing since there are no asset-based subsidies
Deposit all revenue sharing to a segregated trust account in the name
of the Plan. Pay all expenses from this account.
A – B = C.


At the end of the year, if C > 0, a surplus exists. This would be allocated
back to participants in the form of enhanced earnings (similar to a profit
sharing allocation, but pro-rata based on account balances)
At the end of the year, if C < 0, a deficit exists. This can either be paid by
the plan sponsor or charged to the plan as a fee allocation (e.g., a negative
allocation of earnings, based on account balances)
4
An illustration of GTNP
a hypothetical plan with 9 funds, 420 participants, $13.6 million in assets
Total revenue sharing generated = $53,235 / year (A).
70
60
60
Total revenue
sharing paid
by each fund
in the plan in
basis points
(from all
sources)
50
50
40
50
40
35
35
30
20
15
10
0
0
Assets in
each fund:
1.
2.
3.
4.
A
$1.75M
B
$2.9M
C
D
$2.85M
$1.65M
E
$650k
F
$1.4M
(Vanguard
Fund)
0
G
$910k
H
$950k
I
$550k
(Vanguard
Fund)
Total revenue sharing = $53,235 / year (A). (This equals 39.1 basis points on $13.1 million of assets)
Assume annual servicing costs are $40,000 (B)
53,235 – 40,000 = $13,235, which is a surplus (C)
After paying expenses, this surplus would be applied to all participants as an additional earnings credit
of 9.72 basis points on account balances ($13,325 / $13,600,000)
Unfortunately, there is a critical problem with GTNP
Total revenue sharing = $53,235 / year (A).
70
60
60
Total revenue
sharing paid
by each fund
in the plan in
basis points
(from all
sources)
50
50
40
50
40
35
35
30
20
15
10
0
0
Assets in
each fund:
1.
2.
A
$1.75M
B
$2.9M
C
D
$2.85M
$1.65M
E
$650k
F
$1.4M
(Vanguard
Fund)
0
G
$910k
H
$950k
I
$550k
(Vanguard
Fund)
If a surplus of $13,235 exists: a participant with $50,000 in fund F paid $0 in fees, then receives an
earnings allocation from other participants of $48.62, while a participant with $50,000 in Fund C paid $300 in
fees then receives an earnings allocation of $48.62. This $300 difference in fees (60 basis points) is
significant, and very difficult to justify from an ERISA perspective.
If a deficit of $20,000 exists: a participant with $50,000 in fund F paid $0 in fees, then is charged $73.47
or 14.7 basis points in the year-end fee allocation, while a participant with $50,000 in Fund C paid $300 in
fees during the year plus $73.47 in the year-end fee allocation, for total fees of $373.47. This $300 difference
in fees (60 basis points) is significant, and very difficult to justify from an ERISA perspective.
Aside from the “fee fairness problem”,
what other problems does GNTP present?

Timing problems from participants coming and going; the allocation is
only performed periodically (typically annually), based on a snapshot


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New participants receive undue share of earnings or fees from prior period
Participants who take distribution before end of year do not participate in earnings or fee
allocation if they are no longer in the Plan when the ‘snapshot’ is taken
Added cost of accounting for all 12b-1s, shareholder servicing fees and
sub-transfer agent fees (requires plan-level registration), then
performing additional earnings or fee allocation at year end
Audit risk – revenue sharing must be handled with extreme care; since
these are plan assets, improper use can give rise to Prohibited
Transaction
Annual plan audit must include this process. Also, existing trust
statements may now be inaccurate since they do not cover activity in
the ‘recapture account’.
Relies entirely on 12b-1s to generate revenue sharing for use in the
process; this is a very arbitrary way to cover plan expenses. This
philosophy would eliminate many funds from consideration simply
because they don’t offer revenue sharing (institutional share classes,
Vanguard, Dodge & Cox, T. Rowe institutional, and many others).
Communicating all of this to participants
7
Is there a better answer? Absolutely.
“Fee Normalization” from BPAS


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
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Can cover recordkeeping, clearing and custodial, and Trustee / Advisor
fees in a single, automated process
Eliminates all fairness problems of GTNP – all participants pay the
same percentage of total costs, regardless of their asset allocation
Allows a plan to use any combination of funds or share classes,
including pure institutional funds, getting the best deal for participants
Eliminates timing problems from participants coming and going
No quarterly, semi-annual or annual true-up (one automated monthly
routine)
No after-the-fact allocation of earnings or expenses
No outside trust or set of records for revenue recapture account
Very little audit risk – entire process is consistent and automated
BPAS’ certified trust statements cover all activity
BPAS is responsible for all accounting, revenue collection and payment
functions (plan sponsors and financial intermediaries like this)
Can be reviewed every 12, 18 or 24 months for any macro-level
adjustments; keeping it competitive and equitable for all parties
8
How normalization works
a hypothetical plan with 9 funds, 420 participants, $13.6 million in assets.
Assume that BPAS needs 30 bps, Trustee / Advisor needs 30 bps to support plan
70
60
= revenue
sharing
(including
sub TA’s)
50
= custodial fee
added by
BPAS
30
10
10
20
25
40
20
25
45
50
60
60
35
40
10
50
60
35
15
0
Assets in
each fund:
A
$1.75M
B
$2.9M
C
$2.85M
D
$1.65M
E
F
G
H
I
$650k
$1.4M
$910k
$950k
$550k
(Vanguard
Fund)
(Vanguard
Fund)
A fee is applied at the fund level to “normalize” plan-level revenues at 60 basis points across all funds. The
custodial fee is applied in even monthly increments. Assets in Fund A would be charged 2.08 basis points /
month (25 / 12); assets in Fund C would not have an additional charge; and assets in Funds F and I would
be charged 5 basis points / month (60 / 12). BPAS would collect all revenues, pay the Trustee / Advisor 7.5
basis points per quarter (30 bps / year), and retain the remainder as its fee. Other costs can be included in
the “funnel” as well. The normalization level be reduced by a corresponding amount if the plan sponsor
wishes to have part of the fees invoiced; therefore, this approach is both accurate and flexible.
Why is this the best approach?


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Accomplishes the goals of GTNP pricing without all the downsides
Eliminates all conflicts of interest, for all parties, initially and ongoing
Makes the entire universe of funds available for consideration, not just
A, R, R4 or other funds with revenue sharing (true open architecture)
All participants pay the same portion of fees, regardless of asset
allocation decisions
100% consistent with new regulatory environment on fees through
level compensation
Accomplished in one pass without timing problems or a separate trust
account
Automatically adjusted when individual fund revenue sharing levels
change or more revenue is negotiated
Does not impact audit or certified trust statements
Keeps the plan sponsor, participants and providers on the same page
at all times
Can be provided as part of an overall fee schedule that includes fixed
dollar fees (e.g., annual base fee, per participant charge, etc).
Therefore, some fees could be asset-based while others are fixed
dollar.
10
Other issues to consider
 If fee inequities exist within a plan, it will become a
glaring problem under 404(a)(5) when participants
with a similar balance compare their statements
 Six major court cases have been brought by
Schlichter Bogard & Denton (St. Louis) in regards to
retirement plan fees (General Dynamics: $15.1 million
settlement, Caterpillar $16 million settlement, etc)
 Edison International is most glaring example: $1
billion plan used three retail mutual funds alongside
institutional share classes, apparently to generate
enough revenue to cover fees. Judge ruled in
plaintiffs’ favor. Damages have not yet been
determined.
 Read Reish white paper for more on this topic
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The best solution for large plans
 Relying on revenue sharing is a very arbitrary way to
cover costs

Think of a lamp with “off, medium and high” settings
versus a dimmer switch
 For a $30 million plan with 600 participants, a
hypothetical fee might be 22 basis points for
recordkeeper, 21 basis points for the advisor
 Through this approach, revenue can be normalized
exactly at 43 basis points for each fund
 “Dial up exactly the revenue that is needed to service
the plan, without overshooting the target or having to
plow back excess revenue sharing. Do it in one pass with
no audit, timing or fairness issues among participants.”
12