Mutual fund share-classes are back on the radar again. Although advisors have long been obligated to make proper share class recommendations for their clients, the Department of Labor’s fiduciary rule has brought new attention to the proper choice of share class in 401(k) plans.
According to an e-blast released by the Wagner Law Group in January of this year, the SEC’s Office of Compliance Inspections and Examinations (OCIE) has increased its scrutiny of share-class selection in 401(k) plans over the past few years and plans to make it an ongoing examination priority.
To keep themselves out of trouble, advisors and plan sponsors must pay close attention to their share class choices, ensuring that decisions made are in the best interest of the client and that the client receives best execution. It’s more critical than ever to avoid high loads, distribution fees, and conflicts of interest.
A Move Towards “Fiduciary Shares”
Although change in the financial industry often takes time, new product lines are coming to the market to address these fee concerns. The introduction of “Fiduciary Shares” also known as “T-shares” or “Clean shares” give advisors and plan sponsors more appropriate options for company retirement plans. Like many early improvements, however, the transition hasn’t been perfect. One of the primary concerns is the confusion that has been created by the terminology used to describe these new funds, particularly the distinction between T shares and clean shares.
The Definition of a Clean Share
True “clean shares” are the Z-share class, characterized by a complete lack of 12b-1 fees, front-end loads, deferred sales costs, or any other expenses to cover distribution costs. The only expenses included in this fund share-class are there to cover the actual cost of maintaining the fund.
The “clean share” fee structure is perfectly suited for an open-architecture arrangement. This allows advisors, recordkeepers, and other third-party service providers clearly disclose their fees and charge directly for their services instead of bundling them into mutual-fund charges. Since plan sponsors are ultimately responsible for understanding all plan costs and ensuring that they’re reasonable, this additional fee transparency is a major benefit.
Mutual fund T shares are another investment option that was born from efforts to comply with the fiduciary rule. These share classes offer a uniform charge across all mutual fund categories. This means that investors would pay the same expense ratio whether they chose to invest in an international fund, equity fund, small cap, or other option. Although this may help reduce potential conflicts of interest, T-share mutual funds should not be confused with the clean share class.
While the SEC has approved both clean share and T-share classes, it’s likely that more lawsuits will arise regarding appropriate share class selection. The court’s decisions will ultimately influence the direction of the industry. In the meantime, advisors and plan sponsors must clearly understand every aspect of their 401(k) plan and ensure prudent decision-making.
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