News, Vision & Voice for the Advisory Community
The executive branch's endorsement of the fiduciary rule is based on finding that Americans may have to work for an extra three years because of Wall Street overbilling
January 30, 2015 — 9:50 PM UTC by Lisa Shidler
Brooke’s Note: There was news today on this subject — but still no proposal for our perusal. This article will get your mind around what is going on.
It took forever but the White House has endorsed an intense fiduciary standard with a withering attack on the way financial advice is currently applied to the savings of retirees.
A five-page memo sent on Jan. 13, which sent shockwaves in every direction, clearly endorses the Department of Labor’s proposed fiduciary rule, which is set to become public any day, industry leaders say. It could affect attempts at 401(k) reform that have been simmering in Washington all the way back to the days of Enron. See: Warranties and guarantees come to the 401(k) game but can insurance really put the client first?.
The White House’s message to advisors — RIAs and broker-dealers alike — is that their days of charging gratuitous fees and steep commissions in 401(k) plans and individual retirement accounts will no longer be swept under the Oval Office rug.
“This means that the fiduciary proposal is being supported at the highest levels,” says Fred Reish, an ERISA lawyer with Drinker Biddle & Reath LLP.
The memo’s author, namely Jason Furman, chairman of the Council of Economic Advisers, eliminates any doubts about the White House’s intent on this issue. Furman has a Ph.D. in economics from Harvard University but more importantly he helped to craft the Affordable Health Care Act. See: What an RIA needs to know now that health care reform has passed.
Furman’s co-author is Betsey Stevenson, a member of the Council of Economic Advisers. Stevenson is on leave from the University of Michigan’s Gerald R. Ford School of Public Policy and the Economics Department where she is an associate professor of public policy and economics. The memo is entitled: “Draft Conflict of Interest Rule for Retirement Savings.”
Lifeline to fiduciary rule
The memo could be a lifesaver for the DOL fiduciary rules, which were struck down once in 2011, says Rick Meigs founder of the401khelpcenter.com. The Council of Economic Advisors is an agency within the executive office that makes recommendations to President Obama. The authors of the memo are “very senior personnel,” says Reish, who adds that Furman has been a key economic advisor to the president since 2008 and has contributed to most every major proposal Obama has submitted on the economy and jobs.
“Personally, I like the positive enforcement from the White House,” Meigs says. “The DOL needed some political support. The White House coming in like this is very good. I was afraid the industry that represents the brokers was going to win this thing. I’m hoping the DOL is coming to a compromise in what they submit by definition — neither side of the issue will be happy. If both sides are screaming and yelling about it they’ve probably come up with pretty good policy.” See: DOL credits itself for notable evolution in the 401(k) industry — not without criticism.
But such high-level attention by policy-makers with little sensitivity for the practicalities of the matter may have a downside, according Louis Harvey, founder of DALBAR Inc.
“No one will argue that advisors provide a valuable service in preparing America for retirement but instead of encouragement, this and other initiatives discourage that role by taking away compensation,” Harvey says. See: Experts open playbook on retirement plan reform.
Harvey adds that there needs to be a way to compensate all advisors for their guidance in retirement accounts. He notes that many RIAs in the 401(k) arena keep their brokerage license because many small plans don’t want to pay fees and prefer commission. See: Cerulli report: Specialized RIAs likely to win middle-market 401(k) plan battle.
“The solution is to offer a way to compensate advisors for initiating retirement savings. Advisors need a financial incentive to get the 31% of workers who have none and the 60% who have too little for retirement to start/increase savings. If advisors have an alternative method of compensation, they will willingly abandon the 'conflict of interest’ system and energize a saving habit.”
But Furman suggests in his memo that the problem goes too deep for exceptions.
The memo says that that American Investors are losing $8 billion to $17 billion annually because of “conflict” costs. Further, over a period of 30 years, investors lose at least 5% to 10% of potential retirement savings due to conflicted advice, which could result in their having to work three years longer.
“Studies find that investors using financial advisors pay excess fees and that their returns are lower than what they otherwise would be both before and after fees,” the memo states.
It goes on to say: “With brokers advising on approximately $2.8 trillion of IRA assets — even more if employer retirement plan assets are included — the scope for harm to investors is large.”
IRAs at issue
Framing the issue around fees or commissions misses the point, says Jason Roberts, chief executive officer of Pension Resource Institute LLC.
“One of the key takeaways for me, is whether it is commission or fee, we lose track of the value. We should focus on the value. Is a client getting good value if it is conflicted six ways to Sunday? Probably not. But there needs to be an incentive out there for advisors to provide a good value,” Roberts says.
Roberts also fears the final rule based on the White House memo will restrict advisors from providing advice to consumers, particularly as regards IRAs and that the final rule may mandate that advisors who counsel clients on IRAs may need to be fiduciaries. See: Do 401(k) assets require all fiduciary care all the time?.
All agree that the stakes are high for an aging U.S. population. But that makes getting to the right solution all the more urgent.
“Are they using a cannon when you can use a flyswatter?” Roberts asks. “I think they’re lumping all sorts of things together. But the real glaring issue is what they’re talking about and they use the metrics, the average person will have to work longer to make up for commissions but if you looked at someone’s 401(k) plan that had no advice, it generally underperforms. Participants get it wrong and yes, there are fees that go to the advisor, but you have to balance out the fees against the impact if there is no help whatsoever.” See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.
It seems clear the DOL and White House are working to rid the retirement arena of commission assets that could be conflicted, Roberts adds.
The DOL has been tweaking a fiduciary rule regarding retirement accounts for several years. Now dubbed “Conflict of Interest Rule — Investment Advice,” the rule is meant to reduce harmful conflicts of interest by amending the regulatory definition of the word “fiduciary.” The final rule is expected to take into account the types of advice given by advisors to 401(k) plans and IRA holders. See: A four-step plan to cull 401(k) rolls of the accounts of terminated employees.
In 2010, the DOL first laid out a proposal defining the role of the fiduciary, arguing that advisors must act in investors’ best interest. The rule was met with such stiff opposition from the industry that the Labor Department went back to the drawing board. At the time, brokers argued that the proposal would be costly and impact their businesses in a negative way. See: IRA assets could be ripped from the grasp of brokers if DOL has its way.
In 2013, the DOL’s Phyllis Borzi began dropping hints that the refined rule could allow for some conflicts but that fiduciary standards overall would be stiffened. See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.
One purpose of the forthcoming rule is to try to protect investors and their 401(k) and IRA nest eggs from brokers who are only interested in receiving steep commissions. See: As DOL contemplates stiff fiduciary-related penalties on advisors, NAPFA and FPA find rare concord with FSI. RIAs and fiduciary advocates have pushed for measures to eliminate conflicts and ensure investors’ nest eggs are being protected by fiduciaries.
The rule is expected to provide more guidance for advisors who provide advice to retirement plans and IRA holders. The White House and the DOL have said that fee-based advisors should ensure they’re working in the best interest of investors and aren’t getting compensated for conflicted advice. But the White House may also have made concession RIAs will find hard to stomach — like giving conflicted advice on 401(k) plans and IRAs.
The memo states: “The proposal allows businesses to continue using existing, conflicted business models but requires that they adopt additional consumers protections such as ensuring advisors follow a best interest standard, enacting policies and procedures to manage and mitigate conflicts and refraining from certain self-dealing transactions.” See: After years of DOL bluster, new 401(k) rules appear to make RIAs’ low expenses look higher than those of brokers.
The current draft Department of Labor proposal represents a “middle ground between the outright bans on conflicted payments enacted by many countries and the current U.S. policy, which lacks any meaningful protections in the retail IRA market,” according to the memo.
“The proposal allows businesses to continue using existing, conflicted business models but requires that they adopt additional consumers protections such as ensuring advisors follow a best interest standard, enacting policies and procedures to manage and mitigate conflicts and refraining from certain self-dealing transactions,” the memo adds. See: After years of DOL bluster, new 401(k) rules appear to make RIAs’ low expenses look higher than those of brokers.
Is everybody unhappy?
It appears likely that the final rule will be a compromise that will allow brokers to continue offer conflicted advice, something RIAs don’t like. But RIAs may not be off the hot seat either because it appears their fees will be more closely scrutinized.
In the end, it’s quite possible RIAs and brokers alike will criticize the rules.
“If the DOL does their job, I don’t think anyone will be happy,” says Rick Meigs. “The brokers won’t be happy because there will be scrutiny on their commissions. And, I know lots of RIAs for instance that would scream and yell if you tell them this policy require nothing but index funds. The DOL has to be careful because the criteria can’t just be on costs alone,” Meigs adds.
Assets in retirement accounts are climbing rapidly. On Thursday, Boston-based Cerulli Associates released data saying that by the end of this decade total private defined contribution assets will near $6.5 trillion. See: Fidelity Investments recognizes power of RIAs in 401(k) market and has increased efforts to work with advisors.
Although RIAs and broker-dealers often find themselves on different sides of the regulatory fence, Jim O’Shaughnessy, an advisor at Sheridan Road Advisors, says it is impossible to manage retirement assets purely on fees with no commission assets at all. He has stayed away from becoming a pure RIA because of smaller employers who only want to pay commissions rather than a adopt a fee-structure. He uses LPL Financial as his broker-dealer but works with more than a dozen recordkeepers. See: What swayed me to the hybrid cause after an early indoctrination as a 'pure RIA’ disciple.
The White House memo hits all of the negatives regarding fees by citing worst-case scenarios, O’Shaughnessy says.
“For the most part, I believe the industry and the average advisor has the best interests of clients at heart and won’t take advantage. They’re broad-brushing everyone and saying that everyone is doing it. Whenever I see something like this, it’s subjective and they’re making broad generalizations but I do think there are abuses out there. They use the phrase financial advisor very broadly.”
Sheridan Road Advisors has $11 billion in retirement assets and about $200 million in wealth management assets. About 30% of the firm’s plans are broker-dealer assets but represent less than 5% in terms of total assets. About 95% of the $11 billion in assets are fee-based relationships.
In O’Shaughnessy’s view, the perfect 401(k) plan would have a plan sponsor paying 100% of fees as a direct expense. The problem is, less than 5% of clients are actually doing that. “I think that number will increase dramatically. Most plan sponsors and most of our clients want to lower the fees where they can and where it is appropriate without hurting services,” he says.
The real problem
RIAs should brace themselves for some unwanted changes, says Craig Watanabe, an advisor with Penniall & Assoc. Inc. in Pasadena, Calif.
“I am all in favor of the DOL modifying the definition of a fiduciary because I believe it represents a step forward for investors,” he says. “Many RIAs believe their advice is 'conflict-free’ which is not true but especially so in an ERISA context. I have seen conflicted practices by RIAs in the retirement space that have not been in the investors’ best interest but I doubt they will ever be quantified.” See: RIAs join move to right a 401(k) wrong: Lopsided plan expenses — a non-DOL issue.
When the Department of Labor releases the proposed regulation it will be submitted to the Office of Management and Budget. Once it is submitted, there is a period of time for comments before it would be finalized.
Harvey thinks that if legislators truly want to entice small businesses to start up 401(k) plans, they should offer up deductibles to any small business owner who pays a flat fee to an advisor to start up their 401(k) plan. The fee could be at $1,000 to $5,000, but it would help entice advisors to work with startup plans without depending on commission.
Right now, there is little incentive to help start-up 401(k) plans, Harvey says.
“The overarching issue is they’re failing to solve the social problem.”
Mentioned in this article:
Pension Resource Institute, LLC
401k Plan Consultant
Top Executive: Jason C. Roberts
Retirement Law Group, PC
Top Executive: Jason C. Roberts
Sheridan Road Financial
Top Executive: Jim O'Shaughnessy
Share your thoughts and opinions with the author or other readers.