RIA competitors (i.e. brokers) face daunting challenge of explaining complex revenue-sharing arrangements

October 15, 2010 — 4:47 AM UTC by Elizabeth MacBride

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By next January, about 72 million people with 401(k) plans will see, regularly, and in a relatively clear fashion, all the fees they are being charged for investments in and administration of their plans.

Long-awaited Department of Labor rules, released in final form yesterday, require plan fiduciaries, typically the companies sponsoring the plans, to make the disclosures to their workers.

This latest regulation is the second wave of disclosure rules. The first, released in July and going into effect next July, requires investment products companies to disclose their fees to plan sponsors.

Pressure on fees

Experts said the two new regulations would hit the business like a slow-moving tsunami because the disclosures will put pressure on investment companies, plan sponsors, advisors and brokers to lower all kinds of fees.

“The impact of both of them together is going to be huge,” said Louis Harvey, president of Boston-based DALBAR Inc.

In the short-term, the new regulation probably favors fee-based advisors because their fees are easy to disclose. Brokers face the difficulty of explaining complex compensation arrangements to companies and workers.

Sean Cunniff: Having access to the information is going to put more pressure on brokers who sell plans in a revenue sharing arrangement and accelerates the trend toward an RIA fee-only model
Sean Cunniff: Having access to the
information is going to put more
pressure on brokers who sell plans
in a revenue sharing arrangement and
accelerates the trend toward an RIA
fee-only model

“Having access to the information is going to put more pressure on brokers who sell plans in a revenue sharing arrangement and accelerates the trend toward an RIA fee-only model,” said Sean Cunniff, research director, brokerage and wealth management service of TowerGroup of Needham, Mass.

An immense opportunity for RIAs

There is another potential boon for RIAs, too – if they step in to offer their services to help companies explain the disclosures to workers or help companies prepare the disclosures. Of course, advisors will come under pressure, too, to justify their fees.

“The opportunity for qualified advisors is immense,” Harvey said. “But any advisors that have been riding the gravy train will have to get off.”

Ryan Alfred, the co-founder and president of San Diego-based BrightScope Inc., which rates 401(k) plans, called the regulation a “very, very big deal.”

“The two thirds of retirement plan participants who believed they weren’t paying any fees are going to realize that their retirement plan is not free,” he said. “This is going to put a lot of pressure on advisors and providers to justify the fees they are charging. A disciplined process of benchmarking fees is absolutely critical. Advisors that don’t implement benchmarking procedures for their retirement plans are going to be vulnerable.”

Some in the industry are worried the regulations could have a short-term negative impact on investors, because they won’t understand what they’re seeing (here’s a model of the disclosure document prepared by the DOL).

Ryan Alfred:This is going to put a lot of pressure on advisors and providers to justify the fees they are charging.
Ryan Alfred:This is going to put
a lot of pressure on advisors
and providers to justify the fees
they are charging.

“Keep in mind that participants aren’t used to seeing these fees, don’t know how to determine what is reasonable and decade long returns are barely positive for most. Participants are also being squeezed by the new economy. As a result, some may reduce or stop saving,” said Phil Chiricotti, president of the Center for Due Diligence, an information firm serving the retirement plans industry from Western Springs, Ill.

More to come

The disclosure regulations are part of a larger overhaul of 401(k) rules. Still to come are the final regulations on who will be permitted to advise 401(k) plans and under what compensation arrangements. See Why the DOL’s proposed 401(k) rules could ding brokers and leave the spoils to RIAs, and IRA assets could be ripped from the grasp of brokers if DOL has its way.

It was clear back in July that the DOL was embracing disclosure as one major component of its effort to lower costs in 401(k) plans. But this regulation, which took many by surprise, ups the ante because it means fee information will be passed on to workers.

All it will take is a few interested and skeptical employees in a firm to put pressure on a company to change its 401(k) status quo, Harvey pointed out. That puts a big onus on investment products companies, especially those that provide the mutual funds that are ubiquitious in 401(k) plans, to be clear and cheap – or if they’re not, to be able to explain why.

“We’ve been anticipating it for a while and have been preparing for the changes,” Jenny Engle, spokeswoman for Fidelity Investments. “We embrace the efforts to improve disclosure.”

Are brokers prepared?

Brokerage firms may also have difficulty – or at least face an adjustment – as they calculate fees to supply the information to the plan sponsors.

“Most brokerage firms have revenue sharing arrangements with mutual fund companies and under this new regulation I believe this will need to be disclosed,” said Craig Watanabe, principal with Penniall & Associates, Inc., an RIA in Pasadena, Calif. Penniall & Associates has about $600 million in 401(k) assets under management. “This will be challenging because revenue sharing is typically not broken down by client.”

Craig Watanabe:The 401k industry is addicted to 12b-1 fees. Many fee-based advisers have already weaned themselves from 12b-1 fees and those that have not probably will be forced to do so very soon.
Craig Watanabe:The 401k industry is addicted
to 12b-1 fees. Many fee-based advisers
have already weaned themselves from 12b-1
fees and those that have not
probably will be forced to do
so very soon.

“There is also the issue of disclosing unlevel compensation in the form of 12b-1 and sub-TA fees. The 401(k) industry is addicted to 12b-1 fees. Many fee-based advisers have already weaned themselves from 12b-1 fees and those that have not probably will be forced to do so very soon.”

According to the DOL, the final regulation requires plan fiduciaries to:

• Give workers quarterly statements of plan fees and expenses deducted from their accounts.
• Give workers core information about investments available under their plan including the cost of these investments.
• Use standard methodologies when calculating and disclosing expense and return information to achieve uniformity across the spectrum of investments that exist in plans.
• Present the information in a format that makes it easier for workers to comparison shop among the plan’s investment options.
• Give workers access to supplemental investment information in addition to the basic information required under the final rule.

The regulation will go into effect on Dec. 14 and apply to retirement plan years that begin on or after Nov. 1, 2011, which means that calendar-year plans would have to adhere to the rule as of January 2012.

Click here for a model chart showing what the disclosure would look like for plan participants.

Brooke Southall contributed to reporting this article.



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