Phil Chiricotti speaks out on broker-sold commissions, RIA fees and heresy
The 401(k) expert says RIAs generally lack the qualifications to work in the retirement assets market -- and may charge too much
Brooke’s note: This no-nonsense column adds a strong voice to the ongoing discourse about the growing participation of RIAs in the 401(k) market. Many experts applaud the entry of more SEC-registered into this realm. Phil Chiricotti sees the potential for trouble. This column builds on a rigorous debate he helped spark at RIABiz. To read it, click here. It’s carried out in the article’s comments section. Please comment for this article below or contact us about writing a countering or story-advancing column.
Good, bad or indifferent, ERISA is what it is. It may not be fashionable to acknowledge it, but ERISA is based on process rather than results. To avoid liability, the rules must be followed and documentation must be maintained. Regardless of sponsors’ approaches to delegation, they cannot be relieved from their fiduciary responsibility and or liability.
While outcomes are important, sponsors are not obligated to offer a retirement plan or to ensure that participants achieve financial independence. It may be desirable, but sponsors also are not required to provide investment advice or education to their plan participants. They are, however, required to administer their plan in accordance with ERISA.
401(k) plans are the most successful retirement savings plan ever initiated. Like all retirement plan structures, investments held in 401(k) plans suffered during the 2008 meltdown. 401(k) plans were not the cause of the meltdown, but rather a victim. Over time, equally weighted multi-asset portfolios with annual rebalancing have improved performance and reduced risk. However, other than cash, stable value or treasuries, all asset classes suffered during the meltdown.
Once a participant’s initial allocation is determined under an employer-sponsored plan, participants make very few changes. Thus, participants generally do not buy high or sell low inside their employer-sponsored plans. While some allude to it, navigating major market losses through market timing is simply not possible. RIAs and other advisors who position around this nonsense should be eliminated from the RFP process.
Rigorous due diligence
There are always exceptions, but mid to large plans that use institutional investment vehicles do not incur high expenses. In addition to having low expenses, the investments held by plans of size are generally subjected to rigorous due diligence far beyond the analysis provided by small practitioners.
Plan participants encouraged to rollover their assets and work with an advisor may benefit from that relationship and expanded choice, but their investment related fees are often much higher under that arrangement. While the increased fees applicable to rollover accounts are rarely discussed, the services offered may or may not justify the added cost.
While mid to large plans incur low expenses, small plan expenses are all over the map. Fees are directly related to plan assets and small plan expenses are generally high because they lack assets. Small plans also generally pay advisory fees as well as recordkeeping/administrative fees from plan assets.
It may sound like heresy, but small plan RIA fees are comparable to the commissions embedded in broker-sold products. In many cases, they are actually higher. Assuming a 1% asset-based RIA fee and $3,500 in fixed recordkeeping/administrative costs, a $500,000 plan with 50 participants would incur a 1.70% expense structure before considering investment-related expenses.
Given their low asset base, small plans should consider alternative savings vehicles before installing a 401(k) plan. Participants would also benefit if the advisory fees and or recordkeeping/administrative costs were paid from corporate assets rather than deducted from the plan.
When lacking the required expertise, retirement plan sponsors could benefit from hiring an independent qualified fiduciary advisor, but they cannot be entirely relieved of their fiduciary responsibility or liability under ERISA. Given that hiring an advisor is a fiduciary act, sponsors must evaluate and monitor the advisor on an ongoing basis, no small task.
Fuel for litigation
Once hired, the advisor could provide a defense or fuel for litigation. Risk mitigation and shared liability are two of the primary reasons sponsors hire advisors, but many advisors lack the insurance and capital to underwrite a claim, particularly small independent RIAs.
Although it could change over time, very few sponsors retain advisors for anything other than investment advice today. When considering an expanded fiduciary role for the advisor, the advisor should educate the sponsor to the point where the sponsor can make an informed decision that meets their plan and participant objectives.
The licensing, insurance, educational, supervisory and capital requirements to become an independent RIA and accept a fiduciary role are too low. While the independent fiduciary concept has been around for many years, a budding trend is encouraging ill-equipped generalists to adopt the RIA business model to grow their business.
While this may make sense from a distribution standpoint, encouraging RIA generalists to sell ERISA plans without the proper credentials and resources perpetuates the substandard sponsor experience.
Forget on-the-job ERISA training
Higher standards and disclosure are good things, but regardless of their registration status, generalists of any stripe are not qualified to service ERISA plans, particularly in a full scope capacity or as an investment manager. ERISA is not the place for on the job training and this trend may not end well. Generalists, including RIAs, who wish to enter this space, would be wise to team with others who specialize in ERISA plans.
In the end, the sponsor process of hiring an advisor boils down to one question and it has nothing to do with registration or fiduciary status. The suitable question to ask is: Do you have the knowledge, experience, skills, scale and resources to guide us and help us make prudent decisions? Anything less is arguably a fiduciary breach.
Ignoring flawed surveys, 50% of today’s small plan business consists of broker of record (BOR) changes. Given that BOR turnover has increased sharply in recent years, one must conclude that advisors are not delivering the promised services or they don’t know what services to deliver.
This lack of sponsor satisfaction validates the need for a plan sponsor to thoroughly evaluate the advisor through a documented and prudent process, including the determination of fee reasonableness for services rendered. This requirement is now specifically articulated in the new ERISA 408(b)(2) regulations.
There are many different fiduciary titles and almost 30 different categories of services advisors provide to retirement plans. As a result, the advisor’s fees and services must be contrasted against comparable fees and services from other qualified advisors.
Rather than engage in industry cheerleading, we will continue our efforts to turn the retirement plans advisory industry into a profession. As a result, subsequent articles will discuss how sponsors should evaluate plan and participant level advisors as well as how independent fiduciary advisors should position themselves.
Center for Due Diligence
The CFDD is an independent information and strategic resources firm serving the retirement plans industry. The CFDD provides unbiased resources, industry leading conferences, ERISA Advisor Evaluation services, internet broadcasting, new media marketing and online advertising. We can be reached by phone at (630) 662-0284 and by email atCFDD@TheCFDD.com.