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AdvisorNews - October, 2012

Participant Fee Disclosures for Brokerage Windows   

Final Rules – DOL Reg. § 2550.404a-5     Field Assistance Bulletin 2012-02, Q&A #13     

[§ 2550.404a-5(c)(3)(ii)]     General Plan Information – Initial/Annual Disclosure:
· Description of any brokerage window that enables participants to select investments other than DIAs, sufficient to enable individuals to understand how the brokerage window works, including:
o How/to whom to provide instructions.
o Account balance requirements.
o Restrictions/limitations on trading, if any.
o How brokerage window differs from DIAs.
o Contact information.
· Sufficiency of description depends on facts and circumstances.

Individual Expenses – Initial/Annual Disclosure:
· Explanation of any fees or expenses that may be charged against a participant’s account on an individual basis, including:
o Fees/expenses for starting, opening or initially accessing the brokerage window,
o Fees/expenses for stopping, closing or terminating access to the brokerage window,
o Ongoing fees/expenses necessary to maintain access to the brokerage window, including inactivity and minimum balance fees,
o Commissions/fees charged in connection with the purchase/sale of a security, including front or back-end sales loads.
· Does not include fees or expenses of the underlying investment selected by the participant (such as 12b-1 or similar fees included in the expense ratio of the investment).
· In the event fees or expenses are not known or readily ascertainable by the plan administrator, must provide:
o General statement that such fees exist and may be charged against the individual account,
o Directions as to how to obtain information about such fees in connection with any particular investment,
o Advise participants to ask the brokerage window provider about any fees (disclosed or undisclosed) associated with the purchase or sale of a particular investment.

Individual Expenses – Quarterly Disclosure:
Include a statement of the dollar amount of fees and
expenses actually charged during preceding quarter in connection with the brokerage window, including:
· Description of services,
· Clear explanation of charges (i.e., $19.00 brokerage trades, $25.00 minimum balance fee).

In addition, FAB 2012-02, Q&A # 30, added the new requirements for brokerage windows or similar arrangements where a large number of investment options are available to participants. The DOL asserts that plan fiduciaries must take steps to ensure that participants are made aware of their rights, responsibilities and applicable fees to be able to make informed decisions about the management of their individual plan accounts. Though plans are not required to have a particular number of DIAs, the DOL warned that failure to designate a manageable number of investment alternatives raises ERISA fiduciary questions.

FAB 2012-02, Q&A # 30, asserted that an ERISA fiduciary obligation arises if, through a brokerage window or similar arrangement, non-DIAs are selected by significant numbers of participants. According to the guidance, the plan fiduciary must examine these alternatives and determine whether one or more such alternatives should be treated as a DIA under the 404a-5 regulation. Until further notice, the DOL established the following rule for plan administrators where a plan’s investment platform holds more than 25 investment alternatives. All such alternatives are not required to be DIAs IF:

· Required disclosures are provided for at least 3 of the investment alternatives;
· The 3 investment alternatives meet the “broad range” requirements of the ERISA § 404(c) regulation; and
· Required disclosures are made with respect to all other investment alternatives in which the following number of participants are invested under the plan:
o At least 5 participants, or
o For plans with more than 500 participants, at least 1% of all participants

No doubt these “last minute” rules have surprised many plan administrators and service providers.‡ As compliant disclosures for brokerage window fees are being finalized, plan administrators and service providers should seek to demonstrate that initial disclosures have been prepared based on a reasonable interpretation of the 404a-5 regulations, consistent with the good faith standard included in FAB 2012-02, Q&A # 37.

    For more information about fee disclosure requirements, see our prior newsletters about retirement plan fee disclosures at

Retirement Plan Service Provider and Investment Fee Disclosures: More Work To Be Done

6/18/2012John H. McKendry </Professionals/Attorneys/John-H-McKendry>  

U.S. Department of Labor (DOL) regulations require that retirement plan service providers whose fees are paid directly or indirectly from a plan make disclosures of their fees by July 1, 2012. Then, plan sponsors must make disclosure of plan level and individual investment fees and performance to plan participants by August 30, 2012.

Evaluation of Service Provider Disclosures Required

Plan sponsors cannot simply review and file the provider disclosure. The prohibited transaction rules require that the fees be reasonable. In addition, the regulations require that the provider disclose its fiduciary status. To fulfill their duties, plan sponsors must perform at least the following four tasks:
1.    Confirm that all service providers have made the required disclosures. If a service provider that receives at least $1,000 in fees has not made a disclosure, the plan sponsor must demand a disclosure within 90 days and, if it is not provided, notify the DOL of the failure. The plan sponsor should also review the disclosure to confirm that it meets all of the regulatory requirements and provides sufficient information for the sponsor to determine if the fees are reasonable for the services provided. If it does not, the plan sponsor should request the items needed for complete disclosure. If the provider does not provide any requested disclosures, the sponsor may have to terminate the relationship.
2.    Determine the provider’s fiduciary status. Particularly if the provider is receiving fees related to investment advice, there is no legal or practical reason that the provider should not have acknowledged its status as a fiduciary. If the provider attempts to avoid that status, the plan sponsor should evaluate whether the relationship should continue.
3.    Compare the disclosed fees with contractual or promised fees. The fees should not be different from those disclosed in the provider’s service agreement or be used to secure the business. If the fees paid exceed the amount agreed upon, the plan sponsor should request a return of the excessive fees.
4.    Determine whether the fees are reasonable. The prohibited transaction rules require that a provider’s fees be reasonable for the services provided. The preferred method to make this determination is to engage an independent benchmarking service to compare the fees charged in light of the services provided against all plans of similar size and characteristics.

Unanticipated Disclosure Requirements for Brokerage Windows

The original investment fee disclosure requirements applied largely to “designated investment alternatives.” Many plans include an opportunity for participants to leave the designated investment menu and select individual investments through brokerage accounts. Most observers believed that the investment specific disclosure requirements did not apply to these brokerage windows.

The DOL turned these assumptions on their head in a series of Questions and Answers issued on May 5, 2012. Q&A 13 requires a general disclosure of basic information regarding the brokerage window – how the window works, to whom to give investment instructions, any account balance requirements, trading restrictions and whom to contact with questions.

At the fee level, the description must disclose: any start-up fee; ongoing fee or expense; and commissions charged for purchases and sales of securities including sales loads. The statement should advise participants to ask the provider about all investment related fees. Moreover, the participant must be provided a quarterly statement of fees actually charged against the account for the preceding quarter. Q&A 30 indicates that any window that offers more than 25 investment alternatives must provide the designated investment alternative fee information for: (1) at least three investment alternatives: equity, fixed income and balanced; and (2) every other investment in which at least the greater of five participants or 1% of all participants are invested.

Because these disclosures are required by August 30, 2012, plan sponsors should act immediately to:
1.    Identify any brokerage windows provided;
2.    Contact the broker that provides the window requesting the information necessary to meet the general disclosure requirements;
3.    Work with the broker to identify the three investment alternatives that will be utilized to meet the detailed fee disclosure requirements; and
4.    Work with the broker to identify those investments in which the greater of five participants or 1% of all participants were invested and to collect the information needed to satisfy the detailed fee disclosure requirements.

A failure to meet or review the disclosures not only risks a violation of the prohibited transaction requirements but also claims of a breach of fiduciary duties by the DOL and plan participants. A plan sponsor’s work must begin and be completed to mitigate these risks.

How Well Do You Know Your B/D?

September 7, 2012 ( - Do you really know how your broker/dealer makes money? If not, it’s time to learn before a Department of Labor (DOL) investigator knocks at your door.

Plan sponsors and advisers should be well-informed of broker/dealers’ compensation, particularly because of 408(b)(2) fee disclosure, which one source says is prompting more DOL investigations.

For example, 12b-1 fees a broker/dealer receives should be disclosed up front and used for specific purposes or they are prohibited transactions, and the recent disclosures developed by broker/dealers may not include all appropriate information. A 12b-1 fee is paid by a mutual fund out of fund assets to cover certain expenses. This is why it is vital for sponsors and advisers to research their broker/dealers and ask important questions regarding their compensation.

The DOL and the Securities and Exchange Commission (SEC) are cracking down on companies failing to fully disclose 12b-1 fees and revenue-sharing agreements. “The job just got a lot easier for these investigators [because of 408(b)(2)],” Jason Roberts, CEO of Pension Resource Institute and managing partner at Roberts Elliott LLP, told PLANSPONSOR. With 408(b)(2) disclosure information, the DOL has essentially “thrown [sponsors] a bone”because the written disclosure makes it even easier to detect a problem.

Two such cases have come to light in the past several weeks: An investigation by the DOL’s Employee Benefits Security Administration (EBSA) found that Glastonbury, Connecticut-based USI Advisors made investments in mutual funds on behalf of Employee Retirement Income Security Act (ERISA)-covered defined benefit plan clients and received 12b-1 fees from those funds (see “USI Advisors Settles DOL Suit Over Fees”).

USI Advisors failed to fully disclose the receipt of the 12b-1 fees, and failed to use those fees for the benefit of the plans either by directly crediting the amounts to the plans or by offsetting other fees the plans would be obligated to pay the company.

On September 6, the SEC instituted a settled administrative proceeding against two Portland, Oregon-based investment advisory firms and their owner regarding the failure to disclose a revenue-sharing agreement and other potential conflicts of interest to clients.

The USI case created a sort of script for DOL investigators, so plan sponsors and advisers must ensure they know answers to key questions about their broker/dealers. “In my mind … this is not going to be the only case like that,” Roberts said, adding that he has seen an increase in investigations of broker/dealers and their registered representatives.

Under the new Consultant Advisor Project (CAP), for example, potential conflicts uncovered in a routine plan investigation are providing DOL investigators a gateway into the programs, products and policies used by broker/dealers, he added.

The scope of the DOL’s requests for documents and information is “quite broad,” Roberts said, and many stem from routine investigations of plan sponsors.

Roberts emphasized three questions plan advisers and sponsors must know the answer to with regard to their broker/dealers:
1. Do you service, as an ERISA fiduciary, any plans that transact through a broker/dealer?
2. If so, do you understand, and can you describe, all forms of compensation received by the broker/dealer (e.g. markups, bank or money market sweep revenue, revenue sharing, 12b-1 fees)?
3. Have all forms of broker/dealer compensation been disclosed in 408(b)(2) statements?
Plan sponsors who do not know the answer to these questions can be held personally liable, should an investigation arise, because not knowing this foundational information means the plan sponsor has failed to prudently select a provider and thus failed to comply with both 408(b)(2) and 404(a)(5) (participant fee disclosure).

Broker/Dealer Investigations
The requests coming to broker/dealers are also exposing gaps in compliance and supervisory procedures that may result in ERISA violations, Roberts said. “Some of the firms that developed their disclosures internally or with the help of less-experienced ERISA counsel, for example, have failed to report the full extent and or sufficiently identify the source of direct and indirect compensation,” he added.
Prohibited transaction exemptions like PTE 86-128, which allows broker/dealers to make a reasonable profit on executing trades recommended by an affiliated investment advisory representative (IAR)/registered investment adviser (RIA), are often misunderstood or not considered, Roberts said.

While this PTE requires specific authorization for the ERISA-covered client and ongoing reporting, once properly explained, it tends to be the preferred method versus offsetting against the advisory fee or engaging in systemic prohibited transactions, he said.

A number of procedural safeguards are available to broker/dealers, but Roberts said they tend to be underutilized because many firms do not employ in-house ERISA legal or compliance experts. “To properly evaluate a broker/dealer’s exposure under ERISA, one needs to incorporate securities laws and regulations and have a thorough understanding of the products that are sold or serviced,”he added.
If red flags are discovered that suggest gaps in a firm’s ERISA compliance, a DOL investigator may refer the matter to CAP and initiate an investigation of the broker/dealer, Roberts cautioned. “In my experience, few firms have policies for responding to DOL requests, which can result in incomplete productions,” he added.

If the DOL senses a “scramble” or lack of understanding by the broker/dealer personnel, they may look for things outside of the scope of the initial request, he said.

Financial Advisors Turn to the 401(k) Market for More Business

by: Elizabeth Wine
Saturday, September 1, 2012

When John Ludwig was called in to assess the retirement plan of a large electrical contractor in Indiana, it had a relatively low rate of participation, about 55%. The 600 employees earned on average between $40,000 and $50,000, comfortably above the national median salary for individuals. They should have been able to afford contributing enough to receive the employer match of $1,500 a year. So it was strange that so many weren't contributing to the plan at all.

But when Ludwig examined how the company worked, it became clear to the Raymond James advisor: most of the employees did not go to a central office. Almost all were based out of their trucks, going directly from home to their on-site jobs, and were never near the human resources office to drop off their 401(k) enrollment form. "What do you think happened to it?" Ludwig asked. "They're going to throw it in the truck and forget about it. There's nothing to help them understand why it's important, to a build a level of interest in the plan."
Ludwig, who is based in Indianapolis, stepped in and made some changes to the plan design, including automatic enrollment and automatic increases. He also held annual meetings with all the employees and gave presentations on all the benefits offered. Now four years later, plan participation has climbed to 85%.

Ludwig is not alone in looking to 401(k) plans as fertile ground for his business. Increasingly, advisors are betting they can navigate the challenges presented by plan sponsors just as well as they already counsel their individual clients. In fact, financial advisors breaking into the retirement arena is one of the biggest trends right now in the retirement industry, according to analysts at Cerulli Associates and Morningstar. As of the end of 2010, financial advisors managed defined contribution plan assets of $1.38 trillion, according to Boston-based Cerulli. Wirehouse advisors had $465.4 billion of that. Of that amount, "specialists" managed $184.3 billion, while "dabblers" managed $157.2 billion. "Non-producers" oversaw $123.9 billion. (Cerulli defines a non-producer as an advisor who receives less than 20% of revenue from retirement plan business. A dabbler gets between 20% and 40%, and a specialist receives more than 40%.)

Another research consulting group, Brightwork Partners of Stamford, Conn., estimates that the amount and share of assets under advisement by financial advisors in just 401(k) plans was $1 trillion or 31% of those assets as of the end of 2011. For all defined contribution plans, advisors control 28% of those assets, or $1.34 trillion as of year-end 2011. (Brightwork counts registered reps, insurance producers, financial planners and registered investment advisors whose client base is focused on the small to mid-sized plan market.)
As popular as this business is now, however, in a few years the industry likely will look back on these years as the good old days for this market. A round of interviews with advisors, analysts and other experts point ahead to a more challenging future for advisors trying to crack into this business for a number of reasons. More demanding customers, uncertain regulation, and the sheer complexity of this market are three of the factors.

But the thorniest issue may be that of fiduciary responsibility. At the moment, it's possible for advisors who have a traditional commission-based business to advise a 401(k) plan without being a fiduciary. But market participants and observers agree those days are probably numbered.

It seems obvious that this market would be sizzling now. As companies have eliminated traditional pension plans and forced employees to share the burden of providing for their retirement, 401(k) plans and 403(b) plans (for non-profits and the education sector) have become a much bigger business.

That, in turn, has prompted more advisors to start questioning leaving the business of advising the 401(k) plans of their small business clients to others. Why not learn the 401(k) market and keep all the client's business? After all, investments are investments. And why not develop relationships with other key corporate decision makers and business owners while advising a current client's 401(k)?

Regulatory Storms Ahead
But that decision to specialize is becoming tougher. The regulatory winds are shifting toward requiring anyone who advises a retirement plan to serve as a fiduciary. That means those who don't want the responsibility will likely have to forgo working with plans, according to Kevin Chisholm, a senior analyst covering retirement at Cerulli Associates. "That will make a challenge for wirehouses," he says. "There are so many plans out there, and not enough advisors to advise on all of them."

The Department of Labor has been tinkering with a rule defining who should act as a fiduciary when dealing with 401(k) plans for some time. A proposal put out for comment last year required nearly everyone who came in contact with a retirement plan to be a fiduciary. However, it was seen as too broad, according to Boston-based lawyer Marsha Wagner, who specializes in the Employee Retirement Income Security Act of 1974, the federal statute on private pension and health plans, better known as ERISA. "The DOL seems to want to raise the bar for people who are engaged in transacting business with and on behalf of plan sponsors," she says.

The DOL proposal was tabled, and there's no exact date for when a new rule is due. But when a new rule comes out, it will likely be crafted "to make sure the advice corporate retirement plan is done on a fiduciary basis, and there's no conflict of interest," Chisholm says.

But, as is often the case, the market is ahead of regulators. Even now, plan sponsors are starting to demand fiduciary services from their advisors. Moreover, the DOL upped the ante by putting out a new transparency rule in July that requires vendors serving retirement plans, including fund managers, record keepers and advisors, to disclose their services and fees clearly, as well as whether they are acting as a fiduciary. Similar financial disclosure rules will go into effect August 30 for plan participants.

"That ends up forcing the issue," Ed O'Connor, head of Retirement Services at Morgan Stanley, says. "It makes a plan more aware of what they're paying." There has long been confusion as to how plans are paying for which services, because often the billing has been opaque, with brokers often paid by the funds in a plan, rather than directly by the client. O'Connor says plan sponsors will likely start questioning fees and say: "'This is too complicated. Why can't I just pay you a fee for your advice?' Well, that's a fiduciary," he says.

And it's not just big plans demanding this higher bar. "The fiduciary status is quickly moving downstream," Brian Lampsa says. A Raymond James advisor in Chicago, Lampsa specializes in the 401(k) market and is a member of the firm's Retirement Plan Advisory Council. "Years ago we only saw it requested when go to $100 million in [plan] assets. Now many $5 million and $10 million plans are requesting it," he says.

The new DOL rule 408 (b)(2) also brings to a head the issue of what being a fiduciary involves, according to Fred Barstein, executive director of The Retirement Advisor University (TRAU). TRAU, in collaboration with UCLA, offers training and one of the designations for retirement experts. Barstein, who created a database company covering the retirement industry, also started the school two years ago anticipating the need to train advisors to counsel plans with a fiduciary level of responsibility and expertise.

By Barstein's count, of approximately 300,000 advisors actively engaged with the public, half of those advise one defined contribution plan. And, half of those, or 75,000, have at least three plans. Also, 5% of the total group, or 15,000 advisors, have at least five plans. He considers only about 5,000 of those advisors to be real experts, who have 10 plans with $30 million in assets and at least three years of experience. What's more, he says between 60% and 70% of the advisors working in the retirement industry are acting as a fiduciary, but not all of them say so in writing. This is now a problem. The new DOL rule will change that, forcing them to be formally named a plan fiduciary. "The big wirehouses who are aware of this understand rule 408(b)(2) and get the implications. They're strict," Barstein says, noting the firms' legal exposure if the advisors do not fulfill their fiduciary duty. "They're concerned with the 90% of advisors who don't know what they're doing."
By Barstein's reckoning, there are many non-negotiable tasks an advisor has in acting as a fiduciary for a retirement plan. First, they must create an investment policy statement. It details how many funds the plan will have, which asset classes will be covered and what the characteristics are of the funds. Every quarter the advisor must monitor the funds to see if they're meeting the investment policy requirements and how they're performing. Then the advisor must make sure the fees charged by each fund are reasonable, either by benchmarking them or going to the market and getting prices. Do they meet the prescriptions of the investment policy? Have they changed? Then the advisor must break down all the fees within the expense ratio to ensure each of them are reasonable, including the fees going to the transfer agent and the record keepers, as well as the actual money managers. Again, that means benchmarking or pricing each one.
And there are other services in the gray area including holding enrollment meetings for plan participants, and meeting with the participants themselves, Barstein says. Plus, there are meetings with the plan's investment committee, making sure all the plan's filings are done properly, and many more technical requirements. "It's not something you want to dabble in," Barstein says. "We call the ones that don't have at least five plans 'blind squirrels,'" he says, adding that 75% of all advisor-sold plans are advised by a blind squirrel. Barstein doesn't know the amount of assets under such loose management, but estimates it to run into the hundreds of billions of dollars. The good news is: advisors are slowly getting more educated. "Five years ago it was 90%, and I think it will come down to 50%, but it's not going to go away," Barstein says.

The Team Approach
Wirehouses are cautiously feeling their way towards helping their advisors wade into the retirement waters ahead of the new, stricter regulatory environment, Cerulli's Chisholm says. He adds that the likely direction most will take is to allow certain advisors to work on retirement plans along with in-house specialist retirement consultants. "They will have to work with the teams," he says.

Morgan Stanley, for its part, is doing just that. Of the firm's 16,000 advisors, some 500 are specialists, called corporate retirement directors, or CDRs, on about 200 teams. They have completed classes to gain designation as a Chartered Retirement Plans Specialist (CRPS) from the College for Financial Planning, or have an equivalent or higher designation. The CRPS is one of the five modules of the CFP designation. Another designation, the Certified 401(k) Professional (C(k)P) from TRAU, is also accepted by Morgan Stanley and other wirehouses, and is the training course to which Merrill Lynch sends its advisors. UBS and Wells Fargo also have their own programs.
At Morgan Stanley, advisors wanting to enter the retirement arena must work with the CRD specialists in almost all cases. (If the plan sponsor wants the firm to act as fiduciary, it is an absolute requirement. If a plan with under $25 million in assets does not require the firm to act as a fiduciary, a generalist advisor can go it alone.) If advisors want to become specialists themselves, they must prove they already have a level of experience and capabilities. They must have $50 million in qualified plan assets already on their books, plus an extremely clean record with FINRA. Even then, Morgan Stanley requires the advisor to apply and be reviewed. "If you're serious, then show me you're serious," O'Connor says. "They have clearly stated this is an important part of my practice as a specialist servicing 401(k) plans, and that's what we want here." About half of those who apply get approved.

In most cases, they already have the CRPS designation. But in a few cases of an advisor with solid knowledge and other credentials who did not yet have the designation (usually new recruits), the firm gave the advisor six to 12 months to get it. But if they did not get the designation, they were not allowed to continue as a CRD. Getting accredited is more than a weekend seminar. O'Connor says it takes four to five hours of study per week for three months to pass the test. Plus, there's all the continuing education. "It's a technical field and IRS rules and DOL rules keep changing, you have to keep on top of that," he says. But up-to-date knowledge of the byzantine codes governing 401(k) and 403(b) isn't all an advisor needs. The retirement market requires a specialized knowledge of not just investments, but specialized vendors, plan documentation, record keeping, mandatory disclosures and fee scrutiny.

O'Connor estimates that Morgan Stanley will double its number of CRDs in the next five years. "We think the market is going that way," he says. "The mid and small 401(k) market is growing and a growing share of them are expecting a fiduciary relationship. Our clients are asking for it and demand will grow. Then more FAs will decide 'I want to make this a major part of my business.'"

Yet, the margins for the retirement business are shrinking. Several observers say it's not nearly as lucrative as it was a decade ago. Most agree it doesn't make sense for an advisor to spend all the time and energy to learn the industry unless they intend to make it a substantial piece of their practice; O'Connor estimates at least one-third. "It doesn't have all of your practice, but it cannot be a hobby," he says.

The other major change for traditional commission-based advisors is in how they charge. To be a fiduciary, it is best practice to charge on a fee basis to avoid a conflict of interest. That means advisors should charge "level compensation," such as a flat number of basis points for the plan, or a flat dollar amount per quarter or year, rather than getting paid by each fund individually from their ongoing 12b-1 fees. Level compensation avoids even the appearance that the advisor is favoring one fund in the plan over another for his or her personal gain. This is especially critical now, according to Bo Bohanan, director of Retirement Plan Consulting at Raymond James, because money market funds have cut commissions. This does not mean the commission-based advisor has to overhaul his entire practice, but merely draw up new contracts for the retirement plans he serves, Bohanan says.

Still, all this knowledge takes time to build and so does the business. When Ludwig made the move to being a specialist from being a wholesaler of 401(k) plans it took him six months to win his first client. However, he says: "It was definitely, definitely worth it."

Not Making The Grade

Financial advisors aren’t as fiduciary as they should be, a new survey finds.
By Jeff Schlegel

It seems like the debate over a fiduciary standard of care has been one of the financial advisor industry’s most nettlesome issues for eons. Who should it apply to? How do we craft a uniform standard of care that pleases all sides? And, fundamentally speaking, what exactly does “fiduciary” mean?

Of late, the debate has been reduced to a “best interests” issue between investment advisors who are governed by a fiduciary standard of care that places their clients’ interests first and broker-dealers who aren’t governed by a fiduciary standard and thus, by implication, aren’t perceived as required to put their clients’ interests first. The latter camp is miffed by that perception, arguing that their advisors often act as fiduciaries even if they’re not formally held to that standard.

But according to a new survey of 500 registered investment advisors, investment advisory representatives and registered reps, many advisors of all stripes aren’t as fiduciary as they think they are. The study is a partnership between Financial Advisor magazine, Boston Research Group and 3ethos, a Mystic, Conn.-based entity dedicated to fiduciary training that’s run by Don Trone, a longtime leader in promulgating fiduciary standards within the industry.

The survey graded advisors based on questions dealing with fiduciary best practices, along with additional questions focused on legal and procedural aspects related to fiduciary services.

The answers were tabulated on a fiduciary best practices index, and were assigned scores and accompanying letter grades ranging from “A” to “F.” The average, industrywide index score among all respondents was 76, or a “C” letter grade. The mean score was 78, or a “C+” grade.

Among the questions respondents were asked was whether they acknowledged fiduciary responsibility in writing. Of the advisors who say they acknowledge a fiduciary status for all clients, 35% got a “C” or less for their overall fiduciary index grade. Of the advisors who say they acknowledge fiduciary status for some clients, 68% got a “C” or less. And of the advisors (brokers) who say they do not acknowledge fiduciary status, 90% got a “C” or less.

“There’s a disconnect between principles and practices,” says Trone, noting the survey reveals that a number of advisors believe they’re acting in principle to a fiduciary standard but in reality don’t understand the practices.

The survey divided respondents by registration status and graded each of the four different groups. RIAs regulated by the Securities and Exchange Commission collectively scored an 83 on the index, or a “B” grade, while RIAs regulated by the states had a 79 score and a “C+” grade. Dually registered IARs scored 75 with a “C” grade, while registered reps scored 66 and earned a “D.”

“I’m a 25-year veteran of the fiduciary movement, and after the work I’ve done with the financial advisor industry I thought that we were further along [on the fiduciary issue],” Trone says.

This is the first annual survey on fiduciary matters conducted by the three partner entities. The purpose of the survey is to benchmark how well advisors understand fiduciary principles and adhere to fiduciary practices and how that can impact their business. With that information in hand, future surveys will measure the rate of adoption of best practices.

“This will be extremely valuable information when the SEC finally gets around to promulgating a uniform fiduciary standard of conduct,” Trone says. “We will actually be able to measure the impact the new regulations have on the industry.”

Defining ‘Fiduciary’
A fiduciary duty entails a relationship where one person or entity holds something in trust––such as money or other assets––in the beneficiary’s best interest. The concept’s roots go back centuries, and it seems straightforward enough. Namely, put your client’s interests ahead of your own.

But U.S. securities officials and the financial services industry have struggled with this concept for decades, and that includes current efforts to address the matter under the Dodd-Frank financial services reform legislation from two years ago.

As part of that sweeping reform package, the SEC was told to study the current regulatory standards of care for providing investment advice to retail customers. An SEC task force recommended creating a uniform fiduciary standard for broker-dealers and investment advisors who offer advice about securities to customers, and further recommended that the standard should jibe with the current standard that applies to investment advisors.

Broker-dealers are mainly regulated under the Securities Exchange Act of 1934, and investment advisors under the Investment Advisers Act of 1940. The fiduciary standard of care concept, which requires advisors to act in their clients’ best interests, was embedded in the Advisers Act and subsequently upheld in the 1963 Supreme Court decision SEC v. Capital Gains Research Bureau.

Broker-dealers weren’t included in the Advisers Act because investment advice was deemed “solely incidental” to their business and their pay was based on product commissions, not advice-related fees. Thus, they’re held to the suitability standard.

But the differences between the two camps have become increasingly blurred, and fees now represent a much larger share of most advisors’ income, prompting calls for a uniform standard. (More on that later.)

Meanwhile, the questions on the fiduciary survey were vetted by a dozen individuals from a broad spectrum of interests that included consultants and voices from the broker-dealer and investment advisor communities.

The 16 questions that centered on fiduciary best practices covered a host of issues, such as whether advisors aligned their investment process to avoid conflicts of interest, and if they put investment options through a due diligence process. “All of these practices are a synthesis of fiduciary legislation, regulations and case law,” Trone says. “There’s nothing arbitrary about that list.”

Best Practices
One of the survey’s aims was to examine the relationship between fiduciary best practices and successful advisory businesses. It defined successful advisory firms using quantitative measures such as assets under management, minimum account size and number of clients.

The results found a correlation between fiduciary best practices and both assets under management and minimum account size.

Respondents in the top quartile of AUM (at least $150.1 million) scored best on the fiduciary index, with a score of 85. The second quartile (between $50.1 million and $150 million) scored an 81, while the lower two quartiles ($20.1 million to $50 million, and $20 million or less) scored 76 and 73, respectively.

A similar pattern existed regarding minimum account sizes, where the four categories range from more than $1.1 million to less than $50,000, and the scores were highest in the top two quartiles.

“Elevating the standard of care that the advisor is providing to the client deepens the relationship,” Trone says, “and the advisor ends up managing a larger portion of the client’s assets as well as lengthening the client relationship.”

The survey didn’t find much correlation between fiduciary scores and the number of clients reported by survey respondents.

Practice Areas
The survey categorized advisors by how they described their practice area––wealth managers versus retirement advisors versus financial planner––to get a sense of how these areas compared with each other.

That’s relevant considering that the U.S. Department of Labor operates its own fiduciary standard for retirement plans under the Employee Retirement Income Security Act of 1974 (Erisa). The DOL’s Erisa fiduciary standard is considered more stringent than the fiduciary standard for providing investment advice as spelled out in the Investment Advisers Act of 1940.

Advisors who described themselves as wealth managers scored an 80 on the index. That compares with a score of 76 for those who identified themselves solely as retirement advisors and a score of 72 for those who called themselves financial planners.

“I expected to see that the average fiduciary best practices index of retirement advisors to be significantly higher than that of wealth managers and financial planners,” Trone says. He adds he’s also surprised financial planners didn’t score better on the survey index.

But Michele Warholic, managing director of examinations, education and talent at the Certified Financial Planner Board of Standards Inc., notes that the survey doesn’t distinguish between the general definition of “financial planner” and professionals who’ve earned the CFP designation.

“We’d expect the result to be different if it was limited to CFP professionals,” she says.

Nonetheless, the survey found that advisors with a mixed client base––i.e., foundation and endowment accounts thrown into the mix, or when planners added wealth management or wealth managers added retirement planning to their repertoire––scored higher.

“I think that’s because people who work with a mixed client base have a well-defined process that they apply no matter which client they serve,” Trone says, “and that lines up with a fiduciary standard.”

Indeed, survey respondents who said they have a defined investment process scored an 81 on the index, while those who said they have a defined process for some clients scored only 66 and those who have no investment process scored a 49.

The Future Of Fiduciary
The 208-page SEC study mandated by the Dodd-Frank Act attempted to address the basic problem that many investors are confused about the different standards of care that apply to broker-dealers and investment advisors.

Congress told the SEC to evaluate the effectiveness of existing legal or regulatory standards of care when providing investment advice to retail customers, and to determine if there are any legal or regulatory gaps, shortcomings or overlaps pertaining to standards of care that should be addressed by rule or statute.

The SEC’s study, which was released in January 2011, recommended applying a uniform fiduciary standard of care for both investment advisors and broker-dealers. The top officials at the SEC, the Financial Industry Regulatory Authority and the Securities Industry and Financial Markets Association––along with leaders at various broker-dealer companies––have publicly supported a uniform standard.

The SEC study says a new uniform standard should be flexible and accommodate different existing business models, fee structures and account models, and it shouldn’t decrease investors’ access to existing products or services.

But as the old saw goes, the devil is in the details. Industry officials have been lobbying Congress and the SEC with their two cents about what they think a uniform standard should look like.

“We support a uniform standard of care, but it needs to be carefully adopted and adapted to the different business models of broker-dealers and investment advisors,” says David Bellaire, general counsel and director of government affairs at the Financial Services Institute (FSI), a trade group for independent broker-dealers.

In particular, he notes, FSI is concerned that potentially excessive compliance demands incurred by broker-dealers to adhere to a uniform standard would boost their costs and could make it uneconomical for them to serve smaller retail clients who don’t meet the heftier asset minimums that many investment advisors require.

Where the issue goes next is in the hands of the SEC. Bellaire says he’s been told by SEC staff members that the agency has many items on its plate and that the fiduciary standard of care issue isn’t exactly its most pressing issue.

“It doesn’t appear to be on the fast track there,” Bellaire says. He notes that it’s his understanding that the SEC is preparing for a request for information to study the economic impact of a uniform standard, which the agency would have to digest before developing a rule proposal that would go out for comment. And all of that is a long process.

“I’m not sure we’ll see a final rule in 2013,” Bellaire says. “I think it’s a long-term project with the SEC.”

An SEC spokesman said nothing is imminent on the uniform standard of care issue. In fact, there’s no guarantee anything will come of the issue at all because Dodd-Frank mandated only that the SEC conduct the study––any subsequent rule-making is optional.

Watered Down Better Than High And Dry?
Some folks in the investment advisor community fear a uniform standard of care will dilute the fiduciary standard they currently abide by. “Some people are worried about a watered down version,” says Paul Auslander, president of the Financial Planning Association. “I think a watered down version is better than nothing.”

To Auslander, creating a fiduciary standard across the board would “raise the bar for the profession.”

Don Trone, for his part, believes the consensus needed to achieve a uniform fiduciary standard will result in a weakened standard. But that could lay the groundwork for tougher standards down the road. “The courts who hear the first breach-of-fiduciary cases might enact higher standards than what’s defined by the regulators,” he says.

Clearly, the fiduciary standard of care issue won’t be resolved anytime soon. Meanwhile, the best practices detailed in the fiduciary survey taken by 500 advisors are a prescription for putting clients’ best interests first whether or not a uniform standard of care is adopted by regulators.

That’s a point raised by Sean Walters, executive director and CEO of the Investment Management Consultants Association, an education provider and certification body whose members include asset managers, full-serve brokerages and independent financial advisors.

“Most of the [best practices] items on the survey are either part of our curriculum or part of our professional code of responsibility,” he says. “Our members are putting their clients’ interests first, and that’s their primary focus.”

Use of managed 401(k) funds on the rise

September 18, 2012 6:45 AM By Ray Martin

(MoneyWatch) A growing number of retirement plan participants are using what is known as managed asset-allocation investment funds, according to recent report by Vanguard. Of those in retirement plans managed by the mutual giant in 2011, 24 percent were invested in a single target-date fund, 6 percent were in a single traditional balanced fund and 3 percent were in a managed account advisory program. In all, one-third of participants were in a managed allocation plan last year, up from 9 percent at the end of 2005.

Managed asset-allocation funds are a type of 401(k) plan that includes target-date, balanced, and asset-allocation funds, along with managed account services. In short, they're funds or services that provide professional asset allocation and/or management. But using managed funds is not enough to grow your retirement savings. Workers in 401(k) plans must make four critical decisions:

  • When to enroll in the plan
  • How much to contribute
  • How to invest contributions
  • How to manage the account

The problem: Many folks don't join their 401(k) at the earliest opportunity, they don't save enough, and they fail to diversify and manage their accounts. That can cost workers tens of thousands of dollars, or more, in reduced savings for retirement.

Are Your 401(k) funds money losers?

401(k) advice for Gen-Xers
Watch: What you should know about your 401(k)

The good news is that more employers have made changes to their 401(k) plans to help employees. A big change for many 401(k) plans is the "opt-out 401(k)," where enrollment in the plan is automatic as soon as an employee becomes eligible to join. This simple change takes advantage of the power of inertia. New employees are automatically enrolled in a company's 401(k) plan, and they must officially ask to discontinue contributions if they do not want to enroll. The "automatic enrollment 401(k) plan" has proven to increase the number of employees who participate in plans with this feature.

Typically, as soon as an employee is eligible to enroll in a retirement plan, the employer will start funneling contributions at an initial rate of 1-3 percent of pay. The amount will vary by employer. Some plans will automatically escalate the initial contribution rate by increasing it by one percentage point each year until it reaches a specified percentage, such as six percent. The contributions are invested in a default investment fund, usually a target-date fund, which is allocated and managed for a specific set of participants who are in a common age group.

These default settings are a good starting point for many people, but there is so much more that you need to do to help your 401(k) plan grow to become a meaningful retirement benefit. Check back in a few days when I'll write about what people can do to better manage and grow their 401(k) account.