Playing with Fire

The questions above warrant immediate consideration because there is a very strong likelihood that new Federal legislation is going to be passed that will encourage retirement plan sponsors and their participants to seek the services of investment advisors. What Washington doesn't know is that, with few exceptions, the investment industry is woefully unprepared to provide a cadre of qualified investment

The questions above warrant immediate consideration because there is a very strong likelihood that new Federal legislation is going to be passed that will encourage retirement plan sponsors and their participants to seek the services of investment advisors. What Washington doesn't know is that, with few exceptions, the investment industry is woefully unprepared to provide a cadre of qualified investment advisors.

One of Capital Hill's most important agenda items is to address perceived problems with the pension industry. Legislators are in agreement that: (1) 401(k) participants are doing a poor job of managing their retirement plan assets; (2) participants need access to investment advisors who can provide participants with specific investment advice; and (3) investment advisors working with pension plans and participants must be able to demonstrate that their advice meets a fiduciary standard of care. Where there is serious disagreement is on whether the investment advisor should be independent of other vendors providing services to the pension plan (mutual fund families, record keepers, etc.).

The House of Representatives has taken the position that any regulated advisor can provide investment advice provided that potential conflicts of interest are fully disclosed. Hence, an advisor attached to a mutual fund family that is providing services to the 401(k) plan also would also be eligible to serve as an investment advisor. The Senate has taken the position that disclosure is not sufficient to ensure that the participant will be provided objective advice and has proposed that the advisor should be independent of any vendor providing services to the 401(k) plan.

Here's the Rub

What the House and Senate versions both fail to address, is competency. What matters most is that the investment advisor is competent to deliver investment advice. I have never seen a strong correlation between competency and disclosure, or between competency and independence. Over the past year, I have had several informal discussions with Congressional and regulatory officials about competency: Why is competency not defined in any of the proposed bills? The typical response is: The presumption is that the investment industry has already defined a level of competency for investment advisors that meets a defined fiduciary standard of care.

Really, now. Let's review a list of the minimum subjects an investment advisor should be familiar with before the advisor should be permitted to work with a retirement plan:

  1. Retirement plan design, features and administration.

  2. Investment “Safe Harbor” procedures, particularly 404c.

  3. Asset allocation modeling, particularly the ability to incorporate the participant's (or the plan's) risk, return, time horizon and asset class preferences.

  4. The ability to prepare and maintain the retirement plan's investment policy statement.

  5. The ability to conduct a due diligence process in selecting a plan's investment options.

  6. The ability to monitor the plan's investment options on an ongoing basis, including procedures for placing investment options on a “watchlist” and/or for terminating an investment option.

  7. The ability to control and account for the plan's investment-related expenses, particularly the appropriate uses of 12b-1 fees and share-class selection.

  8. Familiarity with ERISA-defined prohibitive transactions, and the ability to recognize potential conflicts of interest.

Last I checked, the Series 7 and/or 65 exams did not cover these subjects. (Although leading legal counsel for one of the industry's top self-regulatory agencies vehemently defended the Series 65 exam as being more than adequate to demonstrate a mastery of the above subjects.) None of the self-regulatory agencies and/or professional associations has defined a fiduciary standard of care, although NAPFA, at least, requires its members to sign a fiduciary oath. The industry's leading training programs (CFP, CFA, CIMA, and/or CESB) do a great job of educating the advisor on the investment-management process, but do a poor job of linking the subject back to a defined fiduciary standard of care.

We need to deal with our industry's dirty little secret before the public discovers these gross inadequacies, although we already may be too late. Arbitration and litigation against brokers and investment advisors is at an all- time high, and the leading cause — surprise — breach of fiduciary responsibility. As an industry, we need to: (1) reach consensus on a minimum fiduciary standard of care; (2) develop policies and procedures at the broker-dealer level to define the requirements a registered rep must meet before that the rep is permitted to work with a fiduciary account; and (3) augment our testing and training programs to include the details of a fiduciary investment process.

Writer's BIO
Don Trone
is the investment counseling industry's representative to the U.S. Secretary of Labor's ERSIA Advisory Council. He also is president of the Foundation for Fiduciary Studies, director of the Center for Fiduciary Studies at the University of Pittsburgh and CEO of Fiduciary Analytics. www.fi360.com.

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