With the Department of Labor’s release in April of rules governing new fiduciary responsibilities for advisors who advise on retirement plans, FAs large and small are beginning to come to terms with what will be expected of them. For the tech sector, it’s a business opportunity—or threat—of historic proportions.
The clock is ticking. Implementation starts phasing in next April, and once again advisors are looking to technology vendors and consultants for software and systems to cover new responsibilities. It’s not the first time that regulatory changes have opened doors for new technology that promises to help advisors smooth over the rough patches.
Michael Kitces, a financial planner and industry commentator, recalls the SEC ban in 1975 on the long-standing practice of fixed commissions on stock shares. Allowing share values to float also led to efforts by tech firms to find efficiencies that lowered transaction costs. Charles Schwab’s discount brokerage opened shortly afterward.
The new DOL fiduciary rule affects some $3 trillion in assets, along with $19 billion in wealth management revenue, Morningstar analyst Michael M. Wong estimates. Using that math, Kitces figures that any tech firm whose compliance solution can solve 5 percent of the impact of the DOL rule will have a billion-dollar company.
“This is a massive market opportunity, as often happens with regulatory change,” Kitces says. “I don’t think it’s going to take the private market that long to figure out the opportunity here and come in to do it.” But rolling out solutions in the short run is still “messy,” he warns. “Can a firm get a great compliance solution off the ground in the next 10 months, before April 10? I don’t know.”
Indeed, the spring deadline should give rise to a greater sense of urgency, according to some tech industry observers. Chip Kispert, founder of the financial services consultancy Beacon Strategies LLC, says tech vendors and their clients will probably be planning solutions through September, then building products in time for rounds of testing at the start of 2017.
“This is a really tight window to basically weave the tech in,” he says. “I’m very concerned that some of these broker/dealers will go out in October and expect to find solutions that can be implemented by April. That’s pretty aggressive.”
Joel Bruckenstein, producer of the T3 financial technology conferences, says tech companies tell him they’re all working on DOL-related projects now, but it’s hard for him to gauge how effective they will be. “Everybody thinks they know what their clients need. Some may be more creative and go further than others. Some may go well beyond what their clients tell them and anticipate needs their clients haven’t thought of yet,” he says. “Obviously, there’s a tremendous incentive for all the leaders in the tech industry to get this right. And my sense is the majority of them will.”
What makes this round of fintech innovation more of a struggle than in years past is the way the DOL rule is likely to change the nature of an advisor’s financial practice. When tech firms want to develop solutions to the business problems that bedevil their advisor clients, one of the first things they need to know is the company processes over which the technology will fit—in this case, what steps an advisory firm has to go through to meet the fiduciary goals that the DOL is seeking.
“Clients are telling us that the business-decision process is difficult,” says Jeff Schwantz, Morningstar’s head of advisor solutions for North America. For example, some firms may decide that a unified sales process is necessary to accommodate best interest contracts—agreements that allow advisors to collect commissions and certain other compensation under the DOL rule provided they agree to put the clients’ interests first, among other conditions.
Certain elements of the sales process would need to be standardized so firms can document the efforts made to ensure the product recommendations meet the criteria. At independent broker/dealers, Schwantz says, this runs counter to the culture that, historically, has allowed brokers freedom to control the sales experience—products, tech tools, marketing materials and other elements.
So it’s difficult for tech vendors to design software products without their clients first making large, and difficult, decisions about the way work needs to be done at their firms.
Once those decisions are made, the tech tools have to be designed, built and rolled out, and then the advisors have to be trained in how to use them. “If you link all those things together with less than 200 business days, that’s a sea change for some organizations,” Schwantz says.
The DOL rule has assigned companies the obligation to oversee the quality of their advisors’ advice, Kitces notes. “What does that mean and how do you do that? I don’t know anyone entirely knows the answer, except that, clearly, if you’re going to do it scalably across a large firm, it will have to involve technology,” he says. “But what that looks like is still fuzzy.”
Some tech firms have opted for a conservative approach: a series of modifications on their platforms rather than wholesale revisions, at least for the moment. Morningstar began discussing options with clients last November and is planning the first of a series of “enhancements” this summer. One new feature will allow an advisor to compare how well a mutual fund or other product measures up with peers over things like fees and disposition costs. The documented use of such data can demonstrate to regulators that advisors are protecting their clients’ interests through efforts to keep costs down.
Some tech firms also are buying companies whose products can help them fill gaps in their own tech offerings. In March, Morningstar acquired RightPond, a data and analytics provider that focuses on the performance of defined benefit and defined contribution plans and government plans. Schwantz said RightPond’s abilities will allow Morningstar to measure the performance metrics of those retirement plans with competing plans of the advisor’s own—a critical ability under DOL fiduciary if the advisor is seeking to roll over a potential client’s 401(k) account into an offering of their own.
Envestnet, the provider of fee-based wealth management platforms, also plans a gradual entry into DOL-fueled tech needs starting in August. Executive Vice President Lincoln Ross, who heads product strategy and marketing, says the firm is working on modifying existing offerings that will let advisors see the differences between current and recommended investments, particularly expenses.
The technical challenges of the new fiduciary rule are less onerous than those that would have been required under the DOL’s proposed rule last year, Ross says, although, in the end, the regulator expanded the scope of the best interest contract by adding more disclosures and places within the workflow where the contract may be required. Like other large tech companies, Envestnet has a working group of several key clients with which it holds monthly conference calls for updates and shared thinking on the new rules. Feedback from clients will shape the look of modifications to follow.
The share of fee-based business has gradually increased in the market (23 percent in 2014, more than three times bigger than in 2005, according to Cerulli Associates), and that momentum is expected to increase under the DOL regimen. But Ross and others don’t see commission business going away. Envestnet is looking to offer tech solutions for advisors who will need best interest contracts to support that side of their businesses. “What we want to do is provide a number of different ways to use our platform that best fits their business,” Ross says.
Tech firms that can master DOL demands will have a competitive advantage, says Carlos Guillen, CEO of BasisCode Compliance, which produces software for advisors’ regulatory needs. BasisCode focuses on pulling in data from multiple sources—fee calculations from back office systems and policies and procedures in document libraries, for example—and integrating it in useful ways. “We are able to leverage what we have done, so it’s not basically starting from scratch,” Guillen says. With more than half its clients in the b/d space, the firm is looking to provide best interest contract solutions later this fall.
Some advisors can cobble together in-house answers to tech problems, Guillen says, but the challenge is to do it efficiently and in a way that satisfies regulators when they walk through the door for an audit. “A technology solution is basically a revenue protector.”