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Identity Crisis

Identity Crisis

New 401(k) advice rules are long overdue, but coming. In the meantime, retirement plan advisors may have to do some soul searching. Do you want to be a fiduciary?

The retirement plan marketplace is experiencing an identity crisis of sorts. To help fix deficiencies in the 401(k) system, Congress passed the Pension Protection Act in 2006, which enacted sweeping legislative changes and set the stage for reform in the areas of participant advice, disclosure, and enforcement. While the U.S. Department of Labor has enacted many of these reforms through rulemaking in the years since then, it has put off doing anything about the participant advice piece of the equation three times. New advice rules were proposed early this year, including an expanded definition of who qualifies as a fiduciary, but a final rule is some ways off. In the meantime, many advisors are reevaluating the nature of their qualified and nonqualified client relationships.

Below are key questions advisors need to explore as they attempt to determine just what kind of advisor they want to be in this new environment.

Am I a fiduciary?

Under the Obama administration, the Department of Labor (DOL) has hired 1,000 enforcers, and ERISA litigation is at an historic high in the U.S. In light of this situation, advisors need to take a look at their books of business and be able to state emphatically whether they are fiduciaries.

Plan fiduciaries (under current ERISA rules):

  • Exercise discretion, authority, or control over the management or disposition of plan assets;
  • Provide investment advice for a fee or other compensation;
  • Must manage plan assets exclusively for the benefit of plan participants;
  • Must act with the care, skill, and prudence of an expert;
  • Are prohibited from using plan assets for their own interest; and,
  • Bear personal liability.

How does compensation impact my role?

Fee disclosure is one of the hot button issues for the DOL on the advice front, and for good reason. Research shows plan sponsors and consumers don't understand how much they are paying in fees or for what. Under rule amendment 408b2, filed early this year, the DOL is requiring that all conflicts of interest be disclosed. Under current ERISA rules, registered reps and dually registered reps must either adopt level compensation arrangements — where they earn the same amount of money on all investment products — or offer only education and information, not investment advice.

Many advisors become investment fiduciaries, however, without intending to. That is because one's fiduciary status is based on the functions the person performs for the plan, not just on the person's title. A registered rep may suddenly slip into a fiduciary role if he or she meets with the plan sponsor on a regular basis and is the primary source of investment information. If that information is used as the primary decision-making criteria, and the rep receives variable compensation, then the rep could unknowingly be engaged in a prohibited transaction under ERISA.

Do I want to provide advice or education?

As the compensation/advice regulations become more defined, advisors are going to be forced to decide between a role as investment fiduciary and consultant or a role as a 401(k) education provider and product representative. Here are some exaggerated versions of the potential client conversations the rules might generate: Which one would you choose?

Option 1: You either maintain your status as a registered rep, offering commissionable products, or you choose a hybrid status with access to both fee and commissionable services:

“I can give you advice for this account, but not for that account; for that account, I can only give you education. What's the difference between education and advice? Well, education generally involves describing the components and administrative options of your plan, whereas advice typically entails providing you with recommendations about a particular course of action for your portfolio. If I have a conflict of interest based on the advice I might provide, I can only give you education about your plan options. What is a conflict of interest? That's when I stand to gain more financially from one product versus another. Therefore, I can only educate you on product options; I can't recommend a particular product, though, as there's a perception that my advice could be tainted because I can earn more from certain products than others. I must disclose to you that I have conflicts of interest here, here, here, and here — but don't worry, I always act in your best interests.

“Okay, so here is the type of product I like best. There are 1,500 funds available on the platform; which ones do you want? Oh, I can't recommend which one you should pick. Why not? Here is how this works; you pay me to get you information on products and services, but, by law, I cannot advise you on what to do because, remember, I have those conflicts of interest here and here. You decide. Isn't your brother an investment guy? Maybe he can help you.

“How do I get paid? Oh, that's easy enough to explain and understand — the investments inside of the plan have internal operating expenses; they are readily available in that easy-to-read prospectus. In addition, the funds are wrapped in an annuity wrapper, which is explained in that easy-to-read contract. This increases your investment costs, and the funds pay the insurance companies a portion of the 12b-1s — you know what those are — to offset the recordkeeping fees. My compensation is derived from both sources, but you pay nothing out of pocket.

“You are excited, clear, and want to move forward? Great! Could you please sign these 10 forms — there's only 30,000 words of disclaimers to get through. Thanks for your business!”

Option 2: You migrate to a fee-based model.

“Yes, Mr. Plan Sponsor, I am happy to help you review and understand the Department of Labor's materials regarding understanding fiduciary duties, fees, selecting a service provider, conflicts of interest, and understanding the differences between advice versus education. I can assist you with these matters, and, in many situations, I share fiduciary responsibilities with you because I have no conflicts of interests, our goals are aligned, and my compensation is not impacted by any investment advisory work we do.

“Yes, we can also provide unbiased advisory services to your participants. Our practice is supported by a fee-based model whereby our compensation is not impacted by our investment recommendations, and, again, our interests are aligned.

“You would like for us to assist you with developing and maintaining an IPS, quarterly reviews, and an annual committee meeting? Great!

“Our fees are as follows; we charge:

  • A $15,000 one-time fee for the initial meetings, criteria establishment, fund diligence, and IPS setup;
  • $2,000 for ongoing quarterly reviews;
  • $15,000 for ongoing comprehensive IPS maintenance and committee reviews.

“Our fees can be debited from the plan, paid outside of the plan, or both.

“Could you please sign this contract that acknowledges our fiduciary role and explicitly identifies the fees and services you have selected?”

In the qualified marketplace, it's pretty clear which conversation is better for all parties involved. But if you think you can just walk away from the 401(k) marketplace because it is too much of a pain in the neck, forget about it; what will you do when IRAs fall under ERISA — which is widely anticipated to occur? In the meantime, let's just call a duck and duck and agree that varying compensation presents an inherent conflict of interest. Which means advisors and their clients must be able to distinguish between advice and education and understand the nature of the engagement.

How can I benefit from a fee-based model?

In the qualified plan marketplace, the advantages of working in a fully transparent and explicit environment are significant. There is less room for confusion and potential exposure to liability. Most importantly, advisors can support clients with a model that has more integrity. Under a fee-based consulting model, you are a fiduciary to the plan. The extent of your fiduciary responsibility is defined by the scope of your advice. For example, if you assist a plan sponsor with the selection and monitoring of the plan's investments, you are considered an investment advice fiduciary and your responsibilities under ERISA are confined to this function. The ability to clearly define the services rendered not only helps you set (and meet) client expectations, but it also helps clarify the scope of your fiduciary responsibility.

Migrating to a fee-based model may include the following steps. If you are at a firm that allows you to work only in a registered rep capacity, move plans to a level commission environment as soon as administratively possible. Use whatever means you have to document what fees and services you and your client have agreed to. Keep detailed and fastidious notes of all plan sponsor and participant interactions. Be aware of prohibited transaction issues — particularly with rollovers — if you work with participants inside of the plan.

If you have commissionable 401(k) clients and have the option to migrate them to a fee-based program, do so. Talk with your clients about the current issues and the need for advice at both plan sponsor and participant levels. Also, explain how you want to move your client relationships into an enhanced ERISA environment where you can contractually engage with them as a fiduciary in an unbiased objective capacity with broader market access and explicit responsibilities. This conversation is usually well-received.

Going fee-based, however, will present another host of questions you'll need to answer. This is when advisors need to put on their CEO hats and quantify the value of the business they do. For example:

  • What services can I and do I want to provide?
  • What should I charge?
  • What are my deliverables?
  • What does it cost me to provide these deliverables?
  • Am I going to work with just plan sponsors or with participants too?
  • If I work with participants, am I going to offer advice and education, call center services to my office, and employee and employer site meetings?

But let's focus on the primary question most advisors are concerned with.

What should I charge?

There is no industry standard for consulting fees charged for corporate retirement plan advisory services, and there are very few resources to reference, as this is an emerging marketplace. Typically, however, advisory fees are based on:

  • An annual retainer for general plan advisory services
  • A flat fee per project
  • A percentage of plan assets
  • An hourly rate as determined by the advisor

The method of compensation may be dictated by the needs and payment preferences of the plan sponsor, recordkeeper/vendor, or other third party.

Examples of services for which you may charge a fee include:

  • Investment policy design
  • Investment menu design and monitoring
  • Fee benchmarking
  • Vendor search
  • Participant education program design and implementation
  • Participant advice programs
  • Fiduciary oversight and compliance support

Advisors may also charge a fee for comprehensive plan management services, based on a percentage of plan assets, or an annual retainer fee. Project work typically ranges from $5,000 for an IPS to $25,000 for a full vendor search. Hourly rates often range from $150 to $400 based on advisor experience, plan size, and complexity of services.

On average, we see both AUM and dollar-based fees range as follows:

  • $1-$3 million = 100 bps
  • $3-$5 million = 50 bps
  • $5-$10 million = 35 bps
  • $10-$50 million = 25 bps
  • $50-$100 million = 10 bps

For more on fees, you might want to check out Ms. Schleck has compiled one of the best collections of average fees in the qualified marketplace, and many of the fees she articulates are low, in my opinion.

In general, fees vary widely based on the services rendered, the expertise of the advisor, and the size of the plan. What's important, though, is that you don't underprice your services or give them away to get an account. One, your time is valuable. Two, you will ruin it for the entire marketplace by driving costs down to margins that make it impossible to maintain a viable practice.

Finally, what's wrong with being a fiduciary anyway?

With all this hype about who is and who isn't a fiduciary, what's wrong with working on a full disclosure basis and working with plan fiduciaries in a truly objective capacity for the exclusive benefit of plan participants? Shouldn't all of our client services be held to the highest of standards and integrity?

Amy Glynn is the director of retirement consulting services at Commonwealth Financial Network, a independent broker/dealer and RIA, in Waltham, Massachusetts. She can be reached at [email protected].

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