Compliance August 3, 2018

ACLI, IAA Comment on SEC Standards of Conduct Proposals

They say that additional interpretation of standards of conduct for investment advisers is unnecessary and that imposing broker/dealer standards on life insurers and investment advisers is inappropriate.

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The American Council of Life Insurers (ACLI) and the Investment Adviser Association (IAA) both commented on the Securities and Exchange Commission’s (SEC)’s standard of conduct proposals, for the most part saying that additional interpretation of standards of conduct for investment advisers is unnecessary and that imposing broker/dealer standards on life insurers and investment advisers is inappropriate.

As for Form CRS, which would create a requirement for a uniform relationship disclosure document to be used by broker/dealers and investment advisers, ACLI says that it is not conducive to life insurance products.

“Life Insurers provide significant written disclosures at the point of sale to satisfy multiple regulators’ requirements and to help customers understand the nature of their various products and relationships,” ACLI says in its letter to the SEC. “These disclosures include many product related materials (insurance sales illustrations, policy contracts, required “buyers’ guides,” prospectuses), marketing materials describing the firm’s offerings, documents that provide the terms for a brokerage or advisory relationship (brokerage account agreements, advisory account agreements, Form ADV, investment policy statements), and other required disclosures.” In addition, “life insurers fulfill a considerable amount of post-sale disclosure depending on the nature of products and services provided, such as in-force insurance ledgers, transaction confirmations, periodic performance reporting for investment accounts, and updated Form ADV brochures.”

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ACLI goes on to say that “the proposed Form CRS is based on a full-service broker/dealer model and does not provide for workable disclosure of information relevant to customers of insurance-affiliated broker/dealers. Firms should have the flexibility in the Form CRS to accurately describe their business model and what their clients can expect from the relationship. This would make the document more user friendly and hopefully make it more likely that a customer would read the document. We believe that the intent of the Commission in creating the proposed form would best be met by allowing for greater flexibility in the required disclosures.”

As for Regulation Best Interest (Reg. BI), regarding appropriate conduct standards for broker/dealers, ACLI is in favor of it, saying in a letter to the SEC, “Reg. BI is vastly superior to the prescriptive, and now vacated, DOL Fiduciary Rule and its BIC exemption. Life insurers strongly support protections serving the best interests of customers, which can be meaningfully safeguarded with disclosure about services and material conflicts of interest. This approach provides an effective means to shield consumers and facilitate informed purchase decisions.”

However, ACLI says, “it is critical that proposed Reg. BI equitably includes life insurers’ products, functions, services and regulatory framework within the scope of the SEC’s focus in developing a final regulation. The disclosure standards and objectives should be consistent and parallel in Form CRS and Reg. BI to avoid confusion and to promote clear understanding. A more flexible approach to required disclosure is preferable and would serve consumers better.”

As far as the SEC’s proposed interpretation regarding standards of conduct for investment advisers, ACLI asks the SEC not to “propose additional, unnecessary requirements in the investment adviser space. Investment advisers are adequately regulated, and ACLI recommends that the SEC not use its current interpretation as a foundation to promulgate additional regulation in an area where it is not needed. ACLI has concerns that any proposed enhanced regulation for investment advisers would create duplicative and unnecessary regulation.  Life insurers with associated investment advisers and broker/dealers are subject to multiple layers of regulation from state insurance commissioners, state securities regulators, the SEC, and FINRA. In lieu of any proposed regulation, the SEC should continue to provide interpretative guidance and rely upon the voluminous existing guidance and case law regarding the duties of investment advisers, rather than attempting to codify this body of existing law.”

For its part, IAA also says that regulations should be more flexible and that the SEC should not impose “unnecessary and ill-fitting” broker/dealer regulation on investment advisers.

“We are concerned that ‘harmonization’ of investment adviser and broker-dealer regulation would result in an overly prescriptive, check-the-box regulatory regime that does not fit advisers’ businesses and is not consistent with the flexible principles-based fiduciary duty for advisers,” IAA tells the SEC in a letter. “Accordingly, we recommend the Commission refrain from any rulemaking in these areas.”

IAA goes on to say that “Investment advisers’ business models and activities differ significantly from those of broker/dealers. Given those differences, financial responsibility rules are inappropriate and unnecessary for advisers. A requirement for advisers to provide account statements would be duplicative. Investment adviser clients currently receive account statements from custodians.  Further, the custodial account statement or an invoice from the adviser specifies the actual advisory fees clients pay. “

IAA adds: “Federal licensing and continuing education requirements for investment adviser personnel are unnecessary.  Advisory personnel who engage with retail clients are already subject to state licensing and qualification requirements. The Commission has not explained why a second layer of licensing and qualification is warranted.  Further, advisory personnel are subject to a range of compliance requirements and already receive training on the laws, regulations, and fiduciary obligations applicable to advisers.  Finally, advisers already are required to provide clients with a description of the qualification, education, business background, disciplinary history, and additional compensation (including sales awards) for personnel providing advice for each client. This information is required to be affirmatively provided to each client for whom the advisers’ personnel are giving or formulating advice, and is far more relevant to a client assessing the qualification of such personnel than passing an exam. There is no such counterpart for broker/dealers.”

 

 

Products August 3, 2018

Reading Into Fidelity’s ‘Zero Expense Ratio’ Retail Mutual Funds

Fidelity this week introduced what it is calling “self-indexed, zero expense ratio mutual funds” on the retail side of its business; the move may not directly touch retirement plans, but it speaks clearly to broader asset management industry trends.

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Fidelity this week announced a sweeping initiative to reduce fees for retail investing customers, including the launch of a series of “Fidelity ZERO Index Funds,” which are billed by the firm as “self-indexed, zero expense ratio mutual funds.”

Coinciding with the launch of these funds, Fidelity says it is implementing “across-the-board zero minimums to open accounts, zero account fees, zero domestic money movement fees, and zero investment minimums on Fidelity retail and adviser mutual funds and 529 plans.”

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As explained to PLANADVISER by a Fidelity spokesperson, the significantly reduced and simplified pricing on the new and existing Fidelity index mutual funds “[is] meant to deliver unparalleled value, simplicity and choice for clients.”

“Right now, these funds are only available to our retail customers,” the spokesperson noted. “However, we’re always reviewing and evaluating our product lineup, and we do currently offer a broad selection of low-cost index funds that are currently available to plan sponsors for their defined contribution [DC] lineups. These [new index] funds are available for IRAs [individual retirement accounts].”

According to the firm, the Fidelity ZERO Total Market Index Fund and the Fidelity ZERO International Index Fund are among the industry’s first self-indexed mutual funds with a zero expense ratio available directly to individual investors.

“This means investors will pay a 0.00% fee, regardless of how much they invest in either fund, while gaining exposure to nearly the entire global stock market,” Fidelity suggests. “The funds will be available on Fidelity.com as of August 3.”

In addition to offering the self-indexed mutual funds with a zero expense ratio, Fidelity is reducing the pricing on its existing stock and bond index mutual funds. Fidelity says it will provide investors the lowest priced share class available, ensuring every investor, regardless of how much they invest, will benefit from the lowest possible fees. The average asset-weighted annual expense across Fidelity’s stock and bond index fund lineup’s will decrease by 35%, with funds as low as 0.015%. These changes will save shareholders approximately $47 million annually, according to the firm.

Implications for the retirement planning market

The news is important for the retirement planning market insofar as it includes the broad pricing cuts on index funds and the new availability of zero expense ratio mutual funds for individual retirement accounts. But these aren’t the only reasons why retirement industry practitioners should take note. As highlighted in the July issue of “The Cerulli Edge, U.S. Asset and Wealth Management Edition,” there are multiple causes of fee compression in the asset management industry today, and the distinct causes of fee compression are compounding upon each other to prompt dramatic industry change.

At a very high level, the increasing importance of asset allocation advice, both within retirement plans and for individual wealth management clients, is perhaps the strongest driver fueling a decline in asset management fees and margins for providers. Bing Waldert, director at Cerulli and lead author of the report, observes that managers “are in many cases actually dropping fees on asset management products to near zero.” Fidelity’s move this week is a perfect example.

“Instead, they are choosing to charge for asset allocation, a task traditionally performed by the wealth manager,” Waldert observes. “The growth of asset allocation advice demonstrates how asset and wealth managers are using these industry trends to enter each other’s value chains and attempt to capture a greater share of a shrinking fee pool.”

While the trend has not yet fully come to pass, Cerulli’s reporting suggests automation is another factor that continues to compress overall management fees.

“Automation will lower the cost of transactions, bringing down fees in wealth management,” Waldert adds. “In addition, digital advice platforms emphasize asset allocation, which pressures fees in individual asset manager products and benefits exchange-traded funds [ETFs].”

Reflections on Fidelity’s position

As readers may recall, Fidelity already made waves once this year with shifts in its fee practices. In February, the firm made an unanticipated announcement that it would begin charging a 0.05% fee on assets invested through its institutional retirement plan recordkeeping platform into Vanguard products, including that firm’s popular (and very low-cost) suite of index-based target-date funds (TDFs) and collective trusts.

The announcement grabbed attention for some obvious reasons, including that Fidelity and Vanguard are two of the largest-volume providers of retirement plan recordkeeping and investment products for defined contribution (DC) retirement plans in the U.S. Speaking then with PLANADVISER, a Fidelity spokesperson confirmed that the nominally small fee “applies only to new clients.” But, given the sheer volume of business conducted by Fidelity and Vanguard in a given year, the fee change could result in a significant amount of new revenue for Fidelity.

Fidelity is still in the process of rolling out the fee on its recordkeeping platform, so it is a little soon to tell how clients may react. However, what is clear is that the move, like the one this week to introduce zero expense ratio mutual funds to retail customers, reflects a fundamental ground shift that is occurring in the way clients perceive the cost-value equation in asset management, both on the retail and the institutional sides. Until only just the last few years, the defined contribution investment only (DCIO) side of the asset management industry remained strongly profitable for diversified providers such as Fidelity, even as clients pushed back on high recordkeeping fees. Today, client expectations are shifting yet again, and there is clear evidence of a similar race to the bottom in terms of costs on the investment management side.

In this respect, it is interesting to ask whether this type of zero expense ratio product could one day work in the institutional space, where it may be harder for a firm to run such products profitably on trading fees alone. This approach is seemingly the bet Fidelity is making on the retail side by offering ostensibly free asset management in its newest funds.

The Fidelity spokesperson declined to specifically address this question, but Kathleen Murphy, president of Fidelity Investments’ personal investing business, shared the following statement: “We are charting a new course in index investing that benefits investors of all ages—from Millennials to Baby Boomers—and at all affluence levels and stages of their lives. The groundbreaking zero expense ratio index funds combined with industry-leading zero minimums for account opening, zero investment minimums, zero account fees, zero domestic money movement fees and significantly reduced index pricing are unmatched by any other financial services company.”

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