Hidden Opportunity in New Fiduciary Rules?

While it has been reported many retirement plan service providers are concerned about pending fiduciary rule changes, one pair of compliance experts is more optimistic about a potential “seismic shift” in advice standards.

In a recent white paper from John Hancock Investments, Robert Rafter, president of RJR Consulting, and Gene Huxhold, senior managing director for investment-only retirement plans at John Hancock Investments, predict pending regulatory changes will significantly expand the number of service providers held to a fiduciary standard.

In fact, the two predict all financial advisers, broker/dealers and registered representatives rendering product-specific investment advice to retirement plan participants will soon be held to a fiduciary standard of care under reconceived fiduciary rules, regardless of the focus area of each adviser’s practice (see “Optimizing Your Practice to Capture Rollovers”). This could spell bad news for retirement specialists, the pair writes, as many plan advisers have historically relied on the willingness to take on fiduciary status for their clients as a key differentiator from larger service providers competing in the investment advice marketplace.

Commission-based broker/dealers may face particular challenges if fiduciary rules are strengthened under the Employee Retirement Income Security Act (ERISA) by the Department of Labor (DOL), as advice given to participants that directly increases an adviser’s compensation could trigger prohibited transaction rules. The Securities and Exchange Commission (SEC) and a number of self-regulatory organizations (SROs) with jurisdiction over financial advice related to retirement planning are considering similar measures (see “An Inside Perspective on Rollover Rulemaking”).

Before new regulations take effect, however, Rafter and Huxhold say plan advisers have a unique opportunity to reconsider their value statement and market their services directly to other employee benefit services providers that do not wish to operate as fiduciaries under the new paradigm. There may be a significant expansion of opportunity within this new channel, the team says, allowing new service partnerships and advice models to emerge even as fiduciary rules tighten.

Like others following the fiduciary redefinition, Rafter and Huxhold expect the DOL could deliver new rules as soon as August—the latest deadline announced by Labor officials—but it is likelier the fiduciary redefinition will be delayed once again and will not be released until after the midterm elections, in late 2014 or early 2015. Advisers should take full advantage of the remaining time to prepare for direct and indirect impacts to their business models, the team says.

“The fact that no rules have changed so far makes this an opportune time for professional retirement plan advisers to talk about this issue with clients and prospects, as well as with other influential lawyers and accountants,” Rafter and Huxhold write. “Advisers have a unique opportunity to speak to the marketplace in advance of these changes and simultaneously reposition their value proposition for the next decade.”

To provide a framework for differentiating their value propositions and building new service delivery relationships, Rafter and Huxhold say, retirement plan advisers should first closely consider the choices that exist for positioning a practice over the next decade. There are currently five fiduciary roles commonly defined under ERISA, the pair writes, and that will likely remain the case after new rules are adopted.

The team notes that the parameters of these fiduciary relationships won’t necessarily change under expanded rules—instead, more service providers will likely be forced to either take on one of these classifications or potentially leave the retirement advice space. The various fiduciary roles are described as follows, named for the sections of ERISA from which they are derived:

  • Limited-Scope 3(21) Fiduciary – Rafter and Huxhold say advisers have been expanding the kinds of fiduciary roles they are willing to assume in recent years, and over the last decade an increasing number have signed on to plans as limited-scope 3(21) fiduciaries, rendering investment advice for a fee while refraining from taking on direct discretion over participant assets.
  • 3(38) Discretionary Investment Manager – Other advisers have stepped up the competition by taking on a discretionary investment manager role under the 3(38) arrangement, the pair writes, taking on responsibility for actually making investment decisions for the plan or its participants. The model looks differently across defined benefit (DB) and defined contribution (DC) plan services, but 3(38) fiduciaries generally take on more responsibility than limited-scope 3(21) advisers.
  • 3(16) Plan Administrator – Some service providers have begun to adopt the fiduciary role of a 3(16) plan administrator in recent years. These fiduciaries are tasked with monitoring such things as fee reasonableness and plan documentation/operations alignment, rather than providing investments advice or discretionary asset management.  
  • Full-Scope 3(21) Fiduciary — Rafter and Huxhold say a fairly small number of advisers have begun to define and offer a full-scope 3(21) fiduciary role, usually covering all three levels of fiduciary services.
  • Outsourced TPA Model – Outsourcing some fiduciary duty to a third-party administrator (TPA) operating in a dual 3(38) and 3(16) fiduciary capacity is another emerging option.

Rafter and Huxhold say it is critical for advisers and other service providers to understand how their unique services and operations fit into this framework. Advisers and service providers who work under or expect to adopt the limited 3(21) model, for instance, should make it clear in their written value proposition that their overall goal is to help the plan sponsor establish a prudent process for managing plan assets.

For advisory firms that want to take on more responsibility for monitoring and directing a plan’s investments, the 3(38) arrangement may be favorable, in which case advisers should ensure they communicate the more comprehensive support plan sponsors and participants will receive.

Rafter and Huxhold admit it may be challenging for advisers to fit their business models into one of these boxes, as even a limited-scope 3(21) adviser, for example, is often asked to advise on everything from menu construction and asset class selection to the process of selecting specific underlying funds on a plan menu. As more discretion is gained over plan investments, Rafter and Huxhold explain, the 3(38) and full-scope 3(21) models may make more sense.

“This process usually begins with the creation of a sample investment policy statement (IPS),” the pair writes. “Displaying a sample IPS is one way to immediately demonstrate value. Advisers should also emphasize that they can provide expertise for prudent selection of all investment options, including target-date funds if they are to be part of the plan’s investment menu. Many advisers also assist in the platform provider search process and serve as the ongoing relationship manager and troubleshooter.”

As more providers are pushed into the limited 3(21) arrangement, Rafter and Huxhold say, it may benefit specialist advisers to consider offering the full-scope 3(21) and 3(38) investment manager arrangements.

“Offering 3(38) discretionary investment manager service is an excellent way for an adviser to differentiate versus the competition,” they write. “But it’s necessary to understand the complexities of this role before either the adviser or the plan sponsor can fully grasp the value … in the context of the participant-directed 401(k) plan.”

A full copy of the pair’s analysis, “A seismic shift: what regulatory reform means for your retirement plan business model,” is available here.