Behind the Scenes

As with everything else in the financial services industry these days, anything new, pertaining to back-office operations, tracks back to the implementation of the fee disclosure rules and the Department of Labor (DOL) redefining plan fiduciary. “What is really driving back-office operations is the fiduciary landscape and fees,” says William David Hand, chief executive officer of Hand Benefits & Trust, a BPAS Company in Houston. As the world of 401(k)s gears up for the biggest change since its inception, advisers and providers of back-office operations are struggling to comply.

Complicating matters is the unsettled status of when an adviser is considered a fiduciary to a plan. Advisers are on the fence, says Hand, because they do not know whether they are going to be fiduciaries to their client plans. Some broker/dealers allow advisers to be fiduciaries; others continue to prohibit it, while some permit advisers to have limited fiduciary status.   

Right now, as they search for back-office assistance, advisers are in three camps, says Hand. First, there are the advisers who do not consider themselves fiduciaries—they will not give investment advice, so the product they sell must have an investment advisory feature, says Hand. Second are the advisers who consider themselves fiduciaries only part of the time, who give limited investment advice and will look for products that can accommodate that. The third type of advisers includes those who always consider themselves fiduciaries and who are essentially always “on the hook,” Hand says. They select investments for the plan, and if these investments do not perform, they will replace them,
says Hand.

For companies serving advisers, it is about efficiency and building scale into the back office, says Skip Schweiss, president of TD Ameritrade Trust Company. Historically, while advisers may have just used a rebalancing application, now back-office vendors are trying to create systems that do it all, says Schweiss. It is now possible for retirement plan advisers to load up all plan data into one system. “It’s now about making it seamless for advisers so that they do not need to increase costs,” he says.

Issue No. 1: Fees  

Advisers now have these new disclosures to make, says Schweiss. Fee disclosure “is issue No. 1 in the business now,” says Schweiss, calling the new disclosure rules a positive development even though they create a lot of work. “It’s not right that participants think the 401(k) is free. They should know what they’re paying for,” he says. In the end, Schweiss believes advisers who are registered investment advisers (RIAs) will be ready to comply, and registered representatives will, as well, although it will be more of a struggle. “RIAs are already disclosing through their Form ADV, so it is not as big a deal for RIAs as it is for broker/dealers,” he says.

Fee disclosure is a good thing for the industry and the market, agrees John Moody, president of Matrix Financial Solutions, a Broadridge Financial Solutions company. Matrix clears mutual fund trades for approximately 350 financial institutions and services approximately 150 third-party administrators and recordkeepers for 401(k) and 403(b) plans.   

“We’ve always supported full fee disclosure,” says Moody. But while disclosure is good, compliance has created a considerable amount of work for 401(k) providers and recordkeepers to determine fees. Going forward, every new product Matrix is in the process of developing will be built to comply with fee disclosure.   

Broadridge Financial Solutions has developed a new product to deliver fee disclosure information to participants and will be sending Employee Retirement Income Security Act (ERISA) section 404 fee disclosure information to more than 25 million participants, says Tim Slavin, senior vice president of defined contribution at Broadridge Financial Solutions. Broadridge, which handles securities and mutual fund processing and investment communications, provides back-office securities processing for many firms, says Slavin, dealing with some $3.4 trillion trades. The firm’s focus is primarily on ’40 Act mutual funds, but it also supports other investment vehicles, including exchange-traded funds (ETFs), company stock and managed portfolios.   

“It would be difficult for our clients to build processing products in-house,” says Slavin. “We bring to the table not just software but delivery. We’ll continue to enhance as the DOL comes out with new rules.

‘Below-the-Water Expenses’ 

Disclosure has also caused more plan sponsors to become aware of fees outside of expense ratios and investment options, says Hand. Plan sponsors, he says, are now asking about other fees not disclosed in expense ratios, such as litigation recovery fees and fees relating to execution of trades, and securities lending. “It’s these below-the-water expenses that are the new focus of plan sponsors,” says Hand.

Additionally, fee disclosure has led to a mad run on mutual funds, with many large-plan sponsors converting to more transparent, separately managed accounts, says Hand. This trend started in the large-plan market and is now progressing down-market as plan sponsors seek funds that are more comprehensible—therefore, simplifying compliance with the new rules.

Some estimate that there is over $1 trillion in plan assets in investment models across the defined contribution system in need of examination for compliance, says Hand. He helps advisers deal with how to fix noncompliant investment models, noting that most current models are not compliant under the new rules.

Advisers concerned about their fiduciary status as it relates to plan investments and asset-allocation models have three options, Hand says. First, they can trash their current models and put all plan assets in qualified default investment alternative (QDIA)-compliant funds such as target-date funds (TDFs). Second, advisers can take their current models to a trust company and create a separately managed account, to try and make them compliant. Third, advisers could limit investment modeling to only the core investments in the plan. For example, if the plan has 10 investments, then the models would only use those 10 designated investment options and work to make them QDIA-compliant.   

At larger brokerage firms, says Moody, there is a desire to ensure that the advisers registered with them get level compensation across the retirement plan. Even an open architecture platform cannot guarantee this. Matrix, he says, can screen and get reportable, level compensation.   

Broadridge also has front-end tools for advisers such as its Retire Tool Kit. Advisers can use this software to screen investments and create investment lineups and investment policy statements, says Slavin. “We work to allow advisers to leverage open architecture to give them the tools to manage the wide range of investment choices. We give advisers the tools to make management­ more manageable,”
he says.

Opportunities Abound 

Right now, experts say, the industry upheaval creates a lot of opportunities for advisers, including winning business from others. “It’s clearly an outstanding opportunity for advisers to build new business,” says Moody. Matrix and Broadridge solutions allow advisers to compare a plan sponsor’s current defined contribution product with potential replacements, free. There is also tremendous opportunity for advisers to present their added value to plan sponsors, says Schweiss. His firm, he says, encourages advisers to de-emphasize price and stress value.    

Opportunity also exists due to another trend pertaining to 403(b) plans, says Schweiss. In recent years, more and more 403(b) accounts are becoming ERISA plans. Instead of individual accounts needing management, says Schweiss, his firm is starting to see plans with consolidated advisers/recordkeepers, etc. “It used to be the Wild West of individual accounts,” he says. “Now they are moving to a more ‘plan-based’ approach.” This creates a perfect occasion for advisers to extend services into the nonprofit arena.   

Pretty soon, the urban legend that 401(k) plans are free of cost will be blown apart, says Slavin. Additional regulation is developing, and it will drive more plans to move away from off-the-shelf bundled products and to embrace more tailored solutions—even custom target-date funds—and open architecture. With each new DOL regulation, Broadridge will “tweak” its products, says Slavin.   

As the industry moves past disclosure, ETFs will continue to move to the forefront because of their lower costs, predicts Schweiss. TD Ameritrade already enables advisers and plan sponsors to include ETFs on the platform, he notes. “When plan sponsors have ETFs, on average, close to half of plan assets are in ETFs as opposed to mutual funds,” he notes.

Regardless of what party is in the White House next year, advisers should not expect any change in direction concerning disclosure or fiduciary status, industry experts say. Rolling back is impossible even if there is a change in administration, says Slavin. People have reached the point where retirement plan service providers are starting to realize they must move forward.

A year from now, predicts Moody, the industry will see even more reform to the fiduciary standard. The DOL is likely to make it more difficult for brokers to claim they are not a fiduciary to a plan, he predicts.