Fiduciary Outsourcing
Before becoming founder and CEO of Unified Trust Co. in Lexington, Kentucky, Gregory Kasten was an M.D. in anesthesiology. When looking for retirement advice, Kasten “found a lot of smart people and advisers to talk to, and some of them had some powerful ideas, but most were ultimately trying to sell me a specific product or bring me back to a particular fund family. In some ways, it’s hard to believe that was 35 years ago, because what the DOL is talking about doing now with strengthening the fiduciary rule could absolutely have applied back then.”
This is the same complaint leveled by many against the financial services industry of today, Kasten says, especially those lobbying for a tougher fiduciary rule under the Employee Retirement Income Security Act (ERISA). As proposed, the rulemaking would essentially make it harder for brokers, advisers, wholesalers and other financial professionals to sell products that lead to an increase in their own compensation—for example, through revenue-sharing payments or sales commissions—to ERISA-covered clients.
The strengthened fiduciary rule language has not yet, as of when this article was written, made it through a final review by the Office of Management and Budget (OMB), but a clear investment industry consensus has emerged that the fiduciary rule will be in effect by the close of this year and will significantly expand the number of advisers and consultants lumped into the fiduciary category.
For Kasten, this is a natural next step for the advisory industry that has been a long time coming. “It will clearly promote positive outcomes for clients, while potentially causing some pain for advisers who have not taken sufficient steps to prepare their businesses.” The good news for advisers in all of this, he says, is that “being a fiduciary is actually a pretty simple proposition, once you get over all the hype. It’s about doing the right thing by your clients—always.
“I have always held the belief that the doctor-patient relationship is a very clear model for fiduciary financial advisers to follow,” he adds. “A doctor is always expected to take the best care of a patient that he can, without considering his own compensation. It’s that simple.”As a new fiduciary paradigm unfolds, many advisers will find themselves facing the same questions Kasten faced in building out fiduciary service offerings at Unified Trust Co. He suspects more and more advisers will move to specifically codify their fiduciary offerings in client agreements and contracts—making tough decisions about pricing and product along the way. Many will move to take on one of the three go-to fiduciary relationship structures programmed directly into ERISA, he predicts. These are, of course, the 3(16), 3(21) and 3(38) fiduciary roles.
Figuring out which model is right for what clients is not always an easy task, says Daniel Notto, managing director at J.P. Morgan Asset Management in New York City. He notes that Section 3 of ERISA is the definitional section. Subsection 3(16), for example, contains the definition of a plan administrator, which includes duties of government and retirement plan participant disclosures. “So a 3(16) fiduciary is going to be limited to the duties of a plan administrator, which includes duties of recordkeeping, governance and disclosures, both to participants and to the government,” Notto explains.
Typically, an adviser will not become a 3(16) fiduciary, due to the huge volumes of repetitive-process-oriented work required—work more befitting of a third-party administrator (TPA) or, perhaps, a recordkeeper, he says.
Grant Arends, president of consulting services at Alliance Benefit Group of Kansas City Inc., in Kansas City, Missouri, says some recordkeepers have taken on a 3(16) role, “but there are still relatively few recordkeepers wanting to do that; the trend is in its infancy.
“Recordkeepers and advisers fear a 3(16) fiduciary role because they will likely have to process hundreds and even thousands of transactions and requests per day; it’s scary to have fiduciary responsibility for those,” Arends says.
ERISA also provides definitions of 3(21) investment advisers and 3(38) investment managers, two increasingly popular approaches. According to Arends, there is greater momentum for the use of these fiduciary services, directly due to the DOL’s pending fiduciary rulemaking.
Craig Bitman, a partner at Morgan, Lewis & Bockius LLP, also in New York City, says 3(21) or 3(38) services are similar in many respects, differing mainly in the final level of discretion an adviser takes over plan participant assets.
The main importance of a 3(21) adviser is setting a process
for the investment committee to select and monitor funds and, in some cases, to
make specific product recommendations. However, because the adviser does not
make the determinations, it is still up to the plan sponsor to formally do so.
“The retirement plan committee actually still votes and makes the final
decision about any investment recommendations and choices,” Arends says. He
notes that many plan sponsors are migrating away from 3(21) in favor of
3(38) services because “Ninety-nine percent of the time, they accept an
investment 3(21) fiduciary adviser’s recommendations, yet [the sponsor is] the
one taking on all of the fiduciary responsibility for selection.”
Pricing for either the 3(21) or the 3(38) fiduciary’s
services will have much to do with the end client’s philosophy and
decisionmaking—i.e., with how high-touch the client wants the advisory
relationship to be. But it is fairly safe to assume 3(38) services will be more
expensive in the end than either 3(21) or 3(16) arrangements, given the added
liability assigned directly to the adviser, the experts suggest.
According to Bitman, the U.S. Supreme Court
decision in Tibble v. Edison International also has led plan
sponsors to pay more attention to the duty to monitor investments and how this
is programmed into either the 3(21) or 3(38) relationship. He observes that the
processes for performing both types of fiduciary functions are much the same.
“The difference is between making recommendations and executing decisions.
“The timing of decisions is usually better if you’re a
3(38),” he says. “If something happens in the market, a 3(38) can make changes
faster than if he had to wait for a plan sponsor decision. So, while he may
have more nominal liability, in practice the greater control involved with
being a 3(38) can actually help reduce your liability.”—John Manganaro
KEY TAKEAWAYS
- 3(16) services are best left to a third-party administrator or recordkeeper;
- Advisers increasingly prefer 3(38) services to 3(21); and
- Recent fee lawsuits and the pending fiduciary rule are prompting interest.