Up in the Air

“The bad news is that everything changes. And the good news is that everything changes,” says Nick Della Vedova, President of Aliso Viejo, California-based Retirement Plan Advisory Group (RPAG), about the business of working with retirement plans. “The people who continue to evolve with the marketplace will continue to gain market share.”

The evolution may take a sharp turn as new regulation in disclosure requirements and fiduciary standards gets implemented. Up to now, plan advisers have not had professional standards similar to those of attorneys or CPAs, says adviser Don Settina, CEO of RetireRight Pittsburgh, an LPL Financial affiliate. “What we are going through right now is the setting of standards,” he says. While virtually all advisers working with retirement plans effectively serve as a fiduciary, probably only about 30% willingly identify themselves as a named fiduciary, estimates Lou Harvey, President of Boston-based Dalbar, Inc., a financial services market-research firm.

Proposed regulations released by the U.S. Department of Labor in October would substantially broaden the definition of fiduciary investment advice, says Bradford Campbell, a Washington-based attorney who is Of Counsel at Schiff Hardin LLP. Since 1975, the DoL has had a five-part test, he explains: The adviser must offer individualized investment advice, for a fee, on a regular basis, pursuant to a mutual agreement or understanding with the plan sponsor that the advice will be the primary basis for the sponsor’s investment decisions.

In the proposed regs, “the DoL would repeal the five-part test and replace it with four broad categories of providers,” Campbell says. “The most expansive of these is whether you are providing individualized advice for a fee that ‘will be considered.’ If you are, you would be a fiduciary. This is a very low bar that could sweep in many providers who traditionally have never been fiduciaries.” The Labor Department also proposed adding a new form of fiduciary advice called “management advice,” he says, but the term is not defined in the proposal. So far, the DoL has offered only two examples of what that term includes: recommendations on proxy voting and investment managers. “We know that it includes these two things, but we do not know what else it includes,” he says (see “A Heavy Load,” page 36).

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That could involve everything from how an adviser charges for his or her services to searching for fiduciary insurance, he says.

The proposed regs may become final regs later this year, Campbell says, or the Labor Department may soften its stance somewhat and do a round of revisions. “They have put out their opening bid, and their opening bid is very big,” he says, “but is this an opening gambit?”   

Do you have a solid plan-management process that you can use to help plan sponsors with their roles and responsibilities around this crazy word ‘fiduciary’ that they do not understand?” asks RetireRight Pittsburgh’s Settina about what compliance help fiduciary advisers need from their broker/dealers.

RPAG’s membership comes from more than 40 different broker/dealers, and certain broker/dealers allow an adviser to be a named fiduciary while others do not, Della Vedova says. But he likes the idea of advisers serving as named fiduciaries. “Ultimately, our platform and our services are agnostic on that issue,” he says “but we believe that advisers who gravitate toward serving in a named-fiduciary capacity will gain more market share, which benefits everyone.”

It has challenges for broker/dealers, though, Della Vedova says, and he points to their training of advisers. “It is really about the process, so the consultant can do investment due diligence and what we call a ‘fiduciary fitness program’” that educates plan sponsor fiduciaries on their responsibilities, their investment policy statement and committee charters, the RFP process, and fee benchmarking.

At Raymond James Financial, Inc., advisers can serve as a fiduciary for investment selection and monitoring if they meet the requirements of its approval process, says Bo Bohanan, Director of Retirement Plan Consulting at the St. Petersburg, Florida-based company. “With the level of responsibilities involved, for our best advisers, we are fine with it,” he says, “but the average adviser needs to understand the level of responsibility that they are taking on. Our job is education and development: We do training across the nation, and we work with them individually, for them to understand the implications.”

Allowing advisers institution-wide to serve as named fiduciaries means broker/dealers will have to adopt standards and have training and procedures in place to address their increased risk, Dalbar’s Harvey agrees. Even among major players, he says, not all have that infrastructure in place. “The biggest argument against it I have heard from broker/dealers is that the fiduciary exposure is disproportionate to the revenue generated,” he says. “When they do the risk-management equation, it does not look good.” They have two main concerns, he adds. “The first is that broker/dealers have no knowledge or control of the plan’s investments, since these are controlled by the plan sponsor and executed by the recordkeeper. The second is the risk/reward ratio: Retail clients pay 100 to 200 basis points, while 401(k) plans pay one-tenth of that, for the same theoretical risk.” There have been very few lawsuits or arbitrations against broker/dealers for fiduciary work done by advisers, he says.

Harvey says it remains “by exception” that most wirehouses let some highly qualified advisers work as a named fiduciary, while most wirehouse reps working with plans do not serve as named fiduciaries. Wirehouses would be smart to let more do it, believes adviser Tom Clark, Washington-based President of Lockton, Inc.’s retirement group. Being a fiduciary is a functional test, he says, focused on what advisers do rather than how they label themselves. Some broker/dealers may see fiduciary advisers as adding extra responsibility for them, but he believes these companies already have the responsibility by virtue of advisers’ fiduciary actions. “I do not think it is an extra layer of risk” to let them become named fiduciaries, he says. “By acknowledging it and planning for it, both the broker/dealer and its clients will be in a better position.”

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To that end, Clark sees a trend of broker/dealers establishing pockets of registered reps who they feel have the qualifications to act as a plan fiduciary, then driving less-experienced advisers to work with these experts rather than novices working with plans on their own. “The broker/dealers are becoming so aware of their exposure that they will institute tighter compliance controls, and for the folks with little or no experience working with plans, the broker/dealer will not allow the rep to be the only adviser on the account,” he predicts.

As broker/dealers judge advisers’ fiduciary chops, advisers evaluating broker/dealers’ compliance abilities need to gauge their compliance departments’ ERISA knowledge and capability. Harvey points to their client agreements as a tell-tale sign. “If it does not cover some of the key ERISA issues—disclosure of conflicts of interest, continuing fiduciary responsibility, applicable exemption from prohibited-transaction rules, and ERISA fiduciary duties of loyalty, diligence, prudence, diversification, and adherence to plan documents—you know they are not ready,” he says. Bohanan also sees the service agreement as a key sign, and he recommends getting answers to these three questions: Does it exclude any fiduciary services? How clearly does it spell out the fiduciary-responsibility level for the sponsor and the adviser? Will they let an adviser charge an RIA fee in a service agreement?

Also, Harvey suggests finding out whether a broker/dealer lets its advisers publicly market their status as a fiduciary. Some broker/dealers also have a specific client-approval process that an adviser must go through, he says. “If you have to jump through hoops to get an ERISA client signed up, that is not fun,” he says. These broker/dealers will review a plan, and may require the adviser to get more information from the employer. “If you have to say, ‘Wait a second, my broker/dealer does not like what your balance sheet looks like,’ it is an awkward situation,” he says.

As for fiduciary insurance, that remains incumbent on the broker/dealer or RIA that an adviser has registered under, Della Vedova says. He cautions that many policies “exclude work in that capacity,” so advisers ought to check the fine print on a policy. An adviser might have good errors and omissions (E&O) insurance that works for a commission-based business, he says, but lacks any coverage for serving as a named fiduciary.

Sponsor Demand Shifting 

Advisers competing for new business from plans with $10 million or more in assets typically find that sponsors want a named fiduciary, RPAG’s Della Vedova says. “In the over $10 million market, it is a process sale: It is about, ‘This is the service that I am going to deliver to you as an adviser.’ I see more and more advisers have a process-driven value proposition versus a product-driven value proposition,” he says. “Typically, companies that have more than $10 million in their plan have formulated an investment committee, are more sophisticated buyers, understand the difference between a fee-based adviser and a commission-driven broker, and are looking for an adviser to work in a fiduciary capacity.”

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The new fiduciary and disclosure regulations will not end the call for all non-fiduciary adviser work, sources say. As an industry, Raymond James’ Bohanan says, “We are gravitating to that [fiduciary advisers], but the demand is not 100%. Many plan sponsors do not even understand their fiduciary responsibilities, and are not expecting that level of service from their adviser.”

However, the new regs inevitably will lead to more demand for fiduciary advisers, sources say. “From a plan sponsor perspective, there is very little awareness now of whether an adviser is a fiduciary,” Harvey says. “Not a lot of plan sponsors say, ‘Dammit, I have got to have a fiduciary on the plan.’ But that is going to change very dramatically in the next year. Advisers are going to have to report whether they are a fiduciary and disclose what services they provide. That is going to put the issue front and center.” He says that, starting July 2011, advisers will be required under ERISA 408(b)(2) to report to plan sponsors what their compensation is, the services provided, and their fiduciary status. “Unless advisers report that they do not provide investment advice, they will have to say they are fiduciaries,” he adds.

Harvey sees an opportunity for advisers who act now. “I really think that, in this case, the early bird will get the worm,” he says. “Advisers who set up their practices as a fiduciary, and who are very clear with clients about what services they are providing and have the right client agreements in place, are going to be the ones who avoid the backlash. And sponsors who are unhappy with their non-fiduciary advisers are going to look for help.”

Some sponsors may want help from advisers willing to take on extra fiduciary responsibility. Lockton’s Clark gets asked regularly these days, being an ERISA 3(38) ­fiduciary who takes discretion versus a 3(21) who does not. A 3(38) fiduciary serves as an investment manager, while a 3(21) fiduciary serves as an investment adviser, explains Campbell of Schiff Hardin.

The majority of clients currently do not want to give up that level of control, such as making tactical asset-allocation decisions for a defined benefit plan, Clark says. “Interest in it is growing, but as it relates to a plain-vanilla 401(k) plan, clients still want to have the final say on the fund lineup for participants,” he says. However, he adds, it can make sense in certain situations, such as a smaller company with a defined benefit plan and an investment committee that does not meet frequently, or a 401(k) plan working with an adviser on customized target-date funds.

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The Co-Fiduciary Adviser: Valuable ­service or marketing hype? 

Clark sometimes gets asked about Lockton’s willingness to serve as a co-fiduciary. “I really do not think there is such a thing,” he says. “When you are a fiduciary, you are automatically responsible for what the other fiduciaries do. You do not need the ‘co’ in front of it.”

Ask a half-dozen people about what the term “co-fiduciary” means for advisers, and you likely will get a half-dozen different answers. Some see the co-fiduciary designation as less all-encompassing than being a fiduciary. RPAG’s Della Vedova thinks of a co-fiduciary as assisting a sponsor in making investment decisions, versus taking discretion on investment decisions.

However, Raymond James’ Bohanan believes that signing on as a co-fiduciary may carry extra risk, as employers may think the adviser has taken on responsibility for broader plan oversight. “The danger is that you will give the inference that you are a fiduciary in areas other than what you are doing,” he says.

The idea that serving as a co-fiduciary can put advisers in more jeopardy by making them responsible for employers’ behavior in ways they otherwise would not be is “a misconception,” Dalbar’s Harvey thinks. The co-fiduciary adviser “is responsible for what his contract says he is responsible for, not across the board,” he says. If an adviser has a contract to make investment recommendations, he says, “That is the responsibility. That is quite different than overall responsibility for a plan.”

Campbell of Schiff Hardin warns that some financial advisers may view the word co-fiduciary as more of a marketing term than a legal one. “We have reviewed a number of these contracts that attempt to define away the ‘co-fiduciary’ status they claim, while others we have reviewed were quite legitimate,” he says.

Labeling oneself as a co-fiduciary potentially adds legal risk for an adviser, Campbell says. “Despite the limitations you may assert in the contract, it is very hard for you to argue that you did not have a duty to be responsible for their conduct,” he says of fellow fiduciaries. Legal liability would depend to some extent on when a co-fiduciary adviser found out about possible misdoings by a fellow plan fiduciary, he says. “If you are a co-fiduciary and you are aware of a breach, you have to take steps to address the issue,” he explains. “What action you need to take depends on the problem at hand—it may be enough just to ask questions or, in very serious cases, you may need to report a violation.”   

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Developing­ Your ­Competitive Advantage 

With more advisers willing to sign on as a plan fiduciary, is that enough anymore?

“Maybe five years ago, a lot of times a big part of Lockton’s value proposition was that we are willing to serve as fiduciaries,” Lockton’s Clark says. Employers liked the risk mitigation that the investment due diligence offers to their investment committee. “More recently, being a fiduciary is not necessarily a reason to hire somebody: It is a reason not to hire somebody” who declines to do it.

So, each advisory firm willing to serve as a fiduciary also has to develop its competitive advantage, Clark says. “If you are experienced in this market and this is the area you want to play in, these are the people who absolutely need to take the ball and run with it,” Raymond James’ Bohanan says. “Clearly, now more so than at any other time, there is a huge opportunity to go after this marketplace. You need to be able to say, ‘Here is what I do as a specialist. You are going to pay X, and you are going to get Y.’ The consultants who have been successful have drawn out a process, and they show their clients what they are doing.”

RetireRight Pittsburgh’s Settina and his colleagues work a lot on sponsor education as part of their interest in doing broader plan analysis. “We have put together an online education program where we train plan sponsors and committee members on their roles and responsibilities. That is our first step, because unless they know, they do not buy in” to changes needed. Next, they do an assessment of the employer’s plan, focusing on three points of view: compliance with regulatory requirements, the plan sponsor’s roles and responsibilities, and  what the plan can do to help participants. Then, he talks to employers about where the plan is doing OK and where it needs to make improvements. As he says, “We tell them, ‘Here is the good, the bad, and the ugly about your plan.’”

Lockton’s specialties include not just fee benchmarking and designing employee communications, but expanding its business to also give advice on corporate acquisitions. Clark and his colleagues team up on their different areas of expertise to do due diligence on qualified and nonqualified plans as well as health and welfare plans, and a risk-management analysis on a target company’s business insurance and property insurance. Plan sponsors and their independent consultants can provide valuable input on acquisition targets, he says, such as identifying possible compliance issues with the other company’s plans, an acquisition’s implications for the plan document, and gauging potentially greater leverage with the plan provider due to the increased asset size. —Judy Ward