Walking a Tightrope

Brian Hubbell believes that retirement plan advisory firms should be more like law firms in how they charge clients. In 2006, Hubbell, who has more than 25 years’ experience in employee benefits consulting, launched a retirement plan investment advisory firm that applies a professional service business model when billing clients. His firm, Hubbell Consulting LLC, which has provided consulting services for plans totaling approximately $1 billion in Charlotte, North Carolina, charges no asset-based fees. Furthermore, Hubbell, who is a registered investment adviser (RIA), has no securities licenses so he cannot accept commissions, and has no affiliation with any brokerage firm or other financial organization. Instead, he says, fees are based on the time it takes to work on a project. Clients can pay either an hourly rate or an annual retainer and, he says, “plan sponsors are embracing” the model.

After years of comfortably earning high fees from commissions and asset-based fee arrangements with vendors, advisers now are being pressured to disclose more fully their earnings and have to justify those earnings to clients. They also may be forced into new fee charging models. Fee disclosure has been a topic of heightened discussion within the Department of Labor (DOL) for several years now, and more recently in Congress, says Hubbell.

The two established revenue models for retirement plan advisers are the broker model, based on product sales and paid commissions, and the “consultant” or RIA model in which services are performed for a fixed fee. In the broker model, the adviser is compensated via 12b-1 and finder’s fees, with no explicit fees charged for actually providing services to the plan. Plans with more than $50 million in assets historically have been handled by consultants receiving flat disclosed fees and little in the way of commissions, while smaller plans traditionally have relied on the broker/commission model.

In particular, the broker/commission-based revenue model has come under intense scrutiny because payments made from the fund are difficult for the plan sponsor to determine, says Ryan Gardner, a Principal with Fiduciary Investment Advisor in Windsor, Connecticut. According to Gardner, the expense ratio of a mutual fund often is disclosed to the plan participant and plan fiduciary.

“Today, fees are bundled so it’s hard to see what fees compare,” says Ann Schleck, Principal with Ann Schleck & Co. in Mendota Heights, Minnesota. Because the fees are “all in” and the scope of services can vary from plan to plan, it is difficult to get a true apples-to-apples comparison across all the categories, she says.

Asset-based compensation also is coming under fire, because advisers’ fees increase for no other reason than asset values going up. Jason Roberts, a Partner at Reish & Reicher in Los Angeles, California, says asset-based compensation is okay, provided, however, that it reflects a reasonable charge for the services rendered. Most fee-based service providers “ladder” their asset-based fees to provide breakpoints at certain predetermined levels to reflect the economies of scale enjoyed by the service provider. Generally speaking, the formulas applied to determine commission-based compensation are static and could be problematic if determined to be unreasonable in light of services provided.

Larry Goldbrum, the general counsel with the Spark Institute in Simsbury, Connecticut, however, believes fees based on assets are unjustly criticized. In separate account plans, he says, asset-based fees benefit lower- and middle-class workers, since fees generally are passed on to the participants. They have less money in their accounts, he explains, and thus pay less to have access to the plan. If flat fees are charged, then lower- and middle-income workers will be paying a higher percentage of their account for plan access than highly paid workers.

Additionally, Roberts does not see asset-based fees being abandoned in the near future. For one thing, he says, since fees are level, there is no incentive to recommend new services to earn additional fees or to recommend one thing over another. However, he adds, there may be movement to a graduated/sliding scale for asset-based fees, with a corresponding decrease in basis points charges as plan assets increase. “The days of ‘set it and forget it’ are probably over,” he says.

Yet, while asset-based fees are receiving some scrutiny, at this time, the DoL does appear to have given its blessing to advisers charging fees equal to a flat percentage of plan assets, says Louis Harvey, the President of Dalbar in Boston. Other fee arrangements the DoL has sanctioned in recent regulations, he says, include: flat-dollar payments, e.g., $5,000 to do X; a sliding scale based on plan assets, e.g., 15 basis points for assets up to $10 million, then 12 basis points for assets thereafter; and a per-participant charge, e.g., $10 per participant.

At Hubbell’s firm, client fees are calculated by multiplying the hours devoted to a project times an hourly rate. Generally, he says, when a new project comes in, an adviser will map out the steps and give the client a proposal detailing the project scope, steps, estimated hours, and fee range. For example, the fee range could be projected at $10,000 to $11,500. If the project actually takes less time, then the client is billed less. “If it takes more time, we need to be proactive with our client and explain why, as well as self-evaluate inefficiencies on our part which should not be charged to the client” he says.

When working on retainer, Hubbell says he evaluates the amount of time necessary for each client’s deliverable to conduct the required analysis, prepare quarterly reports, and attend scheduled meetings with the client. Additionally, expenses attributable to a specific client are passed through “at cost.” For example, Hubbell Consulting passes through the cost of fidelity bond coverage, generally required under ERISA when engaged as the plan’s investment counsel.

Advisers do not have to pick one fee structure and stick to it. It is entirely appropriate for advisers to use different methods to charge different clients. There are now a lot of dually licensed advisers, says Roberts, so it is allowed, although advisers cannot “double dip” with the same clients, getting both commissions and fees. Not only can advisers charge clients differently, says Harvey, but it better serves clients. “Different clients,” he says, “have different needs.”

For example, says Gardener, an adviser can charge one client a straight retainer fee, with additional fees for special projects such as a recordkeeper search. The same adviser can charge another client a flat fee by the hour, and the adviser can charge another client an amount based on the assets in the plan. Fiduciary Investment Advisers primarily charges its clients a flat fee, although it does bill some clients asset-based fees. “It all depends on what the client wants,” says Gardner. The fee is based on a number of factors including: services required, complexity of the plans, and the time that is required to service the relationship.

However, no matter how the client is charged, says Roberts, ERISA (the Employee Retirement Income Security Act) demands that any payments to advisers made from plan assets be “reasonable.” There is more pressure than ever from regulators and Congress to fully vet fee arrangements, says Roberts. ERISA, he says, requires sponsors to ask advisers what compensation they are receiving from the plan, both directly and indirectly. What fees are required to be disclosed in the future will depend upon which disclosure initiative prevails, whether from Congress or the DoL.

A “reasonable” fee, says Rodger Smith, a Managing Director at Greenwich Associates in Stamford, Connecticut, gives the advisory firm a profit and provides value-added to the client. Advisers need to look at the overall services provided, he says. To determine reasonableness, says Harvey, advisers should look at the services provided to the client and map them against what competitors charge for the same services. For example, he says, if an adviser offers participant advice on a per-participant basis and the normal range for that service is $300 to $1,500 annually, if the adviser is operating within that range, then fees are reasonable.

“Understanding what the market place is charging is critical for determining reasonableness,” says Sue Kelley, a Principal with Ann Schleck & Co. Both Ann Schleck & Co., and Greenwich Associates provide retirement plan adviser fee data. Ann Schleck & Co. has two fee benchmarking products: Fee Benchmarker is an online tool that compares adviser/consultant fees, both commission and fee for service, to a database of industry norms for a selected plan size; Monarch Adviser Fee Almanac is a book containing information on adviser fee trends, methods, and pricing norms. Greenwich Associates data on fees paid by 401(k) plans are gathered from finance executives at medium-size and large plans and from intermediary distribution firms (i.e., banks, brokers, insurers, RIAs, and investment-only DC platforms), says Smith.

Reasonableness also may entail going back to a client and reducing or increasing fees. Gardner notes that there have been rare times when his firm had to go back and renegotiate fees with a client. His firm spends a tremendous amount of effort at the inception of a relationship to understand the unique service needs of that client, which then ultimately dictates what a fair fee may be. In theory, once a fee is set, it generally is guaranteed for a certain number of years. “However, we’ve actually decreased fees when we found that the work hasn’t been as much as we thought or if, after a few years, the work decreased,” he says.

New legislation working its way through Congress should also further affect fee arrangements. “Plan fiduciaries have a duty to enter into arrangements that are necessary and reasonable, but do not have the information to make that determination,” says Roberts. Congress is trying to rectify that problem by having service providers make better disclosures, he says, so that fiduciaries can fulfill their obligation to the plan.

If passed, says Gardner, the new House fee disclosure bill breaks down and identifies fees, including recordkeeping and administration fees (see “Proposed Fee Disclosure Bill” on next page). There is a competing bill in the Senate, notes Roberts, but right now it is hard to tell which will prevail.

Going forward, how much advisers can charge will be dependent on services provided, says Harvey. “We’re moving from a structure where you got 12b-1 fees no matter what you did,” he says. “Going forward, fees will be based on what you do for the plan.”

Once plan sponsors see what advisers are receiving in compensation, advisers should be prepared to answer questions, says Roberts, and thinking about how to describe the services they offer to the plan. Define every service performed, and break out fees associated with it, and whether or not it is a fiduciary act. Advisers now should be getting themselves into the position of justifying their compensation.
 
“With fee disclosure coming, the days of advisers charging as much as they can are over; once the client knows the fees, the services have to justify the fees,” says Michael Goss, Executive Vice President of Fiduciary Investment Advisors.

“If you choose this profession, you have to accept the fact that your income is subject to a professional limitation, because, if you are looking out for the best interest of clients, as ERISA requires, then your fees need to be reasonable,” Hubbell says.

Proposed Fee Disclosure Bill

In June, the House Education and Labor Committee approved the 401(k) Fair Disclosure and Pension Security Act (H.R. 2989), and sent the bill on to the full House for consideration.  The bill mandates a number of new requirements including:

• that a single dollar figure, representing all fees deducted from participants’ accounts, appear on quarterly retirement plan statements;
• that a fee breakdown from service providers and plan administrators be provided to sponsors and be presented in four categories: administrative fees, investment management fees, transaction fees, and other fees;
• that service providers must disclose financial relationships so 401(k) sponsors can ensure no conflicts of interest; and
• that investment advice offered to participants be based on the workers’ needs—not the financial interest of those providing the advice.
  

The bill gives the U.S. Department of Labor enforcement powers over the disclosures.