Speaking on a Webcast sponsored by Principal Financial Group, James Delaplane, a partner at Davis & Harman LLP, examined the three major regulations coming out of Washington this year, and identified recurring trends they share and what implications they will have for financial professionals.
new disclosure requirements for service providers to give to clients,
requirements for plan sponsors/fiduciaries to disclose more information to participants, and
the proposed changes to the definition of a fiduciary adviser (Delaplane stressed how this last one is in the earliest stages of consideration, while the first two are nearly finalized).
Delaplane sees several trends repeated throughout these regulations. Policy-makers want to make more “discriminating” customers out of plan sponsors and participants, he said. These disclosures are intended to make plan sponsors and participants better-educated consumers, and give them more leverage in decision-making.
He also said that the Department of Labor (DoL) is giving the impression with these regulations that it wants to impose higher standards of care on financial professionals. This would involve heightening scrutiny of fees–by plan sponsors, participants, and regulators. These new regulations would bring a spotlight on levels and sources of compensation from third parties, Delaplane said.
A third trend from these regulations shows a growing concern over the retirement readiness of Americans. Policymakers will continue to watch the industry; scrutiny is not going to go away, believes Delaplane. He noted that the Obama administration has repeatedly demonstrated that it is paying attention to the treatment of plan participants by the industry.
Delaplane discussed five overarching implications these regulations may have for financial professionals.For one thing, advisers need to clarify for themselves whether their business model makes them a fiduciary. Once this is clear to the adviser, they need to make sure their clients are aware of their fiduciary (or non-fiduciary) status. Additionally, these regulations will lend themselves to formalizing service agreements, if this has been unclear in the past.
Also, regulatory outcomes may impact an adviser’s compensation. Sponsors or participants may react differently if an adviser’s fees are generated from the plan, from participants’ balances, from the plan sponsor, or any number of different ways. Because of this, the regulatory outcomes may lead some advisers to reconsider their business model. And lastly, those advisers with the clearest and strongest value propositions will come out on top. Delaplane suggests tackling this as soon as possible, so it doesn’t appear to clients as though it’s only because the government said to do something a certain way.
James Delaplane, Partner at Davis & Harman LLP, discussed the two types of disclosure requirements on a Webcast hosted by the Principal Financial Group.
The first regulation Delaplane dove into is the Employee Retirement Income Security Act (ERISA) 408(b)(2)–new disclosure requirements service providers will have to give to plan sponsors. He looked at the purpose of the disclosures, what exactly they include and what actionable steps advisers should take to make sure they are in compliance.
The purpose of the 408(b)(2) disclosure requirements is to help plan sponsors ensure the reasonableness of the plan, which is part of their fiduciary duty.What needs to be disclosed by the financial professional includes several things. Advisers will need to specify the service they provide, the direct compensation received from the plan and where it comes from (participant accounts or plan investments), but noticeably not if compensation comes from the plan sponsor, indirect compensation from third parties (but advisers do not have to “unbundle” their service pricing), what compensation you receive if the contract is terminated, and if the adviser will serve as an ERISA fiduciary.All of this information has to be given to the plan sponsor before the plan is implemented. It has to be in writing, but can be separate from the main service agreement. If disclosures aren’t provided, penalties will be dealt, said Delaplane, adding that if mistakes are made, there are ways to correct them.
The original effective date of these disclosure requirements was set for July 16, 2011. But just two weeks ago, the DoL announced a new effective date, Jan 1, 2012. Delaplane mentioned, however, that technically these are still “interim” regulations, and a completely finalized version still needs to be issued. When this will happen is still unknown–potentially by this summer, but the sooner the better, because by January 1, 2012, all disclosures will have to be fully implemented.
The implications of 408(b)(2) are numerous, said Delaplane. He described five of them:
1) The disclosures will highlight the “receipt of and sources of indirect compensation,” so advisers should be prepared to answer questions from sponsor, along the lines of, “So how does it affect our plan that you get paid by Company XYZ?”
2) A sharper focus fiduciary status or lack thereof. For broker/dealers, being an ERISA fiduciary is not even an option under their business model, but clarity is what will matter most.
3) A tighter linkage between compensation received and services provided will be required. Advisers might have to “spell out their services.”
4) Elevated importance of coordination regarding which providers are providing which services. If sponsors see overlap, they will ask the adviser, “Why are three providers providing participant education?”
5) An additional premium on compliance support and practices–advisers will want to get this right because there will be penalties.
The second regulation Delaplane discussed at length are disclosure requirements of plan sponsors to plan participants. This entails ensuring participants have the information they need to make informed decisions about enrollment and investments.
These disclosures will be effective for plan years beginning after November 1, 2011, or January 1, 2012 for calendar year plans. Unlike the 408(b)(2) disclosures which are the responsibility of advisers, plan sponsors are responsible for these disclosures. The only plan sponsors tasked with these disclosures are those working on ERISA-covered, participant-directed defined contribution plans. Delaplane said it’s noteworthy that disclosures must go to all eligible employees, even those who don’t have a balance in the plan.
Several things will need to be disclosed, said Delaplane. On or before a participant invests in the plan, they need to receive investment direction, a “heads up on plan-level administrative charges.” If they use advice services or make withdrawals–any fees that they may incur need to be disclosed. Then there also will be a quarterly report; what will end up being included in this is key, said Delaplane. Participants need to be told about any charges against their account in dollars and cents.If charges come from investment ratios, that needs to disclosed too.For every investment option on a plan’s menu, there needs to be a history, fees, expense ratio, (translated into a dollar amount with a hypothetical $1000 investment).Fee and performance background of the investment options needs to come in a comparative format – a chart. The DoL has provided a model chart for how the information should be displayed. Unlike with the 408(b)(2) disclosures, which can be sent electronically, these disclosures can’t just be available on a Web site–it needs to be “pushed out.” Even electronic delivery is up in the air, said Delaplane–the industry is working to make it more electronically friendly.
These disclosure requirements have been finalized for November 2011, or for calendar plans beginning in 2012.
There will be several implications for plan participants and sponsors. The importance of fees and performance in investment decision-making for participants will be elevated.Advisers should make sure this doesn’t outweigh other considerations, like proper diversification. It’s conceivable more participants will take more affirmative action, and not just accept the default investment option. They may also experience “sticker shock” regarding their quarterly charges, especially if an adviser’s fees are on it in dollars and cents. Advisers will need to be able to communicate why their fees are acceptable and necessary.
Sponsors will also be thinking more about fees as part of their fiduciary responsibility, and how they want to finance the cost of plan administration.They may also want to reevaluate their investment menus – a large investment menu will make the required comparative chart harder to design.
As for the financial professionals - their compensation will be disclosed. If they are paid from participant fees – those charges will show up on quarterly statements in dollars and cents. If paid directly from plan sponsors, rather than the plan, that won’t be disclosed. If paid from within the investment expenses, like a 12b-1 fee, that also does not have to be disclosed. But how the compensation happens, no matter which way, will have to be disclosed. Advisers may want to consider the benefits or costs of compensation practices, because they may notice different treatment depending on what gets disclosed.