fi360 Blog

Fiduciary Links: Obama’s 2013 budget includes bump in SEC examination funding

>>>>Last Monday, President Obama released his proposed budget for the 2013 fiscal year. There is obviously a long way to go before anything becomes settled, but it is worth noting that the SEC has requested a $266 million increase to their budget under the proposal, which includes the cost of hiring an additional 222 new examiners.

However, in addition to the ongoing political tug of war, another question that plays into whether this number is too much, too little, or just right is where we stand on a self-regulatory organization for investment advisers. As both Mark Schoeff of InvestmentNews and Kristen French of RegisteredRep highlight in articles from last week, it is anticipated that we’ll see new legislation introduced this year from the House Financial Services Committee that would empower FINRA to take over the job and/or authorize the creation of a new SRO. If that happens, then the SEC could eventually strip out the bulk of its adviser examinations budget and instead focus on oversight of the SROs. Or, vice versa, if the SEC gets this new funding, maybe they can better demonstrate that they are the most effective regulator for advisers and cause the whole conversation to become moot.

Our stance has remained that the best answer for advisers and for investors is a fully-funded SEC and, failing that, the best option for an SRO is the creation of an adviser-specific organization, rather than trying to fit a square peg into a round hole with FINRA. While we view any increase in the SEC’s oversight and enforcement budget as a good thing, it is difficult to see how annual haggling between the President and both parties in Congress over a number is good for addressing long-term examination adequacy issues. Allowing the SEC budget to be linked to the collection of member user fees, on the other hand, would create a more scalable solution that has no effect on the federal deficit.

>>>>The other story that continues to be at the forefront of advisor concerns is the impact of 408(b)(2). This week, we have two pieces from Fred Reish that should help you to prepare your disclosure programs. In a PLANSPONSOR article, Reish looks at benchmarking as the next logical step for plan sponsors after disclosure. And in his latest bulletin from his own firm, Reish and two of his colleagues look at the impact of 408(b)(2) on RIAs in the following areas: deadlines, DOL guidance, designated investment alternatives, indirect compensation, responsible plan fiduciary exception, disclosure of changes, and disclosure for reporting and disclosure purposes.

Fred will be taking an in-depth look at 408(b)(2) benchmarking at the 2012 fi360 Conference, in addition to this other session on the DOL’s new definition of “fiduciary.”

Now on to the rest of the best links from the past week:

Practice 4.3: Control best execution, soft dollars, and proxy voting

Practice 4.3 is primarily related to monitoring the use of separately managed accounts in a portfolio. The fiduciary is expected to take steps to ensure that the portfolio is managed in the best interest of the end investor. The fiduciary must examine policies and spot check the activities of those managers to be satisfied that:

• Best execution practices are followed in selecting securities
• Soft dollars are expended only for authorized research that directly supports the investment program
• Proxies are voted in a manner most likely to preserve or enhance the value of the subject investment

Mutual funds, ETFs, and other types of commingled accounts are highly regulated and it is generally impractical for the fiduciary to closely monitor those areas.

Let's take a look at the actual Practice and Criteria. You can click on the image to view a larger version:

 

"Best execution" refers to how money managers trade a client's account. Money managers should be shopping trades with various brokerage firms to find the most competitive price for the security, taking into account the size, speed and accuracy of the trade. This is not a requirement to buy the cheapest available services. Rather, it requires that the manager takes into consideration market price, trade quality, and commission cost and demonstrate that any decision to "pay up" is justified in relation to the value of the services received.

Soft dollars are the excess commissions generated from the difference between the negotiated commission and what the brokerage firm has to pay to an exchange to execute a trade plus earn a reasonable profit. The most common use for soft dollars is for the money manager to purchase securities research that will directly benefit the client from whose account the excess commission dollars are taken. The responsible fiduciary should obtain and review a copy of the investment manager's soft dollar policy and periodically sample the manager's soft dollar log to ascertain how diligent the manager is in tracking the soft dollars and how they are utilized. Failure to monitor soft dollars may subject the investment program to possible expenditures that yield little or no benefit, i.e., a fiduciary breach.

Finally, a fiduciary has a responsibility to account for the voting of proxies. The fiduciary can either retain the power to vote proxies or instruct the money manager to vote on behalf of the fiduciary. Typically, only the largest of fiduciary portfolios elect to take responsibility for voting their proxies. The majority of fiduciaries delegate that responsibility to the manager via instructions in the investment policy statement. The fiduciary responsible for monitoring proxy voting should review each investment manager's proxy voting policy and periodically review the manager's proxy voting log. The log review should include periodic sampling of specific proxy votes to assure that votes are cast in a manner that serves the best interests of the end investors.

For more information, consult the following resources:

• Complete text of Practice 4.3 from the Prudent Practices for Investment Stewards handbook
•  Legal substantiation to Practice 4.3 from ERISA, UPIA, UPMIFA, MPERS, and relevant regulation and case law
• CFA Soft Dollar Standards
• SEC Inspection Report on the Soft Dollar Practices of Broker-dealers, investment advisers, and mutual funds
• The SEC Proposes long awaited guidance on soft dollars
• Final Rule: Proxy Voting by Investment Advisers
• SEC Proposes to Require Proxy Voting Disclosure

Fiduciary Links: On professionalism and the AICPA code of conduct

>>>>In his latest Fiduciary Corner column for InvestmentNews, Blaine takes a look at the AICPA code of professional conduct as an aspirational guide for how financial advisors can achieve true professionalism. With central, recognized requirements to adhere to fiduciary principles, to maintain the integrity and reputation of their chosen profession, and to consider their place within society as a whole, accountants meet the classical definition of a professional and thus enjoy a greater reputation than do investment advisors.

While some of the comments to the article point out that actual conduct does not always meet the level of the standard and that there are plenty of advisors whose actual conduct does, in fact, equal or surpass those of the average CPA, the point is that there is a fundamental lack of trust and confidence in the financial industry as a whole that will be hardpressed to be restored for as long as it remains disjointed and with competing interests.

>>>>Also last week, Blaine appeared in a video interview with RegisteredRep, where he discusses the current outlook for regulation of wirehouse advisors and how fi360 has seen more AIF students and Toolkit subscribers recently because of that outlook:

 >>>>Finally, we want to pass on that we are now accepting submissions for our 2012 Article Competition. Our article competition is a chance for AIF® and AIFA® designees to have their writing published and showcase their position as thoughts leaders on fiduciary issues in the investment industry.

All accepted entries will be featured on fi360.com and be eligible to be published by our competition media partner, AdvisorOne. The winner will be featured in AdvisorOne, receive a $1,000 cash prize, and be honored at the annual fi360 Conference.

This year's submission deadline is March 12, 2012. If you are interested in submitting an article, please download the official rules and submission instructions. You can also send questions to resources@fi360.com.

Now on to the rest of the best links from the past week:

A Novel Way to Promote the Fiduciary Standard

Washington continues to be gridlocked, as we are painfully aware, at the SEC and Capitol Hill.  According to one estimate, the SEC has missed more than half of its deadlines for rulemakings under Dodd-Frank, which has also impacted the SEC’s discretionary rulemaking authority under Dodd-Frank.

One of the hostages of the current stalemate is the SEC’s consideration of a rule adopting a uniform fiduciary standard for brokers and investment advisers. Critics argue for a go-slow approach, demanding cost-benefit analyses first.

One novel way to break the impasse – admittedly one that is probably too bold a move for an agency under political siege -- is by eliminating the binding pre-dispute arbitration requirement. By eliminating the requirement, the SEC could then bypass the exercise of crafting detailed rules for fiduciary conduct, which would not likely escape a court challenge, and instead energize its amicus, or ‘friend of the court,’ program, to shape the outlines of a fiduciary standard in case law. Thus the SEC could borrow a page from the Department of Labor, which employs a more active amicus program, one that has been actively engaged for years in defining the fiduciary standard for pension advice. 

At the risk of comparing apples and oranges, let’s begin by looking at the SEC and Department of Labor’s amicus programs.  Both are indeed active, the SEC’s Appellate Litigation Group holds the distinction of filing its first amicus brief in 1936. As a smaller, independent agency, with only three securities laws to administer, the SEC’s amicus program is also smaller than the DoL’s. The DoL’s Office of the Solicitor covers five labor laws in addition to ERISA, and writes seven times as many briefs. Accurate comparisons are, of course, difficult since amicus briefs can vary considerably in length and legal complexity.

Yet in reviewing work production by the two agencies since 2001, it is apparent that DoL is far more active than the SEC in attempting to influence court decisions affecting the fiduciary standard.

Fiduciary Links: Finally, final 408(b)(2) rule released

>>>>The big headline from last week was the “final” release of the final 408(b)(2) fee disclosure rule from DOL. The regulation has been in the works for nearly five years and it has been more than a year-and-a-half since an interim final rule was first published. 

The rule requires covered service providers to disclose to retirement plans a description of services to be provided and all direct and indirect compensation to be received for those services. The idea for the rule is that it will assist responsible plan fiduciaries in fulfilling their duties to assess reasonableness of compensation and identify potential conflicts of interest. The rule also impacts a corollary rule for the responsible plan fiduciary to disclose those facts to the participants directly. With the final rule, the effective date is July 1, 2012 for plan disclosure and is August 30, 2012 for participant disclosure.

You can check out InvestmentNews’ coverage for a news summary of the release.  For more details, see the DOL release statement, rule fact sheet, and the rule itself. Additional reaction can be found below among the rest of this week’s best links. For guidance from fi360, we direct you to a webinar we did early last year with ERISA attorney Fred Reish on the subject. A recording of the session can be downloaded from our site, as can the follow up Q&A Fred did for this blog. Fred also will be appearing at the 2012 fi360 Conference to discuss how this rule will impact advisors moving forward.

>>>>And, now that we’re on the subject, we released our first look at the 2012 fi360 Conference agenda last week. In addition to Fred, we also have Pulitzer Prize-winning author Doris Kearns Goodwin giving a general session address on leadership lessons from Lincoln. Her book, Team of Rivals, examines how Abraham Lincoln built a team of both political supporters and enemies to help him achieve success in running the nation and winning the Civil War. Ms. Goodwin will be discussing what business leaders can learn from President Lincoln’s example.

Visit our 2012 fi360 Conference agenda page for a list of confirmed speakers and the topics they will be covering. It is a diverse offering, covering different portfolio types, legal and regulatory updates, fiduciary assessments, investment best practices, marketing, practice management, the economy, ethics, etc.

Visit our site for more general information and register here if you’ve decided to come.

Now on to the rest of the best links from the past week:

Should advisors have an education policy statement?

It was only recently that we first heard of an education policy statement. But it is something we are increasingly being asked about by our members.  

The only documents we specifically recommend as part of the "fiduciary file" are applicable trust documents, custodial/brokerage statements, investment performance reports, service agreements with investment management vendors, the investment policy statement, investment committee minutes, asset allocation/asset liability studies, due diligence fields on funds/money managers and monitoring procedures for funds and/or money managers.

Although we do not see an education policy statement as an integral part of the fiduciary process, the best reasons for instituting one are for the value it can provide to you in clarifying the goals and strategy in your participant education activities or for marketing purposes, if it is something you are encountering as a demand of the market.

During our training programs, we do discuss participant education as part of 404(c) safe harbor compliance. Part of 404(c) requirements is to ensure participants receive sufficient education on the available investment options to make an informed investment decision. In that regard, we do recommend that a good education program should include providing each participant with:

• each investment option’s most recent prospectus or similar document
• a general description of the investment objectives and risk/return characteristics of each investment option
• information on the fees and expenses associated with each investment option
• a listing of the securities held by each option
• the performance of each investment option
• to be safe, MPT stats, such as the Alpha, Sharpe ratio, and standard deviation of each investment option

For more information on education policy statements and participant education, in general, check out some of the following resources:

• An article in Employee Benefit News on how to reinvigorate 401(k) plans, including a source from Transamerica who recommends an EPS: http://ebn.benefitnews.com/news/out-of-hibernation-2710045-1.html
• A look at what Fred Reish has written on a given subject is usually helpful. Here is the results page for a search on “participant education”: http://www.drinkerbiddle.com/publications/list.aspx?KeywordPhrase=participant%20education
• An article on how to develop an education policy and strategy, including a recommendation to formalize it with an EPS: http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401kEducation.aspx
• A blog post we did a while back on participant education: http://blog.fi360.com/fi360_blog/2008/12/a-question-on-p.html
• DOL guidance on participant investment education: http://www.dol.gov/ebsa/regs/fedreg/final/96_14093.htm

Fiduciary Links: 403(b) Compliance Summit Report a must read for all retirement plan professionals

>>>>An article in PLANSPONSOR this week alerted us to the release of a report from ASPPA’s National Tax Sheltered Accounts Association’s 403(b) Compliance Resolution Summit. The purpose of the summit is to “identify service issues and develop  best practices for the resolution of those issues.” Included in the report from this year’s summit are recommendations related to new 408(b)(2) and 404(a)(5) fee disclosure regulations , the effects of the DOL’s proposal to redefine “fiduciary” and other compliance and plan servicing concerns.

 While specific to 403(b) plans, the report and recommendations are a valuable resource for any professional servicing retirement plans and wrestling with how best to prepare for upcoming regulatory changes. Here is an overview of just some of the recommendations made by the participants at the event:

• In regards to fee disclosure:
  • How to better educate plan sponsors
  • Set expectations at the outset as to who is responsible for which aspects of disclosure
  • Perform a self-evaluation to determine 408(b)(2) obligations
• In regards to participant advice and fiduciary issues:
  • “[R]egardless of whether the definition of fiduciary remains as it has been for the last 35 years, or in the alternative may be expanded, it is always a best practice for employers and participants to select advisors who are competent and helpful, and who will provide full disclosures as to fees and any potential conflicts as it may affect the plan or the participant(s).”

A summary of the report, including a link directly to the report itself, can be found on the NTSAA’s website.

>>>>If you are reading this blog post, you might be inclined to share a particular link you think is interesting or insightful or instructive to your prospects and clients. You might even choose to do so by using a social media platform, such as Twitter, LinkedIn, Facebook, or others. The publishers of those links certainly make it easy to do so with buttons that remove any manual steps for “Liking” or otherwise sharing the article to your audience. However, an article in RIABiz last week reminds you to think first before doing so, lest you be in violation of your firm’s policies or even SEC compliance.  The article summarizes SEC guidance on the issue of social media use by advisers, as well as recommending you be aware of your company’s policies and to pay particular attention to violation of the “testimonial” rule. Fi360 General Counsel Kristina Fausti did a similar blog post just a couple of weeks ago that points advisors to the pertinent guidance as to their use of social media.

Now on to the rest of the best links from the past week:

2012 State of the Union address recap

While Tuesday’s State of the Union address focused largely on jobs and the economy, which was expected, President Obama did touch on some financial services issues. Below are two excerpts from his speech, which can be found in its entirety on the White House site.

On financial reform and regulation:

And I will not go back to the days when Wall Street was allowed to play by its own set of rules. The new rules we passed restore what should be any financial system’s core purpose: Getting funding to entrepreneurs with the best ideas, and getting loans to responsible families who want to buy a home, start a business, or send a kid to college.

So if you’re a big bank or financial institution, you are no longer allowed to make risky bets with your customers’ deposits. You’re required to write out a “living will” that details exactly how you’ll pay the bills if you fail – because the rest of us aren’t bailing you out ever again. And if you’re a mortgage lender or a payday lender or a credit card company, the days of signing people up for products they can’t afford with confusing forms and deceptive practices are over. Today, American consumers finally have a watchdog in Richard Cordray with one job: To look out for them.

We will also establish a Financial Crimes Unit of highly trained investigators to crack down on large-scale fraud and protect people’s investments. Some financial firms violate major anti-fraud laws because there’s no real penalty for being a repeat offender. That’s bad for consumers, and it’s bad for the vast majority of bankers and financial service professionals who do the right thing. So pass legislation that makes the penalties for fraud count.

And tonight, I am asking my Attorney General to create a special unit of federal prosecutors and leading state attorneys general to expand our investigations into the abusive lending and packaging of risky mortgages that led to the housing crisis. This new unit will hold accountable those who broke the law, speed assistance to homeowners, and help turn the page on an era of recklessness that hurt so many Americans.

A return to the American values of fair play and shared responsibility will help us protect our people and our economy. But it should also guide us as we look to pay down our debt and invest in our future.

On insider trading by members of Congress:

I’ve talked tonight about the deficit of trust between Main Street and Wall Street. But the divide between this city and the rest of the country is at least as bad – and it seems to get worse every year.

Some of this has to do with the corrosive influence of money in politics. So together, let’s take some steps to fix that. Send me a bill that bans insider trading by Members of Congress, and I will sign it tomorrow. Let’s limit any elected official from owning stocks in industries they impact. Let’s make sure people who bundle campaign contributions for Congress can’t lobby Congress, and vice versa – an idea that has bipartisan support, at least outside of Washington.

It was encouraging to see the insider trading issue discussed. It has been getting a lot of coverage since the 60 Minutes story late last year. Of course, it was telling that the House chamber was awkwardly silent during that portion of the speech.

With the focus Dodd-Frank has put on the fiduciary duties of financial advisors, it is only fair that Congress follow the same principles. Just as a trusted advisor is expected to act in the best interests of his or her clients and to avoid or manage conflicts of interest, so should elected or appointed officials be beholden to the constituents they serve, i.e., the citizens of this country.

Fiduciary Links: 2012 State of the Union address

Tomorrow, President Obama will deliver the annual State of the Union address to Congress. Beyond the expected emphasis on jobs, the economy and the military, one thing we'd like to see is a raising of the fiduciary bar for members of Congress and other public officials. If we could give him a few bullet points of our own, we would ask him to request Congress for legislation to promote ethics in government, including provisions that would:

• require a statutory fiduciary duty for Congress, the President, and political appointees.
• set up blind investment trusts for all elected and politically appointed federal officials.
• set up an independent ethics agency for Congress, using the GAO structure to limit political influence (fifteen-year appointment for agency head).
• implement and better enforce more uniform ethics rules and procedures across government as it relates to former staff going to work and lobbying for regulated entities, including ‘cooling off’ periods before being paid to lobby or ‘consult’ on public policy issues.
• provide meaningful campaign funding reform.

The White House has an interactive feature for the State of the Union address that will be streaming the event along with other information, as does the Speaker of the House, to cover the Republican response.

Now on to the rest of the best links from the past week:

The latest on social media guidance from federal and state regulators

In an increasingly electronic world social media has become an important communications tool, and many advisors find themselves entering the evolving world of media and communications to connect with current and potential clients.  Regulators have taken note and issued guidance to direct advisors and their firms on how to ensure their social media use complies with existing laws and regulations.    

With guidance available from FINRA in 2010, fi360 presented a webinar in December 2010 on building a strategy for effectively using social media and managing risk associated with social media use.  Now, just a little more than a year later, the SEC and a state regulator have issued guidance for investment advisers.  With greater direction now available for both broker-dealers and investment advisers on social media, it’s more important than ever for all advisors to know the rules of the road.