fi360 Blog

Fiduciary Links: New fiduciary champion on Senate Banking Committee?

>>>Last Thursday, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the progress of Wall Street Reform. The hearing featured leaders from seven regulatory agencies and made headlines as Elizabeth Warren’s first chance to grill regulators as a senator. The clearest fiduciary angle, though, comes from the testimony of SEC Chairman Elisse Walter. The InvestmentNews story of the hearing recaps Senator Jon Tester (D-Mont.) pressing Ms. Walter on fiduciary rulemaking. The article rightly points out that with nearly 100 mandatory Dodd-Frank rules at hand, progress is slow. Ms. Walter, for her part, expressed her support for fiduciary rulemaking, but also used that ominous word, “harmonize.” Complete testimony and video of the hearing is available on the Senate Banking Committee’s website.

>>>We’ve been following the fine blogging work of Roger Wohlner for a while now. Roger is a long-time friend of fi360 and we regularly feature his work in the “Articles your clients should be reading” section at the bottom of these blog posts, so it is nice to see his work recognized. On Friday, his most recent post for the U.S. News and World Report Smarter Investor Blog, Your 401(k): Good or Lousy?, was picked up for the front page of Yahoo! We hope the result is that many more investors are exposed to Roger’s work, because that can only be a good thing.

You can follow Roger’s writing at the Smarter Investor Blog (where a number of other friends of fi360 are blogging as well) and on his own blog, The Chicago Financial Planner. 

Now on to the best of links of the week:

Fiduciary Hedge Clauses, Mary Jo White, and the Pending Rule

>>>>The Investment Advisers Act of 1940 has long prohibited so-called “hedge clauses,” provisions in an advisory agreement that waive compliance with any provision of the Act.  In terms of the advisor’s fiduciary duty,  any effort to waive it would be folly – unless you are Congress or the SEC.

In its own inexplicable wisdom,  Congress chose to narrow the parameters of the fiduciary duty under the Dodd-Frank reform act by limiting investment advice to retail customers, and curtailing the duty once advice is dispensed.  The prognosis for preserving the traditional fiduciary standard isn’t much better at the SEC, unless the putative new SEC Chairman, Mary Jo White, proves to be a wild card.

Form has overtaken substance in the fiduciary debate, with opponents conceding the reality of a fiduciary duty but still resisting its traditional application to “investment advice.”  Wall Street is merely playing the old shell game, by shifting  the old battle over “solely incidental” investment advice -- advice exempted from fiduciary oversight under the Merrill Lynch rule -- to investment advice exempted under Dodd-Frank. 

If SIFMA, Wall Street’s advocacy group, had its way, the new fiduciary duty for securities brokers would be limited to advice on individual securities transactions and portfolio management.  This may seem to be a big concession, given the broad activities that one associates with investment advice on stocks and bonds and in managing portfolios.  Unfortunately, SIFMA also served up novel arguments on why traditional fiduciary activities associated with these activities, such as development of asset allocation strategies, the use of financial planning tools, asset balance reminders to clients with non-discretionary accounts, and needs analysis of investment objectives, were not really investment advice.

In early January, SIFMA went on to predict that a fiduciary rule, or concept release requesting information on costs and benefits, would be forthcoming in the first quarter of this year.  After more than a year of regulatory impasse, even this rosy forecast had to be moved back to the second or third quarter of 2013.  This was undoubtedly due to the Administration’s surprise announcement of Mary Jo White, a former prosecutor, to chair the SEC, thereby placing acting Chairman Elisse Walter in a caretaker role until the Senate approves the nomination.

Fiduciary Links: FINRA, the SRO Bill and Other Updates

 >>>>During the last two years, FINRA has spent over $2 million lobbying Congress, largely in support of bill that would establish an independent SRO for investment advisors. For that reason, the reports last week that suggested FINRA and other advocates of the SRO bill may be moving on from the issue came as something of a surprise. However, indications now are that it probably isn’t so simple.

“It's good news that they're not working the bill on Capitol Hill at this time,” fi360’s Duane Thompson told InvestmentNews. “It doesn't mean they're going to forget about it or walk away completely.”

IN’s updated story indicates that FINRA won’t abandon the issue completely and another report suggests they may be looking to find a champion in the Senate. 

>>>>With more fees and services data available to plan sponsors due to the 408(b)(2) disclosure rules now in effect, many predicted a lot of movement as plans reacted. This has been true with large plans that have significant resources and motivation to seek out the best deals possible. For smaller plans, however, this has not been the case. New research indicates that most small employers are reluctant to change unless necessary, due to the effort and disruption involved. This, of course, raises the interesting question of what is an advisor’s liability if a plan sponsor elects not to make any changes, even if a better deal is theoretically possible?

>>>>As regulators prepare to testify regarding progress under Dodd Frank to the Senate banking committee this week, it appears that rulemaking trudges slowly forward.  According to statistics related to Dodd-Frank released by the Davis Polk law firm, there are 398 rules required to be enacted. Of those, over 37% have been finalized and over 30% yet to be proposed.  The firm also reported that about 60% of the rules are running behind their stated deadlines for enactment.

The Senate hearing is scheduled for Thursday.

 

Fiduciary Links: An IPS can Demonstrate Reasonable Diligence

>>>> In his most recent Fiduciary Corner column for InvestmentNews, Blaine Aikin looks at how brokers need to rethink the investment policy statement in light of FINRA's new suitability rule. An IPS serves as the business plan for a portfolio, laying out instructions or guidelines to be applied in all applicable situations regarding investment decision-making (as described in DOL Interpretive Bulletin 94-2). Regardless of whether dealing with an institutional or retail customer, brokers armed with an adequate IPS should have what they need to demonstrate reasonable diligence to ascertain the customer’s profile and to gauge the suitability of their recommendations.

Institutions routinely maintain investment policy statements to guide their internal portfolio management activities and the activities of the financial service providers they engage. FINRA’s Suitability Rule includes an exemption for recommendations given to an institutional customer that “indicate[s] affirmatively that it is exercising independent judgment in evaluating” the recommendations, among other things. Even so, a broker should obtain the IPS for each institutional customer to guide the development of sound recommendations and to help document that requirements of the institutional investor exemption are met.

Most retail investors don’t have an IPS, even though they should. Investing without a written investment policy virtually assures that success is neither defined nor measurable, making suboptimal outcomes equally assured. Fiduciary advisors routinely work with clients at the start of their relationship to develop an IPS because it establishes the essential framework for effective portfolio management.

To learn more about how a well-crafted IPS is the best way for brokers to comply with the new suitability requirements, visit read the full article at InvestmentNews.com. 

Now on to the rest of the best fiduciary links from last week: 

Birth of an Industry Leads to Need for Specialization

This week we have a guest post from Sharon Pivirotto, PPC™, AIFA, a Managing Partner of Financial Service Standards. The mission of FSS is to help retirement plan professionals understand the specific regulations surrounding ERISA retirement plans, and identify resources that can allow them to meet regulations with process. She is also the author of 401K Service Solution Handbook for Retirement Plan Sponsors and Fiduciaries.

>>>> Any advisor that gets paid from employer-sponsored retirement plan assets should have specialized training as a condition of selling or servicing retirement plans. This opinion is based on personal experience, research, and a commitment to what’s in the best interests of the client.

Twenty years ago, a retirement plan client didn’t seem very different than other clients that needed investments. The advisor role was limited to selling the investments, running an investment analysis report, and educating the employees on basic investment concepts. The retirement segment of the financial industry was not formally carved out and there were no sales or service standards. This outdated service model has evolved into much more by independent advisors and retirement specialists, but is not uncommon in the broker world.

With the introduction to the “F” word by fi360 in the early 2000’s, followed by the Pension Protection Act of 2006, the additional provider and participant disclosures last year, and now the proposed amendment to the definition of an ERISA fiduciary, the competency threshold for selling retirement plans should no longer begin and end with the ability to select and monitor investments.

I believe the evolution of the retirement market into a distinct and specialized industry has caused a shift in what is needed and expected from the advisor community. Since the fees paid to the advisor on a retirement plan can often be more than 50% of the total plan costs, the advisor is the most likely provider to be perceived as the expert or individual best positioned to help the plan sponsor understand and meet the myriad of regulations surrounding retirement plans. Hence, whether an advisor acts in a fiduciary capacity or not in providing retirement plan services, all advisors should be certified and trained on ERISA matters and meet a minimum level of specialization in order to get paid from ERISA plan assets.

In a recent article by Dale Magner, the VP of Retirement Product Sales at Guardian Retirement Solutions, published by RPMI’s Weekly Exchange, Dale noted that the Department of Labor’s focus on fiduciary status during the past year has illuminated the fact that many financial professionals have been unknowingly acting as ERISA fiduciaries.

Investment training is not enough. Designations that indicate a comprehensive investment analysis course of study is not enough. Advisors need a baseline understanding of the different types of employer sponsored retirement plans available, they need to understand the roles and regulations defined in ERISA, and they should have a solid grasp of what resources are available to help plan sponsors meet the regulations surrounding their particular type of retirement plan.

Fiduciary Links: IOSCO report not approved by SEC

>>>> Last Monday, the International Organization of Securities Commissioners released a report on principles for suitability requirements for distribution of complex financial products. IOSCO is made up of member regulators from around the world with a mission to work together on more consistent regulations to promote better markets and protect investors.

The report details nine principles, categorized into the following areas of product distribution by financial intermediaries, as well as recommendations for implementation by both regulators and the regulated:

• Classification of customers
• General duties irrespective of customer classification
• Disclosure requirements
• Protection of customers for non-advisory services
• Suitability protections for advisory services (including portfolio management)
• Compliance function and internal suitability policies and procedures
• Incentives
• Enforcement

It is noteworthy that the report was not approved by the SEC, which is a member of IOSCO. Commissioners Paredes and Gallagher issued a joint statement voicing their opposition to the release of the report. As noted in this Bloomberg article, there are currently only four active commissioners. It isn’t stated if Chairman Walter or Commissioner Aguilar supported the report, but you have to wonder if this is one of the first examples of an even-numbered Commission being unable to reach consensus.

Fiduciary Links: SRO Opponents -- Watch for the Trojan Horse in 2013

>>>>Investment adviser groups probably looked at 2012 as a good year -– maybe even great -- legislatively speaking.  The specter of an investment adviser SRO passing Congress, or at least the House, an effort heavily bankrolled by FINRA and broker-dealer groups, petered out rather abruptly.  House Republicans balked, thanks in part to the unsung grassroots work of various adviser groups, and a distinct distaste by Republicans for getting in the middle of a major intra-industry food fight.  With the prime mover of the SRO bill, Rep. Spencer Bachus, R-Ala., termed out as chairman of the House Financial Services Committee, and incoming chairman Jeb Hensarling, R-Tex., seemingly more interested in dismantling Sallie and Freddy, the prospects of a renewed SRO battle this year seem even more remote.

This may be true, and fiduciary proponents including this blog hope that is the case.  However, there have also been persistent rumblings on Capitol Hill over the need for a technical corrections bill to fix glitches in the massive, 2,300-page Dodd-Frank Reform Act of 2010.  A technical corrections bill is not unusual after a major reform bill has passed Congress, except that ‘technical correction’, usually referred to as typos, is always in the eyes of the beholder and could mean more than that. 

If such a bill were passed by the Senate Banking Committee, look out.  The possibility of a technical corrections bill as a legislative vehicle for mischief, as in an SRO for investment advisers, is always possible.

Have you tested your disaster recovery plan lately?

When was the last time you tested your disaster recovery plan (DRP)?  Industry best practice is to test your DRP annually.  At fi360, we conducted our most recent test last month.

Business continuity planning, which includes a DRP, seeks to prevent interruption of mission-critical services, and to re-establish full capabilities as swiftly and smoothly as possible.  Business continuity has become an increasingly common area of concern as we've seen disruptions to entire regions from natural disasters, such as the recent Hurricane Sandy. Preparation in this area can really pay dividends when a significant event occurs.

Fiduciary Links: FINRA Proposed Regulatory Notice 13-02 and how far does disclosure need to go

>>>>We indicated last month that FINRA was considering a proposed rule to address conflicts of interest relating to recruitment compensation practices.  This is another indication that FINRA is interested in putting rules in place that require representatives to act more like fiduciaries; particularly when retail clients are involved.  FINRA Regulatory Notice 13-02 has since been issued and it is getting some attention as comments received to date both criticize and support the rule .The comment period expires March 5^th and our expectation is there will be numerous comments before then.

The proposed rule would require specific disclosures by the recruiting member firm of the financial incentives a representative receives as part of his or her relationship with the new firm.  Disclosure would be required before a former retail customer of the representative decides whether or not to transfer their account to the new firm.  If the compensation is reasonable, why should a representative be reluctant to disclose it?  On the other hand, if it truly has no bearing on the quality of advice being given, why the requirement to disclose?  These and other questions will be debated as this proposed rule moves forward.  Either way, it will be interesting to see how it plays out.

Fiduciary Links: A Fresh Look at Nonprofit Boards and Alternative Investments

>>>>In his latest Focus on Fiduciary column for Morningstar Advisor, AIFA Designee Scott Simon takes a look at how nonprofit boards tend to interact with alternative investments. In short, in the rush to diversify and seek opportunities for greater returns, too many boards are taking on the risk of alternative investments without really understanding the product they are investing in. While appropriately qualifying his remarks with the disclosure that no investment is “per se prudent or imprudent," Simon reminds us that not enough investors heed Warren Buffet’s lesson “that if [investors] cannot understand an investment product, then they [shouldn’t] buy that product.”

This is an article worth reading or passing on to any nonprofit clients you might be working with. Simon promises a related column next month delving deeper into the topic, which we, as always with Scott’s work, look forward to.

>>>>In the category of tooting our own horn, we would like to alert your attention to the latest recognition of our CEO, Blaine Aikin, who was named to RIABiz’s list of the ten most influential individuals in the 401(k) industry. Congrats, Blaine!