How RIAs can rule the 401(k) realm by becoming advocates for plan sponsors -- and start by eliminating eight marketplace conflicts

Brokers can still claim an edge with their knowledge of DC administrative matters but that's a bowling pin ready for the toppling

Wednesday 2.13.13 by Guest Columnist Sheldon Geller

Brooke’s Note: For two days I couldn’t articulate to myself why I liked this column so much. We (mostly Lisa Shidler) have written dozens of articles about DOL changes that are ushering in an era of opportunity for RIAs to take over. Quite simply the fiduciary standards are being tightened and enforced in a way that is not as friendly to brokers. But we also always get countervailing comments from real experts who say that RIAs are even less qualified because they don’t really know the 401(k) business. I have always accepted the gray area created by these two views as something that was beyond my grasp as a non-401(k) expert. After reading this column I not only feel I get it much better. I also am convinced that RIAs can close this mysterious gap that supposedly only brokers or 401(k)-only RIAs can fill. Sheldon Geller explains it to us like we have brains.

Many investment professionals appear to market fiduciary services, yet their service agreements routinely disclaim exposure to fiduciary liability and affirm non-fiduciary status.

Many service providers give supposed fiduciary guarantees, yet litigation filings reveal how they immediately disavow fiduciary status and actually place blame back on the plan sponsor.

Or at least these firms lead clients to believe they are greater fiduciaries than they are.

For example, financial professionals often help with developing fund menus for plan sponsors but most of these professionals are not equipped to provide actionable guidance for other fiduciary duties, including those associated with the administration of the plan.

Accordingly, there is wide disparity and confusion in the retirement plan marketplace as to who acts in the best interest of plan sponsors. There are more than 200 designations that financial professionals use when marketing services, very few of which include fiduciary-level status. See: Do 401(k) assets require all fiduciary care all the time?.

With such a dense fog of obfuscation pressing onto plan sponsors’ shores, registered investment advisors are in a unique position to protect their plan sponsor clients.

Up to speed

By stepping up, RIAs can protect America’s employers — and staffs — from fiduciary liability and a mistaken reliance upon non-fiduciary service providers. Plan sponsors do not understand that brokers are not required to make sure that sales and recommendations — guided only a by a suitability requirement — are in their plan sponsor client’s best interest. The suitability standard does not include a legal requirement for a broker to disclose whether there is a better product available at a lower charge. See: The suitability standard, defined.

Registered investment advisors need to expand their practice models to manage plan governance challenges, whether arising from plan investments or from plan administration. See: Why gathering big-time 401(k) assets — and charging regular fees — is well within reach for most experienced RIAs.

This may sounds like a daunting task, but I just witnessed an associate get up to speed in about a four-month period. Essentially what she did was — as I do for all clients — tell vendors to copy her on all e-mails. She then takes responsibility for reading each one and any attachments — and understanding the important points from the plan sponsor’s perspective. All the plans are fairly similar. You can be more expert than most people at service providers in short order.

Understand that you don’t necessarily need to solve conflicts that you uncover. These companies have ERISA lawyers and other compliance experts to address these issues.

Marketplace conflicts

As you get into the role and mindset of plan sponsor advocate, there are some recurring conflicts to be vigilant about:

Biased advice
Non-fiduciary service providers who are conflicted as a result of the receipt of third-party payments assist plan sponsors in the selection of investment funds. These arrangements create a conflict because funds pay at different rates and providers may steer plan sponsors into funds that increase their compensation.

Non-fiduciary status
Non-fiduciary advisors structure their relationships with 401(k) plan sponsors to avoid fiduciary status. Most plan sponsors mistakenly believe that their advisors are fiduciaries and that their compensation does not vary based upon investment fund selection.

Investment education
Although investment advice is required to be in the plan’s best interest, investment education may highlight a proprietary fund or use an affiliate that is in the advisor’s best interest. Having a financial stake in the outcome of plan participants’ decisions will likely result in mediocre performance and higher expenses.

Indirect compensation
Utilizing revenue sharing to offset record-keeping fees is likely to create conflicts if fees and offsets are not clearly disclosed to plan sponsors. Many service providers retain the revenue sharing generated on plan asset investments even when revenue sharing exceeds fees.

Upfront commissions
A broker may receive a substantial upfront payment upon the transfer of plan assets to a new custodial platform. These payments create an incentive to recommend one platform over another, thereby increasing plan expenses.

Actively managed funds
Service providers promote the use of actively managed funds with greater expenses as well as model portfolios with wrap fees supposedly designed to achieve greater diversification. These investments have higher expenses than index funds with which to pay greater compensation to service providers and brokers.

Service providers and brokers may market retail investment products to participants for investment outside of plans, which are more expensive than the institutional investment products available inside plans. There is no legal requirement to disclose the difference in share class expenses between plan investments and retail investments.

Informational advantage
Service providers, as experts in retirement plan products and services, use their informational advantage to serve their own economic agenda. Plan sponsors have been told not to probe too deeply into service provider agreements and to accept industry assurances of fair dealing.

Compliance pitfalls

Enforcement efforts focusing on the receipt of undisclosed compensation may be brought only against fiduciary service providers. However, most service providers are non-fiduciaries and are permitted to maintain conflicts. Accordingly, plan sponsors need assistance to interpret whether there is disclosure and whether the conflict leads to higher plan expenses. See: Erring 401(k) plan advisors seek do-overs from DOL to ward off potentially crippling fines.

The new service provider disclosures are broad and expand the plan sponsor’s obligation to assess the reasonableness of service provider agreements. Plan sponsor compliance with the reasonable-belief standard is necessary before plan sponsors can use plan assets to pay plan fees. See: A 401(k) plan dethroning deferred: The DOL-mandated disclosures may not set any legacy palaces on fire near-term.

Courts may go beyond the new service provider regulations to require disclosure that is appropriate if it is material to the plan sponsor’s decision-making process. These courts may require communications to plan sponsors and plan participants on a broad range of issues beyond compensation, plan fees and fund expenses.

Registered investment advisors must help plan sponsors make reasoned decisions pursuant to a deliberative and documented process. In-house ERISA fiduciaries must act as would an independent ERISA fiduciary expert and thus for the exclusive benefit of plan participants. In-house fiduciaries must monitor the delegation of authority and service provider performance.

Industry practices and clever marketing attempt to convert blatant self-interest into illusory fiduciary protection. Plan sponsors almost universally lack complete information related to the economic arrangements of their service providers and brokers.

Non-fiduciary service providers are not bound by the exclusive benefit, loyalty and prudence rules, which would otherwise protect plans against excessive fees, hidden compensation and high investment expenses.

Registered investment advisors can add value by becoming subject matter experts and enhancing plan sponsor fiduciary performance. Fee-only advisors have, by their choice of compensation, eliminated most, if not all, conflicts inherent in the marketplace.

Sheldon M. Geller is Managing Member of Stone Hill Fiduciary Management, LLC, an independent fiduciary and registered investment advisor.

Sheldon Geller

401(k) | ERISA