Part 2: Revised Definition of 'Fiduciary'
By Thomas Rowley
Director, Retirement Business Strategy
This is the second of a three-part series examining how retirement-related regulatory proposals could potentially affect plan consultants, field associates and financial advisors by altering their business models. The series includes discussion of automatic IRAs, revision of the definition of "fiduciary" and the changing 401(k).
"Disruptive innovation" is the term used to describe innovations that change a product or service in ways the market doesn't anticipate. Several proposals among the multitude before Congress, the Department of Labor (DOL) and other regulatory bodies could create disruptive innovation in the retirement marketplace. The long-awaited revised definition of "fiduciary" is certainly one change that could significantly alter your business model within the next few years.
"Trusted advisor" positioning draws scrutiny
The impetus for revising the definition of fiduciary is regulators' opposition to the current business model that positions a financial professional as a trusted advisor. Based on that trust, investors may take advisor recommendations that — while not fraudulent or even unsuitable — are more costly than other options. As a result, investors pay higher fees. Regulators are always on the lookout for potential conflicts of interest.
A 2013 Government Accountability Office (GAO) investigation expanded the trust issue beyond financial advisors. Undercover investigators called 30 firms representing the largest service providers to understand how they market products to employees with 401(k)s. Seven incorrectly said that their IRA was free or that there were no fees to open or maintain an IRA. In addition, a GAO review of the websites of 10 large firms found that five incorrectly indicated their IRAs were free. The investigation also found that service providers play a large role in the decisions workers make when they leave their jobs.
The GAO investigation prompted a response from Sen. Tom Harkin, D-IA, chairman of the Senate Health, Education, Labor, and Pensions Committee; Senator Bill Nelson, D-FL, chairman on the Senate Special Committee on Aging; and Rep. George Miller, D-CA, member of the House Education and the Workforce Committee. Their letter urged the DOL and the Department of the Treasury to:
- Act on GAO's recommendations, including protecting consumers from deceptive marketing materials disguised as advice, establishing uniform standards and model notices to assist 401(k) accountholders in making better-educated decisions on their retirement savings, ensuring the full disclosure of IRA fees and encouraging people to consider keeping their retirement savings in the 401(k) system.
- Make it easier for people to retain or roll over balances into a 401(k) to reduce pre-retirement cash-outs.1
Investment advice: Who can provide it and how?
Decisions about who can provide investment advice and how they can provide it underlie ongoing attempts to redefine who is a fiduciary. The retirement industry has watched the ongoing controversy intently because the outcome could shift the influence currently wielded by advisors, asset managers and recordkeepers.
In October 2010, the DOL's Employee Benefits Security Administration issued a proposed rule to more broadly define the circumstances under which a person who provides investment advice is considered a fiduciary under the Employee Retirement Income Security Act. One consequence of this definition — probably unintended — was that an advisor affiliated with a plan who advised a participant about a rollover may have been perceived to have an insurmountable conflict of interest. But an advisor with no prior knowledge of the plan or participant would probably have been permitted to advise on the same rollover opportunity. This didn't sit well with advisors who regularly work with plans and felt their knowledge would have worked to the participant's advantage, not detriment. This controversial regulation was withdrawn in September 2011. The reproposed DOL fiduciary definition will be issued in 2013. Here are some issues to consider:
- Will the definition apply to the IRA marketplace (which was included in the 2010 proposed draft)? If so, it would change how the entire industry — from 401(k) providers, to recordkeepers to advisors — interacts with rollover prospects and IRA owners.
- How would your business model change if a conversation about a rollover becomes a fiduciary conversation?
- What would become a prohibited transaction?
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 gave the Securities and Exchange Commission (SEC) authority to set a universal fiduciary-duty standard for investment advisors and broker-dealers who provide personalized investment advice about securities to retail customers. We may see a draft from the SEC in 2013. Here's the major question: How will a uniform fiduciary standard apply — to all registered representatives and investment advisor representatives or to some subset of them?
The first revised definition of fiduciary — whether from the DOL or SEC — could influence the other's fiduciary rules, particularly because their jurisdictions overlap, including advisors prospecting IRA rollovers. Here's another possible scenario: The DOL and SEC issue conflicting fiduciary rules. In that case, harmonizing fiduciary standards may become the next big issue.
Whatever the resolution, innovative disruption looms in the retirement marketplace as the revised definition of fiduciary and movement to discourage rollovers force practitioners to renovate their business models.