fi360 Blog

fi360's Comments to the SEC on the fiduciary study

Yesterday, fi360 submitted our comments to the SEC on their study analyzing the effectiveness of existing regulatory standards for brokers, dealers, and investment advisers and identifying any gaps or overlap in regulation.

In short, we believe that too much confusion exists on the part of investors as to how financial service providers' functions differ and how these differences affect investor protection. Over time, the services provided by broker-dealers and investment advisers have come to more closely resemble each other in a way that wasn't envisioned when the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 were passed. This has made it necessary to introduce new regulations that clearly demarcate the roles of product providers versus advice providers.

Some of the specific recommendations for the SEC's study and eventual rulemaking that we suggest are:

• That Congress remove the exemption for incidental advice from the Advisers Act
• Create uniform disclosure requirements for brokers and advisers that emphasize avoiding and managing conflicts of interest, but that do not bog down the provision of investment advice
• Define "fiduciary," "best interests of the customer," and "personalized investment advice" in line with the Committee for the Fiduciary Standard's five core principles and existing SEC regulations

Our full comments can be downloaded here.

All comments submitted on this issue can be found on the SEC's website.

Major commenting periods drawing to a close

Today is the deadline to submit comments on both the SEC's Congressionally-mandated study of the regulation of broker-dealers and RIAs and the DOL's proposed 408(b)(2) fee disclosure rule. In addition, last week was the deadline for comment to the SEC on the naming and marketing of target date funds. If you are still considering submitting comment, make sure you take a look at Kristina's post from last week on writing an effective SEC comment letter. Kristina is an attorney who came from the SEC before joining fi360 and lets us know what the SEC finds most valuable when reviewing public comments. In addition, check out The Committee for the Fiduciary Standard for their advice on how to voice your support for the fiduciary standard for investment advice.

Now on to the rest of the week's best links.

In the news:

• Will 12b-1 reform fizzle with the departure of Buddy Donahue? [InvestmentNews]
• Target date fund reform proposal not receiving much feedback [InvestmentNews]
• Three senators weigh in on target date funds [PLANSPONSOR]
• Comments agree thattarget date funds could be explained better, but renaming is excessive [PLANSPONSOR]
• New FDIC insured investment products now being offered for retirement plans [MarketWatch]
• Kate McBride attempts to clear up the misinformation being spread about the fiduciary standard [Investment Advisor]
• Our 2009 article competition winner, Andy Rice, follows up his winning article with a further look at Roth conversions [Investment Advisor]

From the organizations/associations/government/academia:

• The impact of 408(b)(2) on RIAs [Reish & Reicher]
• The greatestliability risks faced by plan sponsors [Chubb] Fiduciary News also provides an analysis
• Addressing target date fund naming and marketing [Brightscope]
• New proposed accounting standards for loans taken by employees from DC plans [Financial Accounting Standards Board]
• Study shows companies adding 401(k) features to spur saving [Charles Schwab]

From the blogs:

• Some advice for employees, don't borrow from your 401(k) [bnet's Evil HR Lady]
• Advice to investors, don't ask if it is a good investment, ask if it's a good investment for you [Chicago Financial Planner]
• A sampling of the target date fund reform proposal comments [WSJ's Financial Adviser Blog]

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

How to write an effective comment letter to the SEC

Have you submitted your comments to the SEC on its Study Regarding Investment Obligations of Brokers, Dealers, and Investment Advisers?  If not, I highly encourage you to take the time to get involved in the SEC's efforts to bring clarity to the regulation of investment professionals and provide greater protection to investors.  You must act fast as the deadline for comments is this Monday, August 30.

In writing and submitting comments, it's important to recognize the unique opportunity being provided to investment professionals and the investing public with this comment period.  First, it's an opportunity to provide input to the SEC that will be incorporated into its overall study and the final report that it must submit to Congress in January.  Second, it is also an opportunity to potentially shape future rulemaking by the SEC that will codify the existing fiduciary standard for investment advisers in SEC regulations and extend the same fiduciary duty to broker-dealers who provide investment advice.  With this in mind, I would advise those that would like to submit comments to take the time to consider the type of input that will both allow you to voice your opinion on the regulation of investment professionals, but also asssist the SEC in fulfilling its duties and exercising its authority under the Dodd-Frank Act.  

As a former SEC attorney, I speak from experience when I say that the most helpful comments are the ones that take the time to address issues and questions presented by the SEC, provide specific examples of how regulations play out in professional practice, cite to concrete numbers and statistics (and their source), and offer potential solutions on how to address a regulatory issue. 

Looking at the current request for comment, it's important to note that the SEC has been tasked with analyzing fourteen specific topics.  To the extent commenters take the time to comment on any or all of these areas, it will be extremely helpful to the SEC. In addition, SEC Chairman Schapiro stated in a speech in July that "Comments that recognize the primary and central importance of investor protection, but offer suggestions on implementing fair and flexible regulation, will help us craft rules that increase investor confidence while preserving brokers' ability to offer a full spectrum of services." Thus, the agency essentially has provided a roadmap to commenters on what information will be most useful.

In viewing comments that have already been submitted to the SEC, I would note that a form letter, referred to as Type A, submitted by over 200 insurance brokers provides a good example of a letter that could be useful to regulators.  While I don't necesarily agree with all of the viewpoints expressed in the letter and I also question the effectiveness of only submitting a form letter, the format of the letter itself is good because it addresses both issues raised by the study and addresses potential rulemaking.  The letter could be improved by including some of the examples and concrete number or statistics I mention above.  

Fi360 is diligently working on finalizing its comments for the SEC, and our hope is that other supporters of the fiduciary standard will take the time to submit comments as well and provide the SEC with the information and support it needs to effectively implement regulations that promote fiduciary principles.  

Fiduciary Links: Everyone could use a little advice

For a lot of people, the idea of paying for investment advice seems like a waste. Do-it-yourself types and those who have been very successful in their careers believe they can put together an investment plan just as well as an advisor can. One article we found this week found that this is particularly true of young affluent investors who are web-savvy. But, as another article points out, everyone could use a little objective advice. Building a financial plan that covers all of your bases can be complex, and may include elements that never occurred to you. In addition, even those investors who are experienced at building a comprehensive financial plan, such as investment advisors, would probably benefit from the eyes of an objective, outside observer. In short, just about everyone could find a significant benefit from a knowledgeable professional who is putting the client's best interests first.

Now on to the rest of the week's best links.

In the news:

• Advisors, brokers spar over fiduciary standard, pt. 1 [Financial Advisor]
• Brokers, advisors spar over fiduciary standard, pt. 2 [WSJ]
• Advisors, brokers spar over fiduciary standard, pt. 3 [InvestmentNews]
• Is asset allocation just a cop-out for managers? [The Street]
• DOL fee disclosure rules were long overdue [Pensions & Investments]
• A sampling of the comments being submitted to the SEC on the fiduciary, other issues [RIA Biz]

From the organizations/associations/government/academia:

• The Committee for the Fiduciary Standard and four advisor organizations are holding a fiduciary forum next month. [Financial Advisor]
• Even advisors are in need of a little advice [Financial Post's Wealthy Boomer Blog]
• Carl Richards has launched a newsletter for his unique sketches [Behavior Gap]
• Fred Reish breaks down 408(b)(2) [Reish & Reicher]
• A wiki on expense ratios picks up our explanation of what's in an expense ratio [Bogleheads Wiki]
• Sign up for our free webinar on new fiduciary regulation [fi360]

From the blogs:

• Do 12b-1 rules create additional liability for plan sponsors [Fiduciary News]
• Letters in opposition to the fiduciary standard are outnumbering those in support so far [WSJ Financial Adviser blog]

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Practice 2.3: Model a level of return that is optimal and realistic

In last month's post on Practice 2.2, we talked primarily about the risk side of the balancing act a fiduciary must perform in meeting the investment time horizon objectives set in Practice 2.1. Practice 2.3 then focuses on the return side of the equation. It focuses on modeling a portfolio that is tied to cash requirements and is based on reasonable assumptions.

Let's take a look at the Practice itself and the associated criteria:

We say that the modeled level of return needs to be both optimal and realistic. "Optimal" means that the selected profile can be found on the efficient frontier at a point that is expected to allow the investor to meet his or her objectives without taking on unacceptable risk. "Realistic" means that there is a fiduciary obligation to use reasonable assumptions and reliable tools to estimate the return. Projecting returns that are unlikely to be achievable or unfairly skew to favor types of investments that an advisor or manager would benefit from at the expense of the investor would be considered fiduciary breeches.

That said, there is no fiduciary requirement or expectation that the advisor be capable of forecasting future returns. Rather, fiduciaries are required to demonstrate that a prudent process was followed in developing the assumptions used to model the probable outcomes of a range of investment strategies. Equipped with a modeled return, a fiduciary can conduct discounted cash flow models to determine if the return will be sufficient to meet the portfolio goals and objectives.

To learn more, consult the following resources:

• Complete text of Practice 2.3 from the Prudent Practices for Investment Stewards handbook
• Legal substantiation to Practice 2.3 from ERISA, UPIA, UPMIFA and MPERS
• fi360's Asset Allocation Optimizer, which can calculate the risk, return, and large loss scenarios of a client’s portfolio utilizing the Resampled Efficiency™ portfolio optimization technique
• Research from New Frontier Advisors, the developers of Resampled Efficiency™
• Harry Markowtiz's landmark work on modern portfolio theory: Portfolio Selection: Efficient Diversification of Investments

 * * * * *

The Spotlight on Practices series highlights one of the Prudent Practices for Investment Fiduciaries in order each month. To learn more about the Practices, click "Spotlight on Practices" link in the categories list or visit the Practices page on fi360.com.  If you have any questions or comments, leave them in the comments section below each post, or email us at blog@fi360.com.

Fiduciary concepts are as old as law itself

In his most recent Fiduciary Corner column, Blaine suggests that the SEC would do well to remember during their six month study on the fiduciary issue that fiduciary obligations have been based for millenia on the idea that society cannot function effectively in the absence of a code of conduct that requires trustworthy behavior by those who are entrusted with responsibility for looking after the property of others. The core principles of this code, the fiduciary standard, have been recognized, honored, and demanded by professionals and government authorities through the ages for both moral and practical reasons.

Blaine concludes his look at the timelessness of a fiduciary standard by highlighting three key considerations applied by Judge Benjamin Cardozo in the Meinhard v. Salmon case:

1. Fiduciary matters, including the provision of investment advice, demand a higher standard than normal marketplace transactions.
2. Exceptions to the fiduciary standard are a source of "disintegrating erosion" that undermine the duty of loyalty.
3. Whether it is by the courts or legislators or regulators, those who are charged with interpreting, enforcing or modifying the fiduciary standard should not conciously weaken it.

These considerations are not adequately addressed in the current regulatory regimes governing those who provide investment products along with advice. The current crisis of trust being faced by the financial services industry provides evidence of that fact. The SEC has the opportunity to better align regulatory requirements with society’s long-standing expectation for all professionals who render advice to adhere to the un-diluted fiduciary standard.

Fiduciary Links: Preparing for reform

We may still be a ways away from new regulation from the SEC, but that doesn't mean you shouldn't be preparing for it already. Even without the details, there are still some indications of what can be expected, both through new rules and the evolving investment advice landscape. One article this week from Researchmag.com addressed this topic with some tips on how to make reform work for you, including creative marketing, buttoning up your processes and looking for new trends in the retail industry.

At fi360, we'll be conducting our next free webinar on the subject of what to expect from new regulations and how advisors and brokers can be preparing themselves for a new reality. Attendance is open to everyone and space is limited, so make sure you sign up soon.

Now on to the rest of the week's best links.

In the news:

• Taking exception to the columnist who said last week that the fiduciary debate is much ado about nothing. [Advisor Perspectives]
• The CEO of Stifel is downplaying the impact of the fiduciary standard on brokers [InvestmentNews]
• The role of a fiduciary is timeless [InvestmentNews]
• SEC's 12b-1 proposal doesn't quite reach the level of full disclosure [MarketWatch]
• Lack of self-funding preventing SEC from reaching full potential in regulating [WealthManagerWeb]
• Securities worried that fiduciary standard could prevent the sale of IPOs [InvestmentNews]

From the organizations/associations/government/academia:

• Low fees predict better performance. [Morningstar]
• An auto-IRA bill is introduced in the Senate, would provide a safe harbor for employers. [Senator Jeff Bingaman (D-NM) & InvestmentNews]
• Free webinar on how financial regulatory reform is going to affect how advisors and brokers do business [fi360]
• The Committee for the Fiduciary Standard, Financial Planning Coalition and Financial Services Institute are holding a fiduciary forum on September 24 in Washington. [Financial Advisor]
• An overview of 408(b)(2) regulation [Reish & Reicher]

From the blogs:

• Target date funds require equal due diligence to other investment options. [Chicago Financial Planner]
• The industry is taking sides in the 12b-1 debate [Fiduciary News]

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Your questions on monitoring client and investment fees

For our last webinar in June, we addressed the topic "monitoring client and investment fees." Both during the webinar and in follow-up, we received a lot of questions asking for further clarification. In this post, you'll find answers to the majority of questions submitted during the session written by the panelists from the original webinar. 

A recording of the webinar can be viewed on the webinars page of our website. If you still have any questions, let us know in the comments below.

Our next webinar will be on Thursday, September 9 from 4:00-5:00 p.m. EDT on the topic of how regulatory reform will change the way advisors and brokers do business. To register, click here.

Now on to those questions:

Q: For the mutual fund companies, the management fee is normally included in the expense ratio, correct?
A: Yes, the management fee is included in the expense ratio.  We typically use the Prospectus Net Expense Ratio in our analysis and it includes the management fee, 12b-1 fee, administrative fee, and all other asset-based costs incurred by the fund.

Q: Where do you get the information for the sub t/a fees? We have found that different custodians negotiate different sub t/a fees from fund families.
A: The sub t/a fees used in the presentation were examples.  You are correct in stating that the sub t/a fees can change from custodian to custodian and from plan to plan.

Q: For an individual with a 403b annuity plan, it sounds like all annuity fees are included in the published "expense ratio," correct?
A: When evaluating an annuity expense ratio we look at the expense ratio for the underlying investment and the M&E risk charge for the annuity component.  There are other fees and expenses that are not part of this "expense ratio" that should be considered such as contract charges, annuity administration fees and surrender fees.  These components are not part of the expense ratio.

Q: What resources do you recommend (books, websites, etc.) to determine what are reasonable plan fee's, industry avg's  etc.
A: Fiduciary Benchmarks, Brightscope, icifactbook.com, and 401k Averages Book

Q: Please clarify how the ERISA bucket works, why created, etc.

Fiduciary Links: Separating skill from luck

In his post last week for Morningstar Advisor's Markets & the Economy Blog, Michael Zhuang (who also writes the very good The Investment Fiduciary blog) uncovered a study from the Journal of Finance that seeks to separate luck from skill in alpha. The study finds that most skill is wiped out in fees and expenses and money managers who provide real alpha are virtually nonexistant. This leads Mr. Zhuang to wonder how advisors justify their value. He also asks in the comments section of the post if past performance is advisors' number one criteria in fund selection.

If it is by claiming you can find that needle in the haystack, then it would seem you are taking a significant risk of not coming through. And if past performance is your primary consideration in fund selection, it would seem that you are more likely to be getting in after the manager's luck has run out. Unless you have a magic formula for fund selection, this study is another layer of evidence that advisors would be better served focusing on and communicating a strategy based on diversification and geared to achieve investor goals, not a pursuit of alpha.

Now on to the rest of the week's best links.

In the news:

• Collective trusts are a new alternative to mutual funds in 401(k) plans [Wall Street Journal]
• An interview with TD Ameritrade's Tom Bradley touches on fiduciary issues [Registered Rep]
• Ex-regulators leading the way in lobbying regulatory agencies [NY Times]
• While 12b-1 fees get scrutinized, soft dollars escape regulators' microscope [InvestmentNews]
• Scott Simon declares MPT and diversification "still good" [Morningstar Advisor]
• Matt Hutcheson: fiduciary crusader [Retirement Income Journal]
• Tamar Frankel: fiduciary thinker [Investment Advisor]
• Community foundations should think twice before allowing a donor's wealth manager to manage assets [Investment Advisor]
• More mutual fund fee scrutiny doesn't mean better performance [Forbes' Zenvesting Blog]

From the organizations/associations/government/academia:

• A fiduciary stress test for plan sponsors to make sure they are fulfilling key obligations [Vanguard]
• Five tips for plan sponsors to select and monitor fiduciary advisors [Reish & Reicher]
• A direct link to the online form to submit comments on the SEC fiduciary study [SEC]
• The Committee for the Fiduciary Standard is asking advisors to let the SEC know thatfiduciary standards are a must for protecting investosr [The Committee for the Fiduciary Standard]

From the blogs:

• A conversation on advice vs. guidance [The 401(k) fiduciary advice blog]
• The rest of the "Ten things you're probably still doing wrong as a plan fiduciary" list [PLANSPONSOR Perspectives]

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Yes, the fiduciary standard debate does matter

An interesting article came out yesterday that made the case that the fiduciary debate was basically meaningless because brokers can already be held to fiduciary standards through ERISA and various state laws. The author is of course correct as it applies to the cases and laws he cites. However, the article omits the gap around which the entire debate is centered. As Kristina explained to RegisteredRep yesterday, the big controversy and the target of the current reform efforts is about federal securities laws and the confusion among retail investors as to what standard of care they are receiving.

As the RAND Report on Investor and Industry Perspectives on Investment Advisers and Broker-Dealers illustrated, the services offered by brokers have come more and more to resemble those traditionally provided by investment advisers while both sets of professionals have continued to be regulated based on traditional definitions of their roles. More importantly, investors often can't tell the difference between the two. Brokers will often refer to themselves as "financial advisors" and investors typically assume a relationship of trust with investment professionals. Yet, the report reflects investors' doubt or surprise that a fiduciary standard doesn't necessarily apply. In addition, investment advisers and brokers themselves don't always know where the dividing line is between the recommendations and "incidental" advice that falls under the fair dealing (suitability) standard and individualized advice that falls under the fiduciary standard.

It's not hard to see why some would oppose a fiduciary standard to protect their interests or to find fault with the legislative and regulatory process. But it is much more difficult to believe that the pursuit of closing gaps and providing clarity and consistency in the interest of investor protection isn't a cause worth pursuing.