fi360 Blog

New era of regulation begins, now is the time to let SEC and DOL know what you think

On the heels of the financial crisis and last week's passage of the Dodd-Frank Act of 2010, a new era of regulation is now upon us and Washington regulator's are moving at a brisk pace to vet and implement new rules that will provide greater protections for investors by increasing transparency and accountability by market participants.  What is most notable about this new era is the opportunity for the public to provide input that could shape new regulations.  Here is a run down of some key issues currently being considered in Washington: 

• SEC Study of Broker-Dealers and Investment Advisers.  The SEC must study and report back to Congress by January 2011 on regulatory standards of care for brokers and advisers.  The results of the study are expected to form the basis for future rulemaking by the SEC to implement a consistent fiduciary standard for brokers and advisers.  The SEC has initiated a 30-day public comment period, which will likely end on August 30, 2010.
• Open Comments on SEC Initiatives under Dodd-Frank Bill.  The SEC also has invited public comment on a host of other initiatives that it must undertake pursuant to the Dodd-Frank bill.  Of most interest to our readers may be the SEC's review of investment adviser exams (which the SEC must study and report on by January 2011), and pre-dispute arbitration (which the SEC now has the authority to limit).  There currently is no deadline for comments, but the public should note that deadlines will be imposed once the SEC announces a formal request for comments or engages in rulemaking for any particular issue.  
• SEC "12b-1" Proposal.  The SEC has put forth a proposal that would eliminate traditional 12b-1 fees and break them down into "ongoing sales charges" and "marketing and service fees" that will be subject to caps and new disclosure requirements.  Comments on the proposal are due November 5, 2010.
• DOL 408(b)(2) Interim Final Rule. DOL issued its final rules under ERISA Section 408(b)(2) requiring service providers to provide specific service and compensation disclosures to plans.  The new rules will go into effect July 16, 2011.  In the meantime, DOL has invited public comment on the new rules, specifically on the feasibility and cost effectiveness of requiring plan service providers to furnish plan fiduciaries a summary disclosure statement. Comments are due August 30, 2010.
• SEC Target Date Fund Proposal.  The SEC issued a proposal in June that would establish new dislcosure and advertising requirements for target date funds.  Comments are due August 23, 2010.

These initiatives and comment periods only mark the beginning of the new wave of regulation expected from Washington in the next couple of years.  We urge our readers to stay informed on regulatory reform, provide input to regulators, and encourage your business partners and clients to do the same. 

Fiduciary Links: SEC proposes eliminating 12b-1, introducing a capped "marketing and service" fee

Earlier this year, SEC Chairman Mary Schapiro said that they would be reviewing 12b-1 fees and that it may result in their elimination. Last week, the SEC followed through with a proposal for new rules that would eliminate 12b-1 fees and introduce a new, capped fee with a more easily recognizable "marketing and service" label. The official SEC press release includes a fact sheet overview, links to the rule itself and instructions for the public to submit comment.

The 12b-1 debate always promises to be contentious (See Blaine's January Fiduciary Corner column and the submitted comments), and the reaction has been predictably mixed and strong. Here is just a sampling of both the the positive and negative reaction to the SEC's proposed rules:

• FSI thinks the new proposal will hurt investors [InvestmentNews]
• Broker/dealer executives also see problems for both the industry and advisors [InvestmentNews]
• IN's Evan Cooper says it is a good move that was a long time coming [InvestmentNews]
• New rules will be a boon to investment consultants who can analyze fees for a plan [Pensions & Investments]
• Tara Siegel Bernard sees the rules as a positive first step in better fee clarity [New York Times]

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

In the news:

• Trust is the single most important attribute to look for in an adviser [Index Universe]
• An interview with Jeff Spears, who leads an organization that supports advisors who have decided to go independent, on financial regulation, the fiduciary standard and more [WealthManagerWeb.com]
• Financial reform gives regulators, especially the SEC, more bite [RIA Biz]
• Humberto Cruz calls out Congress for not including the fiduciary standard in reform [Chicago Tribune]

From the organizations/associations/government/academia:

• The fiduciary duty to make 401(k) deposits in a timely manner [WithumSmith+Brown's The Journal]
• The Boston University Review of Banking and Financial Law and the Committee for the Fiduciary Standard have issued a call for papers on the fiduciary standard [The Committee for the Fiduciary Standard]
• Changes are coming to Form ADV, Part 2 with an emphasis on plain English [SEC]
• Most advisors not familiar with financial reform and how it will affect them [SEI]

From the blogs:

• Jason Roberts of Reish & Reichergoes over 408(b)(2) [PPA Fiduciary Adviser Legal and Compliance Report]
• How the ground breaking events in Washington will impact fiduciaries and plan sponsors [Fiduciary News]
• 401(k) Resource Guide: the summary plan description for plan participants [401kBasics]
• You need to forget about the past when valuing your own investments [NYT Bucks Blog]
• An AIF designee gives six signs that it is time to fire your broker [Forbes's Money Builder Blog]
• An advisor gives his thoughts on how financial reform affects his business practices [Seeking Alpha]
• The fiduciary duty to ask [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.

Practice 2.2: Find a level of risk that is necessary and tolerable

Proper diversification and effective portfolio management techniques can help control the amount of investment risk a portfolio is exposed to. However, in most cases, some level of risk is necessary in order to meet future cash flow requirements. The second practice of the Formalize step of the Fiduciary Quality Management System is to identify a level of risk for a portfolio that is just enough to meet investment objectives, yet not so much that fiduciaries would be compelled to abandon the investment strategy at exactly the wrong time.

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

  

The balancing act that the fiduciary must perform is to both be comfortable that they have put the portfolio in a position to succeed in meeting it's stated objectives as well as not exposing it to so much risk that it couldn't weather a "large loss" scenario if things didn't play out as anticipated. Simply stated, a fiduciary has the potential to "fail" by being too conservative or too aggressive. A fiduciary could adopt a "safe" strategy by keeping a portfolio in cash, but then see the portfolio's purchasing power whither under inflation. Or, a fiduciary could adopt a sound, long-term aggressive growth strategy that is abandoned at the first sight of a downturn in the market.

One suggested approach is to "stress test" an investment strategy by analyzing possible investment outcomes (large loss, most likely, and best case) over the next one, three, and five years. The fiduciary should then consider the possible consequences of each outcome:

1. Will the investment results enable the fiduciary to cover short- and long-term liabilities and/or objectives?
2. Can the fiduciary stomach the "large loss" scenario?

If the answer to either of these questions is "no," then the fiduciary has some decisions to make. They must either adjust the investment strategy until they find one that passes this stress test, or recalibrate objectives to allow a lower risk and return strategy.

To learn more, consult the following resources:

• Complete text of Practice 2.2 from the Prudent Practices for Investment Stewards handbook
• Legal substantiation to Practice 2.2 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
• A primer from FINRA on managing investment risk
• FinaMetrica's risk profiling system, an article that profiles their strides in making risk tolerance profiling a more meaningful pursuit, a study using FinaMetrica that measures peoples' behaviors when confronted with investment risk and their own primer on risk profiling (Note: Finametrica is an fi360 partner)
• The Ibbotson® SBBI® Valuation Yearbook for "estimating the cost of capital"
• The online book An Introduction to Investment Theory on calculating risk and return

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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.

Three reasons to be pessimistic about the fiduciary standard

Generally, we at fi360 have been pleased with what we've seen happen with the fiduciary debate over the past year and a half. The final bill passed by Congress wasn't all that we hoped for, but we are still closer to fiduciary reform than we imagined at the outset. And the awareness among advisors and investors throughout the debate has forced a broader adoption of a fiduciary culture than existed before the recent financial collapse. However, in his latest Fiduciary Corner column for InvestmentNews, Blaine advises fiduciary backers to contain any enthusiasm they may have about the Dodd-Frank Act for financial regulatory reform. He cited three reasons that the bill may fall short of establishing a strong fiduciary standard for all investment advice.

1. Congress did not mandate that the SEC establish a fiduciary standard.
2. Congress included language suggesting that business model issues be considered in rulemaking.
3. A Senate provision for SEC self-funding didn't make it to the final bill.

Just one week later and a mere days after the bill was finally passed by both houses of Congress, we're already seeing early signs validating Blaine's tempered optimism. While it is true that many in Congress, Barney Frank in particular, and the majority of the SEC Commissioners have been vocal in their insistance that the intent is for the SEC to make fiduciary rules for advice, the fact of the matter is that Congress passed the buck on the issue when they had the chance to have it stop with them, leaving a happy ending for fiduciary backers anything but certain. With the SEC on the verge of kicking off their six month study of the issue, we've already seen one columnist wondering why SEC Chairman Schapiro would use the word "harmonization" when speaking on the fiduciary standard.

"Harmonization" has been a buzz word for the dilution of the fiduciary standard to a level that brokers can live with, so it is curious that she would choose that word now. Also, the combination of the business-model language in the bill and the lack of self-funding for the SEC could equate for a fiduciary future that isn't quite as rosie as we would have hoped for. Without the funds to step up their enforcement programs, some are saying the SEC may be forced to rely on FINRA as the fiduciary regulator, and, without being freed from the appropriations process, the SEC is still beholden to Congress, which just demonstrated their inability to take a firm stand for investors.

All in all, we still feel that the SEC wants to do what is in the best interests of investors. But if, in the end, we see them make rules that dilute the standard to appease Wall Street, we'll look back and see that the writing has been on the wall for a long time.

Fiduciary Links: Financial reform, 408(b)(2) and more, oh my!

With the financial reform bill and it's direction for the SEC to conduct a study on the fiduciary standard of care being passed this week and the DOL finally releasing the long-awaited 408(b)(2) rule, last week was one of the most intriguing in recent memory on the fiduciary front. No one is quite sure what it all means yet, but we certainly weren't without opinion. If there is one theme to this week's links it is that advocates on both sides of the fiduciary debate are already positioning themselves to have their voice heard during the next six months as the SEC begins its fiducary study.

For fi360's take on last week's developments, make sure you check out Kristina's blog post from the end of last week.

This edition of the weekly Fiduciary Links might be our most extensive one yet. And there were many more worthy articles and blog posts that we weren't able to hit this week. Now on to those links.

In the news:

• Reform is passed with much remaining to be seen on the fiduciary issue. [RegisteredRep]
• Finding investment committee members can be a challenge when they are afraid of their fiduciary duties. [Employee Benefit News]
• An opinion piece likens the current Wall Street culture to a betting culture [Pittsburgh Post-Gazette]
• Government getting a head start on implementing reform bill for what promises to be a very busy coming year [The Washington Post]
• Some brokers see the fiduciary standard as more of an annoyance than anything else [Financial Advisor]
• The financial reform bill finally brings some clarity to where the fiduciary buck stops. [Money Management Executive] 
• Harold Evensky thinks its best to work with the idea of FINRA as fiduciary regulator and thinks that it can work [RIABiz]
• Target date funds continue to be enhanced with annuities despite tepid response from plan sponsors [InvestmentNews]
• Many questions remain with reform bill passed [InvestmentNews]
• Panel at SIFMA Summit discuss ramifications of reform bill [Wealth Manager Web]
• The effects of the reform bill on the portfolios of individual investors [Wall Street Journal]
• Brokers don't need to be afraid of the fiduciary standard [Investment Advisor]
• Not everyone thinks the reform bill was a success [MarketWatch]
• 408(b)(2) should make it easier for plan sponsors to assess fees [InvestmentNews]
• Is fiduciary oversight headed to FINRA? [InvestmentNews]

From the organizations/associations/government/academia:

•  DOL releases 408(b)(2) fee disclosure rules. Here's the news release, the rule fact sheet and the full text of the rule itself [DOL EBSA]
• Everything you need to know about the financial regulatory reform bill [House Financial Services Committee]
• Goldman settles SEC complaint, agrees to pay large fine and reform business practices [SEC]
• Reish runs through the details of 408(b)(2) [Reish & Reicher]
• Six steps for avoiding being sued and keeping your reputation intact [RIABiz]

From the blogs:

• Mike Alfred of BrightScope is interviewed on reform, fiduciary duties, plan fees, and more. [NYT Bucks Blog]
• Where did the ethics of investment advice go wrong? [Pilant's Business Ethics Blog]
• Knut Rostad's latest post uses the NFL-AFL merger as an analogy to merging the standards of care for brokers and advisors [Wealth Manager Web]
• Best practices for plan sponsors to avoid compliance issues [The Metropolitan Corporate Council]
• High fees can make small plans a sucker 401(k) plan [The Investment Fiduciary]
• In breach of fiduciary duty cases, the best defense is a good offense [Boston ERISA and Insurance Litigation Blog]
• It will cost money to build systems to disclose fees [Securities Technology Monitor]
• Deciphering Schapiro's words: what did she mean by "harmonized" fiduciary standard? [Registered Rep's The Advisor Reformation 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.

With regulatory reform passed, the hard work begins

Today the Senate pushed financial regulatory reform past it's final hurdle by first voting for cloture (60-38) and then just a few hours later approving (60-39) the Dodd-Frank conference report.  Now that the conference report has gained both House and Senate approval, the Dodd-Frank Wall Street Reform and Consumer Protection Act will be sent to President Obama for his signature in a matter of days.  And once the ink of the president's signature dries, the clock will start ticking for federal agencies who will be required to complete numerous studies and rulemakings within the next few years under timetables set by the new legislation.  This means that while Congress heads into its August recess, federal agencies that are accustomed to a quiet August, will be kicking into high gear to meet their new obligations.

The SEC, in particular, will have its work cut out for it as it scrambles to complete approximately 20 studies and 95 new rules and coordinate with other agencies on several other studies and rules.  While most studies have a time line of one to three years, in the next six months, the agency must study and report back to Congress on (1) the effectiveness of standards of care for broker-dealers and investment advisers, (2) the need for enhanced examination and enforcement resources for investment advisers (including whether an SRO is needed), and (3) how to improve investor access to information on broker-dealers and investment advisers.   

Meanwhile, the DOL appears to be set for a flurry of activity of its own.  The DOL's Employment Benefits Security Administration released on its website earlier today the soon to be published ERISA 408(b)(2) regulation.  These long-awaited rules will finalize requirements for disclosures by service providers to defined contribution and defined benefit plans and will go into effect July 16, 2011.  Although the final rules differ in some respects from the proposed rules, they will put into place strong disclosure requirements.  In particular, service providers will be required to disclose their services and compensation, including whether they are providing any services as a fiduciary to the plan.  

In addition to the release of the 408(b)(2) rules, DOL is also expected to release a proposal later this year that will address disclosures to participants under 404(a)(5), and a separate proposal that will clarify and expand the definition of "fiduciary" under ERISA.  Additional guidance on target date funds is also expected as well as a proposed amendment to 404(c)(5) concerning qualified default investment alternatives.  

Is it prudent to cap retirement plan investment options?

Today's fiduciary Q&A comes from an advisor concerned about the perception and advisability of capping the amount that can be invested in a particularly volatile investment option.

Q: We have been introducing more specialty type funds to our plan sponsors.  In a few cases the plan sponsors have asked if we would limit a participant’s exposure to certain funds.  For example, by only allowing participants to direct a maximum of 6% of their current allocation into a commodities fund.  Yesterday at a client meeting the plan sponsor asked what if any liability the fiduciaries would have if a participant complained at some point in the future that by restricting their purchase of this fund they were held back from meeting their retirement goals?  What is fi360's opinion about limiting access to certain funds within a plan? 

A:  There is always the potential that a participant may complain about how the plan has been managed.  A participant could complain about limitations placed on an investment option to which they wanted to allocate a greater percentage of their portfolio.  Conversely, if the commodities fund performs poorly, they could complain that you should not have made it available to begin with because of its inherent volatility.  It’s a judgment call that must be made with the overriding objective of doing what is in the best interest of the participants.  If volatility is the issue, the safest approach is not to offer the commodities fund in the plan.  But if the decision is made to include it, capping the amount participants can invest is probably prudent. 

If the decision is made to cap the investment, the plan sponsor should clearly communicate the risk/return profile and other characteristics of each investment option to the participants.  This is one of the requirements of 404(c).  In conjunction with that disclosure, information about the cap should be provided as well.  If the participants have issues with the cap, they can always opt not to invest.

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If you have a fiduciary question you would like to have answered, submit it to blog@fi360.com. 

The opinions expressed in this post are those of fi360 and should not be regarded as advice.  Fiduciaries should always make decisions within the context of achieving the goals of the investors they serve.  When in doubt, it always best to consult legal counsel regarding the liability associated with investment decisions.

Fiduciary Links: Battleground of fight for fiduciary debate shifts to SEC

When the financial reform bill is finally passed sometime this week, the fiduciary debate will continue on no longer in the hands of Congress, but of the SEC. While on the surface this seems like a good thing, the SEC Commissioners have indicated their preferance for a strong fiduciary standard for all advice, time often has the effect of changing things. Blaine's most recent Fiduciary Corner column looks at what's ahead for the mandated study the SEC must undertake and eventual rulemaking, including where the progress for fiduciary reform may be derailed.

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

In the news: 

• What exactly are 12b-1 fees, anyways? [Wall Street Journal]
• Sheryl Garret, founder of the Garrett Planning Network discusses a la carte advice, the fiduciary standard, and more in an interview. [Morningstar Advisor]
• With the end of the fiduciary debate within sight, a reminder that Washington is merely codifying what the market is already demanding [InvestmentNews] 
• Could a broader fiduciary standard result in higher insurance costs? [Registered Rep]
• The chief executive of RBC's U.S. Wealth Management says fiduciary standard should vary by function [Reuters]

From the organizations/associations/government/academia:

• SEC hosting an open meeting on rule changes for target date fund naming and marketing [SEC]
• Even though lawsuits involving large plans make the biggest headlines, small plan litigation is increasingly prevalent as well. [Reish & Reicher] Also, the Boston ERISA Law Blog had some comments to add to the newsletter.
• One study says that many plan sponsors don't want more fee information [Transamerica Center for Retirement Studies]

From the blogs:

• Carl Richards of Behavior Gap recommends caution before applying generic investment advice to your individual needs [NYT Bucks Blog]
• Roger Wohlner updates his 2010 Fiduciary Wishlist and offers an analogy to investment advice using his experience at two Chicago restaurants [Chicago Financial Planner]
• Danny Sarch points out that enacting a fiduciary standard won't eliminate crooks [IN's From the Headhunter]
• Why the fiduciary standard isn't at the front of advisors' minds [Unlocking Real Value 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.

Would LeBron make a good fiduciary?

Last night, LeBron “King” James, the two-time league MVP and past NBA scoring champion, and arguably the most sought after free agent player in the league, made a decision on where he would play the next segment of his short, but superstar career.  The press coverage was astounding, reaching crescendo with his live announcement on ESPN entitled “Decision 2010.”  As I watched the broadcast, it occurred to me that LeBron may make a good fiduciary.

LeBron needed to decide where to continue his career.  As a free agent, the ball was largely in his court.  He set his priorities: winning an NBA championship was number one.  He and his trusted advisors defined a due diligence process to be used to help make the best decision for him to meet his objective.  The process consisted of quantitative and qualitative factors, to be sure.  He applied the process.  Meetings were held; presentations were given by the finalist candidates.  He took his time and considered all the facts and factors that would play into his decision.  He smartly consulted with his trusted advisors.  Finally, he made the decision that lined him up best to obtain his goal of winning an NBA championship. 

Whether or not he knows it, by setting his objective, doing his due diligence, following a process, and focusing on his goal, LeBron exhibited the skills of a good fiduciary.  For example:

He set priorities. The foremost of which was putting him in a situation where he had the best opportunity to win an NBA championship. Having a clearly defined objective lended well to his next step.

He defined a due diligence selection process. Factors likely included:

• The organization, management, coach, and teammates;
• The team history of success; and  
• The compensation he would receive.

Note the parallels with the fi360 Fiduciary Score™ factors that evaluate: Stability of the organization, track record of the investment, and performance relative to peers.  

Importantly, he followed the process.  He faced enormous pressure, but stuck to his process and kept his focus on his objective.  This enabled him to be disciplined and rational, avoiding potential mistakes, including:

• Listening and reacting to “market noise.”  For example, the incumbent lobbied hard for his return.  
• Chasing performance in terms of money or ego.  Certain finalist candidates offered him an opportunity to make much more money than others and also be the sole superstar on the team.
• Being complacent.  He had an opportunity to remain with the incumbent who was familiar and easy.  LeBron grew up in that location, had his family there, and all the comforts of home.

He consulted with trusted advisors throughout.  Knowing that his skills were on the basketball court, he smartly sought counsel from professionals.

He met the call to action and decided.  Executing your decision in a timely manner is important.  And remember, he has no guarantee of success (winning an NBA championship), however he has put himself in the best position to do so with the facts and circumstances now known

Let me know what you think.  Does LeBron have a future career as a fiduciary?

[By the way, if you’ve somehow managed to avoid the newscasts, radiocasts, email alerts, blog posts, tweets, and office water cooler, LeBron selected the Miami Heat.  Other finalist candidates included: the Cleveland Cavaliers (the incumbent), the New York Knicks, the New Jersey Nets, and the Chicago Bulls.  Time will tell whether LeBron's decision ultimately yields him an NBA championship.]

Fiduciary Links: Fireworks on the Fourth

Fi360 hopes that you had a wonderful Independence Day weekend with friends and family.  In the spirit of the holiday, we’ve decided to bring you some fireworks and some links from the past week.

After a recall of the conference committee last week, the House approved the Finance Reform Bill.  The committee was reopened to review and replace a bank tax, used to help pay for the Bill. After the Senate returns from their holiday recess, they will review and vote on the bill. 

The Senate review does not come without its own fireworks. The death of Senator Robert Byrd and the votes of Senators Brown and Feingold cast uncertainty on the passage of the bill.

One of the provisions of the bill shifts the oversight of advisors with $25 million to $100 million to the states.  Some states are preparing for this shift by collaborating on resources and examinations. However, Carlo di Florio, director of the SEC's Office of Compliance Inspections and Examinations does not believe that some states have adequate examination procedures in place. 

Another provision that has gotten a lot of press is the proposed six month study by the SEC on the fiduciary standard of care versus the suitability standard of care.  But that’s not the only study the bill requires the SEC to undertake.   

In other news…

While the U.S. is wrangling over the fiduciary debate and the financial reform bill, Canada is still debating appropriate mutual fund disclosure standards.

In other international news, Venezuela cracks down on their brokerage industry.

How do you calculate a safe withdrawal rate?  And where did the 4% withdrawal rate come from?

Let’s wrap up with some more fireworks!  Fi360’s hometown of Pittsburgh is not too far away from the Fireworks Capital of America, New Castle, PA.  New Castle is home to both Zambelli Fireworks and Pyrotechnico.  Enjoy the fireworks!