fi360 Blog

3(21) vs. 3(38) and are you holding yourself to the fiduciary standard?

This week we have a guest post from Mike DiCenso, who is president of GBS Investment Consulting, which provides integrity driven, comprehensive investment consulting services for institutions of higher learning, endowments/foundations, healthcare institutions, insurance companies, corporations, non-profit organizations, family trusts, and retirement plans. He is an AIF Designee and a former speaker at the fi360 Conference.

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We are all aware that many brokers, consultants and advisors are creating confusion in the market by positioning themselves as fiduciaries to a plan when they are not actually alleviating any fiduciary liability for plan sponsors. Making matters worse,  when the plan sponsor believes that an advisor is relieving them of its liability, the plan sponsor may be taking their eye off the ball because they think someone else is handling this for them, putting them at greater risk. This is exactly why the DOL is looking to enhance and evolve the 1974 version of the “Definition of Fiduciary.” The DOL is looking to make it more difficult to avoid fiduciary responsibility and make anyone who states they are a fiduciary to actually take on the corporate and personal liability of a fiduciary. To help alleviate this confusion in the market, we have assembled this piece to help clarify the differences between 3(21) Investment Advisors and 3(38) Investment Managers under ERISA. Let’s take a look:

Fiduciary Links: FINRA members getting to know their customers better

FINRA was featured prominently in the Sunday papers this weekend with articles in both the New York Times and Wall Street Journal. The more interesting article from the perspective of FINRA's push to become the SRO for advisors, is WSJ's look at how brokerages are gearing up for new suitability and know-your-customer rules. The rules require brokerages to compile specific client data so that real-time suitability determinations can be made, rather than just at the onset of relationships. This will also help with additional monitoring related to long-term investments. These represent major changes to customer data requirements and a possible signal that FINRA is both bracing for more fiduciary-type rules to come in the future as well as prove itself as an SRO for the advisory industry.

The second article is equally interesting, though probably more nebulous in terms of greater meaning. In it, Gretchen Morgensen of the NYT looks at a recent arbitration decision that went against Citigroup in which the arbitrators rejected three defenses to their sale of municipal bond investments to two high-net work investors. Those defenses were that the financial crisis was to blame for their losses, that, being wealthy and sophisticated, the investors should have understood the risks, and that the prospectus warned of inherent risks of investment. While it is hard to attach greater meaning to the decision in terms of FINRA's potential expanded regulatory role, it is a good example of investors gaining satisfaction through FINRA's existing processes.

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

"The price of reform is a small one compared to the cost of crisis"

Throughout the comment periods for the SEC staff's fiduciary study and the DOL's recent proposal to update the definition of fiduciary, it has been perplexing to hear the increasing rhetoric claiming that expanding fiduciary protections will kill business. Over and over again, we have heard the request for a thorough cost-benefit analysis followed by a summary conclusion that such analysis likely will show that costs outweigh the benefit of fiduciary reform. 

This leaves us asking what exactly is the cost of principles?  Should we only adhere to fiduciary principles and putting the client’s interest first when it is good for business?  Congress certainly didn’t think so when it passed the Investment Advisers Act in 1940 and ERISA in 1974, and it's hard to imagine why Congress or anyone else would take a different view now at a time when our economy is still recovering from severe market failures and investors are sitting on the sidelines holding their money outside of the market. 

Fiduciary Links: Australia sets a good fiduciary example

InvestmentNews’ Evan Cooper has a column this week on how Australia has tough new fiduciary rules that go into effect next year. Similar to the United States, Australia was faced with a difficult reform debate in the aftermath of the financial crisis. Also similar to the U.S., fiduciary advocates faced strong opposition from various segments of the financial services industry to imposing stronger fiduciary protections. Nonetheless, the pro-fiduciary segment prevailed and, according to Evan, the following rules go into effect next year:

• Commissions on the sale of new financial products will be forbidden.
• A fiduciary standard will apply to all advisers.
• Volume-based discounts will be banned.
• Clients will be asked to renew their advice arrangements annually.

Evan goes on to describe how Australian officials never bought into the same arguments being lobbied here about how fiduciary duties can be anti-investor for reasons like cost and access and how anecdotal evidence suggest that firms who have begun preparing for the new regulatory environment perform better and are more successful businesses in general.

Doing some reading up on the subject also turned up a speech from Australian Minister of Financial Services, Chris Bowen, talking about the importance of quality advice for investors. One line in particular stood out on just how important their reform efforts were for Australia in general, “The reforms will also support our ongoing work to position Australia as a financial services centre in the Asia-Pacific region. It would be impossible to ask professionals in other countries to place their trust and confidence in our financial planning industry if Australians do not.”

The reform debate is coming down the homestretch soon for the United States, and hopefully persistence will pay off and common sense will prevail here as well so that our domestic investors will similarly feel that they are among the most well protected in the world.

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

Practice 3.1: Implement with sound and consistent due diligence

Now having gone through all of the Practices in the Organize and Formalize Steps of the Fiduciary Quality Management System, we move on to the Implement Step. The Practices in this Step define procedures for a fiduciary to implement a client's current investment strategy. To a large degree, this equates to due diligence: What is the process for selecting your investments? Who are the service providers that will assist you? Is the process objective? And is it consistently applied?

The first Practice in the Step is to implement the investment strategy that was formalized in Step 2 with the required level of prudence. Let's take a look at the Practice and associated Criteria:

The law does not mandate the use of professional money managers, but to do otherwise would be foolish. A fiduciary is required to act prudently in implementing the investment strategy and will be held to a "prudent expert" standard. It is far more effective and efficient to manage the managers, rather than do it yourself.

Fiduciary Links: To be or not to be independent

A couple of studies from the past two weeks have shown that most advisors see independence as potentially more profitable or more fulfilling. This begs the question, then why aren't all of these advisors going independent? Time, money and uncertainty are the obvious answers for why it isn't an easy decision to change the business model in which you operate. One quote made the parallel to buying a new car: ask someone if they want to buy a new car and you'll likely get "yes" as the answer, but that doesn't mean he or she can or will go through with it.

"Going independent" is a subject we hear a lot about as many advisors contemplate moving to an environment that allows them more freedom. While we are proponents of investment advice that comes with a fiduciary standard of care, that doesn't mean independence is right for everyone or that we diminish the value of non-advisory services. Much depends on the services you want to perform and your comfort level with the uncertainty of having to adapt to new income, regulatory, operational and compliance structures. But if you are contemplating making a jump, here are some resources to check out. We'd also be interested in hearing your experiences from going independent or why you have chosen not to. Let us know in the comments or by emailing blog@fi360.com.

Resources on going independent:

• An fi360 case study with David Bromelkamp from Allodium Investment Consultants [fi360]
• Going independent workshops [InvestmentNews]
• Mike Patton's Road to Independence blog [AdvisorOne]
• Advisors 4 Advisors has a going independent channel [Advisors Going Independent]
• Basic fact sheets and checklists for RIAs and IARs [NASAA]

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

FINRA’s Back Door Regulation of Fiduciaries

A country lawyer named Abe Lincoln enjoyed using folksy tales to make a point in court.  Once he witnessed a neighbor’s fancy red rooster back down in a cock fight.  As the story goes, the frenzied rooster ran in circles around the pit till its owner got so disgusted he jumped in, grabbed the bird by the neck, and threw it out of the ring.  There the rooster stood up, stretched its neck, flapped its wings, and let out a long cock-a-doodle-doo.  The disgusted owner yelled, “Yes, you little son of a gun, you’re great on dress parade, but you’re not worth a damn in a fight.”

One wonders how much of the rooster is in FINRA, the newest and most enthusiastic booster of a fiduciary standard for brokers.  Its chairman, Richard Ketchum, probably hasn't been in charge long enough for a fair assessment to be made of his conviction to stand up for a comprehensive and undiluted fiduciary approach.  And while the rhetoric there is supportive of a seeming strong standard, there are things FINRA can do now to demonstrate that commitment instead of waiting for the SEC or Congress to make the next move.

Fiduciary Links: One more week for comment on DOL's fiduciary definition regulation

The Department of Labor released transcripts last week from the early March hearings on their definition of fiduciary rule proposal (Day 1 here; Day 2 here). As they had previously announced a 15 day extension to submit public comments from the time the transcript was posted, this puts the deadline on April 12.

The proposed rule seeks to expand what qualifies as fiduciary advice to reflect changes in retirement planning over the past 30+ years. We submitted our comments of general support for the rule proposal during the initial public comment period and plan on reiterating that support in an additional comment before the deadline. Not everyone is in agreement, however, as significant opposition can be found among both the hundreds of already submitted comments and in the hearing testimony, all of which can be found here. Most of the criticism centers around the idea that the expanded regulation will increase cost and limit investment options for investors. 

We would encourage anyone who has a strong opinion on the rule to submit comment to the DOL. In particular, DOL would find the following information helpful:

1. Comments that directly address specific opposition to the rule;
2. Comments referring to specific examples of abuses in the marketplace that DOL’s proposal would address;
3. Comments that demonstrate how fiduciary principles are and can be applied to practical situations.

Again, those comments are due on April 12. A rule proposal overview can be found here and submission instructions can be found here. For more information on how this and the 408(b)(2) rule proposals will affect you, we refer you to the webinar we hosted last month with Fred Reish.

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