fi360 Blog

Fiduciary Links: A shift in culture trumps reform

In his latest Fiduciary Corner column for InvestmentNews, Blaine uses his recent trip to New Zealand and Australia to contrast the role legislators and regulators can have in affecting change as part of a broader cultural shift. But while his observations are that the counterparts in reform on the other side of the world are doing a better job of embracing and furthering the fiduciary cause than our own at home, he reaches the conclusion that rules in this context are only a part of a broader fiduciary movement that isn’t waiting for reform.

On a side note, Blaine's extended profile as part of his IA 25 recognition was also published this past week. Read it here.

Now on to the best links from the past week:

Practice 3.2: Applicable "safe harbor" provisions are followed

Practice 3.2 requires that a fiduciary adhere to the provisions of any elected safe harbors. "Safe harbors" are defined by three basic traits. The first is that they are voluntary, though it would be almost foolish not to take advantage of available "safe harbor" provisions because of their second trait, which is that they may insulate a fiduciary from certain liability associated with the management of a portfolio's assets. Finally, they carry certain requirements on the fiduciary in order to qualify for protection, such as demonstrating prudent selection, prudent monitoring and acknowledgement of fiduciary status.

There are four established safe harbor provisions under ERISA for qualified retirement plans, which line up to the four criteria for this Practice:

 

The general, or 404(a), safe harbor protects the fiduciary from liability for actions of experts to whom they have delegated responsibility. The 404(c) safe harbor protects the fiduciary from liability for the actions of the participants.The fiduciary adviser safe harbor protects the fiduciary from liability for the advice of a Fiduciary Adviser. The QDIA safe harbor protects the plan sponsor from liability for having placed participants assets into an investment in the absence of direction from the participant.

In order to gain those protections, here are the basic requirements for each of the above safe harbors:

Fiduciary Links: Annuity sales, concerns on the rise

Annuity products have been getting a lot of attention recently as a “guaranteed” income source that mitigates some of the risk of a 2008-like market crash. An InvestmentNews article this week cited a 24% rise in annuity sales over last year, marking five straight quarters of increases.

Of course, annuity products aren’t without their controversy. An article in IN just a day later also highlighted some of the problems with the products, namely high fees and complexity. In addition, “guaranteed” and “safe” can be relative terms when it comes to investment products and the fine print can often reveal more than the investor bargained for.  It is also one of the more contentious areas in regulatory reform, territory that the insurance lobby is fiercely defending.

That isn’t to say that annuities should necessarily be shied away from. A recent Wall Street Journal article makes a pretty compelling case for annuities. Our point, as is often our point on the fi360 Blog, is that a fiduciary has a lot to consider when deciding whether or not to recommend an annuity and which one to recommend. Choosing annuity products, as with all other investment vehicles, insurance-related or otherwise, involves assessing the needs of the client, performing necessary due diligence, weighting risk tolerance considerations and more.

For this reason, we’re offering a free webinar on the subject next week. Guest-presenter Joe Maczuga of Fee Advisors Network, who also did a recent guest blog post for us, will be looking at how to employ a fiduciary methodology for the analysis, design, and recommendations related to life insurance, along with co-presenter Rich Lynch from fi360. For more information and registration information, visit our website.

Update: The webinar has now been approved for one hour of CFP CE credit.

Now on to the best links from the past week:

The Difference Between Suitability and Fiduciary

I recently read an industry organization's account of a presentation by a FINRA official who promoted a "uniform fiduciary standard" but questioned its efficacy for brokers because he believes that the sum of FINRA’s rules are equivalent to the fiduciary standard.  In addition, he believes that FINRA's suitability rule incorporates a fiduciary duty.  

While FINRA has taken steps to strengthen its suitability rule, I still find it hard to swallow a tale where suitability combined with sales practice rules equals fiduciary.  Nonetheless, while working at the SEC, I often interacted with FINRA staff members and officials and do in fact respect many of them on a personal and professional level, so I thought why not do some research on this. 

Being a sophisticated attorney, I first turned to my most trusted research tool and typed "suitability" into Google.  Interestingly, the link at the top of the search results led me right to the SEC website where I found suitability defined as follows:

"When your broker recommends that you buy or sell a particular security, your broker must have a reasonable basis for believing that the recommendation is suitable for you. In making this assessment, your broker must consider your risk tolerance, other security holdings, financial situation (income and net worth), financial needs, and investment objectives."

With such easy results, I quickly typed "fiduciary" into both Google and the SEC search engine, but my trusty tools failed me, which also disconcerted me considering that the SEC has now concluded more than once that investors are confused about when a financial professional has a fiduciary duty (see Rand Report and Fiduciary Report).  Fortunately for me, though, I have spent quite a bit of time searching resources on the SEC website and turned to another trusty source, an outline on the regulation of investment advisers written by SEC staff (which curiously is buried under the Office of International Affairs webpage).  In that outline, I found this familiar description of fiduciary duty: 

"Fundamental to the [Advisers Act of 1940] is the notion that an adviser is a fiduciary. As a fiduciary, an adviser must avoid conflicts of interest with clients and is prohibited from overreaching or taking unfair advantage of a client’s trust. A fiduciary owes its clients more than mere honesty and good faith alone. A fiduciary must be sensitive to the conscious and unconscious possibility of providing less than disinterested advice, and it may be faulted even when it does not intend to injure a client and even if the client does not suffer a monetary loss."

Fiduciary Links: Disputing the "cost" of fiduciary

Both the Consumer Federation of America (CFA) and the Committee for the Fiduciary Standard went after the notion that the fiduciary standard of care being extended to all investment advice would somehow harm average investors by increasing costs and limiting availability to products and services. In separate letters to House Financial Services members and leadership, the two groups urged that the SEC be allowed to continue progress towards fiduciary rulemaking under the Dodd-Frank Act.

CFA’s letter from Barbara Roper notes that the SEC’s report stressed the importance of the broker-dealer transactional business model and that it is only personalized advice that needs to be brought under a uniform standard. The letter goes on to stress that while any arguments of a cost to investors from the fiduciary standard is largely anecdotal, the recent market failure and the current disparity in fees for conflicted advice serve as very real evidence of the cost of non-fiduciary advice currently being dispensed.

The Committee’s letter further stresses that a cornerstone of the SEC’s mission is to protect investors and, while business costs must always be a consideration, they have stated clearly that the fiduciary standard offers much better investor protections.

Here is that very well-reasoned passage from their letter:

How should the SEC weigh the acknowledged benefits of the higher standard of putting investors’ interests first (a standard that the staff agrees  provides a “significant” difference in investor protection) as compared to the standard applied to broker-dealers, against the industry’s “concerns of costs”? 

If there were an actual incremental cost (a cost that is not offset by a cost-savings elsewhere) to firms directly associated with practices and procedures required to place investors’ interests ahead of the firm or its representatives, should this incremental cost, hypothetically, be presumed to be reasonable? At what point does the Commission determine such a hypothetical cost becomes unreasonable or too high? At what point and on what basis does the Commission determine that adhering to the duties of loyalty and care is “too costly” for the industry and, in so doing, effectively, decree these fiduciary duties null and void? Even contemplating such a scenario would seem to put into question the rationale of the anti-fraud provisions within the Advisers Act.  

And, again, this even presumes that the cost is real, which is hardly a given.

For more on the subject here are a few more links from the past week covering the issue:

• At the fi360 conference Knut Rostad released a response to the House Republicans’ letter to the SEC on the fiduciary standard [AdvisorOne]
• Advocates for imposing a fiduciary duty are stepping up their campaign [InvestmentNews]
• Subjecting broker-dealers to a fiduciary standard could increase their compliance costs and force them to curtail services to middle-income investors [InvestmentNews]

Now on to the best links from the past week:

SEC Backlog Leaves Self-Dealing Loophole Intact

Last December, the SEC approved the second extension of a ‘temporary rule’ making it easier for brokerage firms to self-deal under the Investment Advisers Act of 1940.  The latest extension of the rule, first adopted in 2007, carries on through the end of 2012.

The rule in question, 206(3)-3T, significantly loosened the original principal transaction restrictions for investment advisors.  That provision of the law requires an advisor selling stocks or bonds out of its own inventory to inform the client in writing and receive consent prior to executing each principal transaction.  Of course, few investment advisors engage in principal transactions, so this provision of the law gathered dust for nearly 70 years until the wirehouses lobbied the SEC for relief after an increasing number of their registered reps began to register as investment adviser reps in the early 2000s.  Under ERISA, such activities would be strictly prohibited, offering additional support to the Department of Labor’s claims that its own fiduciary protections provide the highest standard under federal law.

In what is a familiar line up of public commenters, advisor and consumer groups generally opposed the original temporary rule, and the brokerage industry supported it.  The temporary rule essentially streamlines compliance by allowing broker-advisors to secure a blanket, revocable consent in advance from the client for principle trades, along with a boilerplate disclosure of the conflicts and how these would be managed while acting in a fiduciary capacity.  It also includes several other restrictions by prohibiting self-dealing in discretionary accounts and banning trading in stock or bond issues where the broker-dealer serves as an underwriter, except for investment grade bonds.  Many proponents of a strong fiduciary standard argue that it is impossible to manage such conflicts where loyalty to the firm and client is so clearly at odds.

So far the SEC claims the temporary rule is working, stating there is no evidence of dumping of devalued stocks or bonds into client accounts, although it has admitted to finding numerous technical problems with compliance.  In addition, former SEC Investment Management Division Director Buddy Donohue last summer notified SIFMA, Wall Street’s lobbying organization, that it did not plan to renew the temporary rule, saying that only a ‘few’ firms used the exemption.  The SEC then contradicted itself several months later by saying ‘some’ firms were relying on the rule, and therefore needed to extend it yet again.  However, the Commission didn’t offer the number of firms relying on the rule or an explanation for the discrepancy with the Donohue missive.

The latest wrinkle is twofold.  First, in extending the temporary rule another two years, the SEC’s proposing release stated that it intends to address principal trading issues in a final rule imposing a fiduciary standard on brokers, therefore allowing 3T to lapse in 2012.   Thus there is an assumption that a fiduciary rule will be in effect no later than Dec. 31, 2012.  Although many observers remain confident that the SEC will muster enough political courage to adopt a fiduciary standard for brokers in the face of strident House opposition, the clock is ticking down.  Secondly, the Dodd-Frank Act also required the SEC and other federal agencies to purge from their regulations any reference to credit agency ratings, and to report back to Congress on actions taken.  Since 3T is a temporary rule, it appears likely that the SEC will use this as a basis for ignoring the temporary rule’s current reliance on bond ratings, even as it has begun removing references to the ratings agencies under other securities rules.

Given these mixed signals coming from the SEC, and in particular by not offering any details on how brokerage firms are managing their fiduciary duty of loyalty in the presence of sloppy compliance, the possibility that credit ratings for principal transactions will likely be left in place is not reassuring news that the SEC is serious about a strong fiduciary duty.

Fiduciary Links: Conference Wrap Up

If it seems we’ve been hitting you over head too much about our conference over the past couple of weeks on the blog, we apologize, but this’ll be the last time we give it the full feature treatment this year, we promise. The event is the culmination of year-long process to bring it all together that involves the efforts of almost our entire staff and we believe the results speak for themselves. As fi360 has grown, so too has our conference. It has been a huge part in growing the societal culture amongst our membership of investment advisors and other financial services professionals who share their pursuit of self-improvement, fiduciary ethics and improved processes for the benefit of investors. If you are a follower of fi360 and have never been to one of conferences, I strongly suggest you consider it. You won’t find another conference experience quite like it.

That said, here are some conference wrap-up links to check out and get a little sense of this year’s activities:

• We live-blogged the conference on Thursday and Friday. If you were following on those days, check them out again as I’ve added some additional nuggets and links. You can also check out our Twitter feed for some live updates we sent on those days.
• AdvisorOne coverage of Senator Dodd’s keynote address.
• Dodd also gave an interview to AdvisorOne’s Kate McBride.
• Michael Montgomery won the annual article competition for his article on Multiple Employer Plans. His winning article can be found on AdvisorOne and all entries can be read on fi360.com.
• Coverage of Mercer Bullard’s session on the Self-Regulatory Organization for Independent Investment Advisers.
• A story about a 16-year “breakaway cycle” that really got moving at an fi360 Conference. Just one example of relationships forged at our event. Did you know that the genesis of the Committee for the Fiduciary Standard occurred at an fi360 Conference?
• You can still find presentation slides from this year’s event on our agenda page.

And, with that, we’d like to say thanks to everyone for making this year yet another successful fi360 Conference. Everyone from the fi360 Conference Committee, the fi360 Staff, all of the speakers, moderators, attendees and more contribute to creating the unique atmosphere and we look forward to it again next year. If you have any questions or comments about this year’s event, let us know in the comments or by emailing conference@fi360.com.

Now on to the best links from the past week:

fi360 Conference, Day 2

Day 2 of the fi360 Conference is underway (see day 1 notes here). Last night featured another networking cocktail reception and some organized trips to the San Antonio Riverwalk. Today's lineup features keynote speaker Peter Elkind and the awarding of the inaugural Tamar Frankel Fiduciary of the Year Award from the Committee for the Fiduciary Standard.

3:00 p.m. breakouts: The last breakout of the conference features Dan Bernstein of MarketCounsel making sense of regulation, another session on understanding DOL audits from Ed Lynch's crew and TDF investing with the expert Ron Surz.

The conference draws to a close soon and we want to thank everyone who was with us in San Antonio or followed us on the blog or on Twitter. Once again, the conference was an overwhelming success. If you have never been to our event before, we encourage you to come try it out. You won't find a better gathering of investment advisors anywhere. It's a great chance to hear some great content from an agenda chosen via an extensive selection process and interact with some of the most innovative and conscientious people in the industry. Check back to these blog posts next week, we'll clean them up with some good links and other information. 

1:45 p.m. breakouts: Duane Thompson spoke following lunch on one of the two things you don't typically want to get a look at (sausage being the other): law being made, fiduciary in this case. Duane, of course, was involved in FPA's successful campaign to overturn the broker-dealer exemption. Also in this time slot were Barbara Lewis on marketing, David Blanchett of First Affirmative on SRI and Financial Service Standards on applying prudent practices.

11:00 a.m. breakouts: fi360 Conference hall-of-famer Fred Reish was up before lunch discussing DOL's fiduciary definition proposal and its implications to advisors. This was a similar topic to the webinar he did with us in March. We also had our economic forecasting session from Jeff Cleveland of Payden & Rygel, and Ed Lynch's group discussing the CAFE.

Jeff Cleveland is a senior economist for Payden & Rygel, which has a fairly deep and developed library, including economic forecasts available from their website. Along with some caveats to the reliability economic forecasting, Jeff offered a relatively optimistic view of the economy.

In their first session of the day, Ed Lynch & Co. looked at how the CAFE is an effective assessment and business development tool, but how even trained analysts sometimes need a little help.

9:30 a.m. breakouts: Following up on his award presentation, Ron Rhoades took the stage during the first breakout timeslow to discuss form adv, part 2 and how they relate to your investment strategies and product due diligence. Speaking of which, Knut's introduction to Rhoades included a reference that his own form adv is a must see. You can see it featured prominently at the Joseph Capital website.

Also in this time slow were sessions on professionally managed accounts from Greg Kasten and Jim McMichael, professional codes of ethics from Mark Mensack and informed consent from Johann Klaassen.

The managed account sessions asks the fundamental question of how an employer can move beyond just providing a 401(k) to ensuring that their employees are able to meet their retirement needs.

The code of ethics session looked at just how far down the perception of the professionalism of financial services providers is and how individual providers can rise above those numbers by learning from the codes of ethics from the variouis leading professional groups, such as fi360, CFP and ASPPA.

Conference staple Johann Klaassen of First Affirmative is looking at how fiduciaries must ensure their clients understand the investment policy in a way that they can make informed decisions, much like a doctor must ensure his or her patients understand a proposed plan of treatment before proceeding. Johann framed the information discussion in terms of potential complications, alternatives, risk and benefits. An example of framing he raised comes the linked passage from Jason Zweig's 2007 book Your Money and Your Brain: How the New Science of Neuroeconomics Can Help.

Peter Elkind: Day 2's general session featured Fortune columnist Peter Elkind. He spoke from his experience investigating and writing on Enron and Eliot Spitzer to illustrate how individuals and cultures influence ethics and compliance around them. His session was followed up with a book signing where both his Spitzer and Enron books were available for inscription.

Elkind's approach was a good counterbalance to the Dodd session the previous day. Whereas Dodd stressed compliance and a procedural approach to dealing with the problems that caused the financial crisis, Elkind stressed the importance individuals can play in building the right culture of high ethical standards. We'll have copies of both of his books available in our online store soon.

Tamar Frankel Award: The day kicked off with Knut Rostad of the Committee for the Fiduciary Standard awarding the first Fiduciary of the Year Award to Ron Rhoades. After a nice intro to Tamar and her works and why the award was named for her, Knut introduced Ron with a summary of his prolific efforts to explain and advocate for the fiduciary standard.

 

2011 fi360 Conference, Day 1

Welcome to everyone at the fi360 and to those following here on the blog. We kicked off last night with check in and a cocktail reception in the beautiful Texas weather. We've already completed AIF and AIFA training, CEFEX analyst training, and updates on the fi360 Toolkits. We'll be live blogging updates on this page throughout the day, so check in often. If you are at the conference and active on Twitter, use the hashtag #fi360_2011 so we can see you and we'll retweet your updates as well.

4:15 p.m. breakouts: Last session of the day now underway. Mercer Bullard is discussing the current oversight landscape for advisors and how SROIIA will act as the higher standard alternative to FINRA, Stephen Lansing and Peter Gulia are discussing computer models for PPA advice, NAPLIA and Marcia Wagner are covering ERISA bonding and our own Tools team is doing a demo on modeling software.

Mercer says that an SRO for advisers needs to be in place before the SEC authorizes self-regulation or else FINRA will be the SRO. Announces that fi360 has agreed to provide a fiduciary exam; hints at possible role for CEFEX.

The Lansing-Gulia PPA advice session starts off with a pretty good list of more than a dozen RFP questions for advice and managed accounts for the consideration of the audience.

2:45 p.m. breakouts: Midway through the afternoon and we have breakout sessions on CEFEX assessments from the always-entertaining Scott Reed, a session on value standards from Fiduciary Benchmarks CEO Tom Kmak, Liza Horvath on investment policy for trusts, and an update on fiduciary reform from Committee for the Fiduciary Standard founder Knut Rostad.

Tom Kmak is kicking off his session by comparing increasing MPG on automobiles to the maturation of value standards in financial services. "Value standards propel an industry forward," says Kmak, listing performance, people, process and price as value standards for our industry.

Carlos just finished an update on CEFEX activities, including insurance premium reduction, form ADV help, CEFEX fact sheets and profiles and more. Scott Reed now taking the stage to talk about how to leverage fiduciary assessments to generate consulting business. Of course, Scott's presentations always include a little rock 'n roll. He is also handing out Jezebel Pesticide envelopes that contain one of our fiduciary cards.

Just saw our first media coverage from the conference, from AdvisorOne's Kate McBride, who is here in San Antonio. On the Senator Chris Dodd keynote address.

Bob Clark just followed Knut Rostad at the Committee for the Fiduciary Standard's session, commending the audience, the Committee and fi360 on their job advocating for the fiduciary standard. Clark is, of course, a staunch advocate for the standard. Speaking specifically on the large obstacles of overcoming the huge financial service industry. As always, he is both skeptical of the ability for the pro-fiduciary side to win, but hopeful nonetheless.

Liza Horvath's investment policy for trusts and endowments session seems to have struck a chord as it is very well attended. Some of her listed underpinning for endowment investment policy include: economic conditions, tax consequences, other resources, inflation/deflation, expected returns, the role of each investment in the portfolio and the needs to make distributions and preserve capital.

1:30 p.m. breakouts: The first post-lunch sessions are under way. ERISA attorney and fi360 Conference staple Fred Reish is talking 408(b)(2), Katie Umile is discussing how to leverage fi360 designations and software to win new business, and Kevin Mahoney's session is on transitioning from the suitability standard to a fiduciary standard from a wirehouse. Plus we've got an fi360 Toolkit demo going on.

Katie Umile drove home her point on selling yourself by giving out free beers as attendees walked in the door. She also has some very nice things to say about fi360, saying the monitoring reports (see bottom of that link for a sample) from the toolkits give plan sponsors everything they need in an easy to use format from an independent source.

Fred Reish is discussing 408(b)(2) disclosures and agreements and when advice becomes individualized under ERISA. He partially covered this topic in his webinar in March, a recording of which can be found here.

10:30 a.m. breakouts: For our first lineup of breakout sessions, we have Ron Rhoades on retail advice, the gentlemen from Envestnet on practical advice for an industry in transition, the Platinum 401k Group and Scott Pritchard on multiple-employer plans and Professor David Upton on Sharia finance.

Professor Upton says 70% of Muslim investors would prefer to adhere to Sharia law in their investing, a challenge, but significant opportunity for fiduciaries.

MEP session discussing how to deal with a single bad apple in a multiple employer plan. Mike Montgomery, our article competition winner, is a member of this panel, which includes his partner Terrance Power from the Platinum 401k and Scott Pritchard, who has previously participated in an fi360 webinar.

You can find more information on Ron Rhoades' topic in the following letter he submitted to DOL on their fiduciary advice rule proposal.

Opening remarks: The conference opened up this morning with remarks from COO Rich Lynch and CEO Blaine Aikin. Rich introduced the fi360 staff and shared the newest developments from fi360. Blaine did an update on the state of the industry, noting progress towards a strong fiduciary standard and the challenges still ahead.

AdivsorOne wealth editor-in-chief Kate McBride then took the stage to honor Mike Montgomery, who won the 2011 fi360-AdvisorOne Article Competition for his article on multiple-employer plans. You can read his article here and the other entries from our deep pool of competitors here.

Keynote speaker Chris Dodd is on stage now discussing the evolution of the Dodd-Frank Act from the financial crisis until now and how a balance must be struck between fostering innovation and reforming a wild west culture with legislation and regulation.

 
His stated goals for legislation include:

1. A new framework to suit the modern financial system
2. Don't strangle innovation.
3. International harmonization of rules.

AdvisorOne covered the address in this article, noting Dodd's remark that he wanted to get SEC self-funding into the bill, but wouldn't have been able to get it passed.

Fiduciary Links: fi360 Conference week is here!

It's our favorite time of year at fi360, as we kick off the festivities for our seventh annual national conference. Our staff has begun their migration to San Antonio, with AIF and AIFA training programs happening on site Monday and Tuesday, and Toolkit training on Wednesday. Official conference activities start Wednesday with check in and cocktail reception, then two full days of presentations from some of the most influential individuals in the fiduciary debate, subject matter experts spanning a wide variety of topics, and much more. We'll be providing updates here on the blog all week to pass on quotes, useful information and interesting tidbits from the event. Stay tuned!

Here are just a few of the highlights:

• Day 1 Keynote speaker Christopher Dodd, the former senator and co-author of the Dodd-Frank Wall Street Reform Act, will be discussing the legislation with a specific focus on the fiduciary aspects and his thoughts on implementation and rulemaking thus far.
• Day 2 Keynote speaker Peter Elkind, Fortune columnist and author of books on both Enron and Eliot Spitzer, will be discussing ethics in government and business and the importance of smart regulation for the fairness of capital markets.
• Sessions from ERISA attorney Fred Reish on 408(b)(2) and the DOL's fiduciary advice rules
• Sessions from recent IA 25 honoree Ron Rhoades
• An update on his Self-Regulatory Organization for Independent Investment Advisers from Mercer Bullard
• The announcement of the 2011 fi360 Article Competition winner
• An update from the Committee for the Fiduciary Standard
• Over 30 unique sessions in total

Now on to the best links from the past week: