fi360 Blog

Do investors really need investment advisors?

Anytime we receive the same or similar questions a few times within a short time frame, we're normally thinking that it is probably a good topic for a blog post.  This particular question is one we have heard in the past, but has taken on a different twist more recently.  Previously we would hear, "how can I convince prospective clients that they need to hire an advisor who will assume much of, or at least help them manage, their fiduciary responsibility?  They don't have a sense of urgency that this is important and needs to be addressed."  More recently, the question has changed to, "how do I respond to a current client that is questioning the need to keep me; not that they are looking for a better or cheaper advisor, rather they wonder if they need an advisor at all?"

The question has surprised us because our general sense is that investment stewards, the lay fiduciaries, are growing more uneasy in this volatile market and more likely to seek professional help.  But there are some who are feeling quite the opposite, in which case they may be thinking one or both of the following:

• We have sufficient internal expertise to do this ourselves.
• Eliminating our investment advisor or consultant could save us a lot of money.

Investors (plan sponsors, investment committees for foundations and endowments, and individuals) may have sufficient internal resources to oversee the investment management process and nothing in the law prevents them from doing so.  However, in their fiduciary role they are expected to ensure that investments entrusted to their care are managed with the skill and judgment of a professional.  If they can't meet that high standard, and most can't, they should hire outside professionals.  For plan sponsors, ERISA requires fiduciaries to get help when they need it.  A big part of mitigating fiduciary risk is to seek professional help as appropriate.

Fiduciary Links: A fiduciary approach to alternative investments

>>>>On Wednesday afternoon, fi360 is hosting a free webinar on alternative investments. Our guest presenters, Tom Orecchio and Mark Willoughby of Modera Wealth Management and Guy Barudin of Terrapin Partners, will take a look at a fiduciary approach to implementing alternative investments into a long-term investment portfolio. This includes a look at asset class correlation, portfolio diversification, different types of alternative investment vehicles, and a prudent selection and monitoring process.

The session is free and open to all comers. It is also approved for one hour of CE credit for the AIF, AIFA and CFP credentials.

If you are interested in attending, register via the webinars page on our website, where you can also find the session slides available for download.

>>>>SROIIA continues to build a compelling case that a self-regulator that is separate from FINRA and specific to independent advisers is not only better for investors and the financial services industry, but is also preferred by advisers themselves. In their latest round of survey results, they show overwhelming support for an alternative to FINRA, for a higher standard of care than whatever standard FINRA is to support, and that prohibits principal transactions and commissions.  

It is both interesting and encouraging to see that even if a harmonized standard emerges that is lower than the current standard for RIA firms, many advisors see the benefit in voluntarily associating themselves to the more stringent standard.

You can view SROIIA's results here.

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

Recent cases place emphasis on diversity of investment options for retirement plans

A body of law appears to be forming across federal Circuit courts giving employers greater guidance on how to build the range of investment options available in employee retirement plans in a way that fulfills the employers' fiduciary duty under ERISA.  The most recent case, Renfro v. Unisys Corp., comes from the Court of Appeals for the Third Circuit.  

In Renfro, plan participants claimed the employer breached its fiduciary duty by choosing investments for its 401(k) plan that had excessive fees.  The trial court and Third Circuit disagreed, however, finding that the employer offered a broad enough range of investment options with different fees. 

In reaching its decision, the Third Circuit looked to the Hecker v. Deere case from the Seventh Circuit and the Braden v. Wal-Mart Stores, Inc. case from the Eighth Circuit.  As the Third Circuit noted, Hecker and Braden “share a similar analytical framework for evaluating an ERISA breach of fiduciary duty claim targeting the selection and maintenance of a mix and range of investment options in a 401(k) defined contribution plan.”  Both cases examined the characteristics of the mix and range of investment options and then evaluated the validity of claims challenging fund selection against the backdrop of the reasonableness of the mix and range of investment options.

Fiduciary Links: Regulatory reform once again the hot topic

After having quieted down for most of the summer, the regulatory and fiduciary debates have heated up once again. With dual hearings from the House Financial Services Committee on adviser oversight, fiduciary rulemaking and SEC reform, this week’s headlines were clearly dominated by the latest developments from Congress and the major players in and interests in the reform debate. So much so, the topic deserves its own special section in today’s links:

• As we’ve mentioned in our analysis, the lone bright spot of the draft Congressional bill for authorization of self-regulatory organizations is that it does leave room for multiple SROs. The possibility of an SRO specific to independent advisers is what prompted InvestmentNews to lend their endorsement to the Bachus bill. [InvestmentNews]
• Speaking of a new SRO for independent advisers, such a start up is already in the works with the backing of Mercer Bullard and a group of his Ole Miss law students. Mercer wrote about the SRO issue and SROIIA in his latest column. [Morningstar]
• You would think elected representatives would put the onus on the industry to demonstrate they are protecting investors, but, in fact, the opposite occurred at Tuesday’s Financial Services subcommittee hearing [InvestmentNews]
• NASAA reaffirmed its belief in a fully funded SEC as the regulator of choice, while also recognizing the importance of working together with FINRA for the benefit of advisers and investors. [InvestmentNews]
• The Municipal Securities Rulemaking Board pulled back on their fiduciary rulemaking until they get a clear definition of municipal adviser from the SEC. [InvestmentNews]
• Not limited just to the media, regulatory issues were also a hot topic at the FPA Experience 2011 conference this past weekend.  [InvestmentNews]
• At the week’s second House Financial Services hearing, there was a small reversal of roles as Schapiro acknowledged the potential of an adviser SRO and Bachus acknowledged the need for increased funding of the SEC. [InvestmentNews]
• In the face of a good deal of pressure from both sides, the DOL today announced it will go back to the drawing board on a fiduciary rule, now expected in early 2012. This is unfortunate as we supported the proposed rule. [DOL EBSA]

Now on to the rest of the best links from the past week, which includes a whole lot more on the regulatory developments of the past week:

Practice 3.4: Follow a due diligence process to select service providers

We covered in a previous post the need to engage service providers to manage those investment decisions that are beyond the responsible fiduciary's capabilities. The selection process is one of the most overlooked functions. Most fiduciaries simply abdicate the decisions to a vendor, adviser or money manager. Yet as with other prudent practices, there are a number of important decisions that need to be managed. Just as important as making a prudent selection of service providers is documenting how the decisions were made.

Let's take a look at the actual Practice and Criteria. You can click on the image to view a larger version:

 
The fiduciary must be able to demonstrate that process was followed in selecting service providers and written documentation is the most effective way to accomplish this. Upcoming 408(b)(2) regulation is going to have the effect of standardizing much of this process for ERISA plans when it becomes effective in April 2012 and shift a certain amount of the burden to the service providers themselves. Even with non-ERISA plans, requesting 408(b)(2)-like disclosures in a formal RFP process is a good way to manage the selection process. The key is to gather sufficient information from a number of potential providers that addresses capabilities, costs, fiduciary and non-fiduciary services to be provided, and security requirements.

Other considerations in custodian selection would be ensuring there is sufficient insurance to cover the portfolio, whether assets are commingled along with the assets of other clients, the expense ratio of the cash sweep vehicle that will be used with the separately managed accounts, and the custodians capabilities for corrected year-end statements, tax reporting and performance reporting.

For more information, consult the following resources:

• Complete text of Practice 3.4 from the Prudent Practices for Investment Stewards handbook
• Legal substantiation to Practice 3.4 from ERISA, UPIA, UPMIFA, MPERS, and relevant regulation and case law.
• DOL's meeting your fiduciary responsibilities page
• An overview of the SEC adopted Custody Rule
• DrinkerBiddle: benchmarking as a part of a prudent process
• SEC staff responds to questions about the Custody Rule
• DOL offers tips for selecting and monitoring service providers for your employee benefit plan
• fi360 answers your questions on 408(b)(2) and fiduciary advice   

Fiduciary Links: Who should be afraid of cost-benefit analyses?

>>>>In his latest Fiduciary Corner column for InvestmentNews, Blaine combats the notion that fiduciary advocates should fear a cost-benefit analysis of fiduciary rulemaking. Ever since the SEC staff study on standards of care for advisers and broker-dealers was first released, opponents of strong fiduciary standards of care have put a great deal of focus on claiming regulators have failed to adequately support proposed rulemaking with careful consideration of costs vs. benefits. The implication of this strategy has been that such scrutiny would clearly show that the costs of implementing high fiduciary standards of care would be prohibitively expensive to both the small advisor and retail consumer.

Not so fast, according to Blaine, who cites four reasons the cost-benefit strategy should backfire on fiduciary opponents:

1. Advice under a low standard is inherently less valuable than under a high standard.
2. There is no evidence to suggest that low standard advice is available at a discount below high standard advice.
3. A “harmonized” standard that is weaker than that established under the Investment Advisers Act of 1940 would weaken the protections currently afforded clients of SEC-registered advisers.
4. The true value to investors of fiduciary conduct includes objectivity, competence and trust, values that would be compromised under a weakened standard.

>>>>The House Financial Services Committee is holding a hearing tomorrow, September 13, on investment adviser and broker-dealer oversight. The hearing will address the discussion draft bill released on Thursday that would authorize multiple self-regulatory organizations. We’ve been all over this story and will continue to follow it closely. The hearing will be webcast from the Committee’s site, where written testimony should also be available shortly. We’ll also have more information her on the blog, and our advocacy page, where we already have an official statement and executive summary available.

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

Draft SRO Bill not in best interests of investors or advisers

Yesterday, the House Finacial Services Committee released a discussion draft SRO bill for investment adviser oversight. The bill would authorize the creation of one or more self-regulatory organizations. This was one of three options presented by the SEC staff in January, the others being SEC self-funding and the authorization of a single regulator for dual registrants.

Fi360 opposes the bill and still believes that a fully funded SEC is the most cost effective and least conflicted option. If there is a silver lining, it is that the bill calls for one or more SROs, opening the door for an alternative regulator to FINRA that gives investors the choice of advisors who are being held accountable to a true fiduciary standard.  

For more information, consult the following resources:

• Text of the draft bill
• The House Financial Services Committee's page for Tuesday's hearing on the bill. Expect testimony to be linked to this page in the coming days.
• fi360's official statement on the bill
• fi360's executive summary of the bill
• The Advocacy page of fi360.com.  The most recent section is related to the release of the draft bill. We will be posting more information there soon, including an executive summary of the bill. You can also view materials related to the SEC's study on investment adviser examinations in the fifth section from the top.
• While the bill opens the possibility for multiple SROs, bill sponsor Representative Bachus said in a press conference yesterday that he endorses FINRA as regulator.
• fi360's Blaine Aikin gives his first reaction to the bill in an AdvisorOne article, Draft Bill Calling for SRO for Advisors Introduced in House
• Duane Thompson discusses the House proposed bill that would give SROs oversight of investment advisers with Registered Rep
• The website of SROIIA, the startup self-regulator for advisers that hopes to gain authorization as the higher standard alternative to FINRA
• Financial Planning Coalition press release and statement
• Duane Thompson speaks out about his reaction to the House hearing on SRO, fiduciary standard

The Battle over Principle

"War is the continuation of policy (politics) by other means."
- Karl von Clausewitz, Prussian military strategist

Von Clausewitz, a witness to the titanic struggle between nations in the Napoleonic era, once wrote of war being merely an extension of foreign policy.  So, too, in perhaps less dramatic fashion, should the struggle over investment advice be viewed as shifting over the years from the marketplace to Washington politics. 

Today, the most important distinguishing feature between Wall Street and independent financial advisors is the common law fiduciary standard.  Wall Street, while eagerly adopting the lucrative business model of advisors, over the last decade has pressed Washington to keep the FINRA sales model for regulation in play for its advisory services.

When reviewing the uneven battle between the two, given Wall Street’s deep pockets, the latest salvo from the wirehouses is likely to be fired on Sept. 13, when its supporters in Congress convene a House subcommittee to hear testimony on ways to strengthen the Commission’s investment adviser examination as well as on a uniform fiduciary standard for brokers and advisors. 

While the question of a self-regulatory organization for investment advisers can be expected to dominate the discussion, the subtext that will be hard to ignore is how an SRO will ultimately shape the pending uniform fiduciary standard for brokers and advisers.  Will it be an overlay of advisor conduct largely based on principles that follow the common law standard under the Advisers Act, or a rules-dominated standard administered by FINRA, or a mix of the two?

Fiduciary Links: Progress on SRO suddenly moving quickly; some upcoming dates to remember

>>>>A press release from the House Financial Services Committee announced that there will be a September 13 hearing of the Capital Markets Subcommittee on “regulation and oversight of broker-dealers and investment advisers.” The hearing is expected to focus on who should be responsible for oversight of advisers and may even include fiduciary rulemaking.

Fi360 policy analyst Duane Thompson has said that he expects to see a bill introduced following the hearing, which would be a prerequisite to transferring adviser oversight to an SRO. As part of its requirement to examine the issue, an SEC report in January laid out three options for enhancing adviser examinations: 1) authorize SEC self-funding through user fees, 2) authorize one or more SROs for oversight of all SEC-registered advisers, or 3) authorize limited SRO by expanding FINRA’s oversight to include dual registrants.

This is an issue we have and will continue to monitor closely over the coming weeks. In addition to our blog, we also recommend following SROIIA, the recently created Self-Regulatory Organization for Independent Investment Advisers, for updates. A recent post on their blog summarized nicely why, despite being in favor of SEC oversight, they feel it is so important to establish a feasible framework now for the likelihood that an SRO will be authorized by Congress. You can also see our reaction from the SEC’s SRO report on our Advocacy page (fourth item from the top).

>>>>We’d also like to alert you to two upcoming webinars that you might want to add to your calendars.

First, friend-of-fi360 Ron Surz of Target Date Solutions is leading a session at 4:00 p.m. ET on September 15 on how fiduciaries should handle TDFs now that they have become a target for more critical scrutiny. More information and a link to register can be found here.

Second, our own quarterly Resources webinar is taking place at 4:00 p.m. ET on September 28. We’ll be covering how fiduciaries should approach alternative investments in their client portfolios. More information and registration, as well as an archive of our previous webinars, can be found on the Webinars page of fi360.com. Registration is free and attendance will be recorded for one hour of CE credit for the AIF, AIFA and CFP credentials.

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

Fiduciary consulting--embrace it

We received a call from an AIF designee earlier this week asking for help.  He was updating his personal information in the CFP database and having trouble finding a category in the database drop down list that fit the fiduciary service he was providing to clients.  My impression was that there must have been an "Other" category that he could select, but he needed to provide a short description of what "Other" was.  His voice mail indicated that he was thinking of using "Fiduciary Adviser," but when we talked, we agreed that "Fiduciary Adviser" was too narrow as it typically refers to providing specific investment advice to qualified plan participants per the Pension Protection Act.  After listening to what services he was providing, my suggested description was "fiduciary consulting."  He liked the description and intended to contact the CFP Board and suggest it be added to the drop down list in their database.

Our sense is that the demand for fiduciary consulting is increasing.  We just completed AIF and AIFA programs at the University of Pittsburgh that had to be added to the initial schedule released at the beginning of the year.  CEFEX has seen a steady increase in phone calls asking about fiduciary assessments and certification programs.  Large insurance providers are partnering with registered investment advisory firms that provide ERISA 3(21) and 3(38) services to qualified plans.