fi360 Blog

A unique end of the year review

The week between Christmas and New Year's Day is typically very quiet in the fi360 office and this year has been no exception.  So it was unusual for us to have a conference call scheduled with a local registered investment advisory firm to review the current status of legislative/regulatory reform.

This firm was conscientiously seeking to ensure they were keeping abreast of regulatory changes that had recently occurred (or were coming soon) so as to determine what changes they would need to make to their business model, service agreements, or disclosure documents.  Our presentation and the ensuing discussion covered the following topics:

• SEC's still yet-to-be-proposed Fiduciary Rule for brokers and advisers providing investment advice to retail investors
• Investment advisor oversight (SRO Draft Bill)
• The following Department of Labor (DOL) regulatory initiatives:
  • Proposed new federal fiduciary definition
  • Proposed Target-Date-Fund Disclosure (TDF) Rule
  • Fiduciary Advice Rule--individual participant advice
  • Interim Final 408(b)(2) Regulation (plan disclosure)
  • Final 404(a)(5) Regulation (participant disclosure)

Much uncertainty surrounds all of these regulatory/legislative initiatives.  The SEC has yet to write their new fiduciary rule, and there is much debate on how stringent it should be.  It's unlikely that an SRO Bill will clear Congress in 2012 so FINRA, SROIIA and others may have to be patient.  DOL's proposed federal fiduciary definition has encountered stiff political headwinds, and it is likely that the revisions in the next proposal will be material, particularly with respect to IRAs.  The TDF Regulation continues to languish, and most expect only a tepid industry response to the final participant advice regulation.  The plan [408(b)(2)] and participant [404(a)(5)] disclosure regulations will become effective on April 1 and May 30, respectively, but there are rumors of further delays.  In the case of 408(b)(2), it is still an "Interim Final" regulation so it is possible there may be additional changes; though probably minor if they do occur.

During the conference call, as we discussed this uncertain environment, it became clear that this particular firm was well-positioned to navigate these shifting waters. They are a registered investment adviser that only accepts asset-based fees; no commissions, 12b-1 fees or revenue sharing of any sort.  They have no affiliations that would create inherent conflicts of interest.  It became clear that their business model will not have to change regardless of how the aforementioned proposed rules unfold.  They realized that their primary focus should be on the plan and participant disclosure regulations which they considered to be a manageable endeavor.  In short, they were relieved.

It won't be as simple for the registered reps and insurance agents providing investment advice.

Fiduciary Links: Our predictions for 2012

As 2011 comes to a close fi360 would like to wish all of our readers a very happy holiday season and a great new year! The chart below is a quick look at some of our industry experts top regulatory predictions for 2012.

	Rich Lynch, COO	Kristina Fausti Broumand, General Counsel	Duane Thompson, Senior Policy Analyst
Will a uniform fiduciary standard be proposed by the SEC in 2012?	Yes	Yes. While I believe that the SEC will make a proposal to extend the fiduciary standard to broker-dealers, whether that standard will in fact be "uniform" remains to be seen.	Yes
Will the fiduciary rule be litigated, once adopted?	Yes	Maybe. Given that a proposal has not been issued yet, it's hard to predict whether litigation would follow adoption, but the stage appears to be set for litigation.	Yes, most likely by the insurance industry.
Will the fiduciary rule proposals make anyone happy?	No	No, no one is ever truly happy with regulation, but hopefully there will be strong support for the proposal.	No
Will the SRO bill reach the Senate, or become law in 2012?	No	No. With the recent delay at the House committee level until the spring and the release of the new Boston Consulting Group study, a final law in 2012 seems unlikely.	It will get to the Senate, but won’t be signed into law.
Will a revised fiduciary definition be adopted by the DOL next year?	Yes	It depends. If the DOL drops IRAs from the rule, then I think the chances of adoption are good, assuming the brokerage industry is willing to live with the so-called seller's exemption to the rule.	Yes, with not any significant changes.
Will the ‘Big Switch’, IAs to the states, be smooth?	No	Yes and no. It will be smooth at the registration phase, but actual oversight by the states will be more complicated.	Yes, only a few minor headaches—especially if you’re at $99 million.
Estimate how many firms will use the new fiduciary advice rule, compared to its official estimate.	Very few. We have not seen much interest when this is discussed in class.	10-25%. Reception to the rule has been cold, and it appears that only a small percentage of the firms DOL expected to use the rule will.	Two percent. The rule would cost plan administrators too much to provide the quality of advice needed to help someone plan effectively for retirement.
Will Dodd-Frank be repealed if Republicans take control of the Senate in the November 2012 election?	No	No. I think you also need a Republican in the White House to support repeal. However, even with full Republican control, it's become clear over the past year that it is easier to change small pieces of the law rather than repeal the whole thing.	No. They’ll definitely try, but without 60 seats held by the GOP in the Senate, any repeal will fail.
What are the top three issues advisors and investors need to keep an eye on in 2012?	1. Implementation of the 408(b)(2) and 404(a)(5) regulations. 2.The DOL’s revised fiduciary definition. 3.The 2012 general election.	Disclosure, transparency, and compliance. Between the new Form ADV from the SEC and the new participant disclosure rules from the DOL., more information will be out there for investors, but transparency of this information and what investors are actually paying for their investments and related services will be key. In addition, we are seeing oversight at the federal and state level shift. Regulators are cracking down on bad practices at an earlier stage in order to prevent future frauds. Therefore, advisors will need to place an even greater emphasis on regulatory compliance.	1.Staying the course through market volatility 2.Watching client cash flow 3.Watching client debt

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

Walmart settlement a lesson in prudent practices

Earlier this month, a federal court in Missouri granted preliminary approval of a settlement in the Braden v. Walmart case. Perhaps mostly well known because of it's recognizable defendant, the case was brought by Walmart employees who alleged significant fiduciary breaches by Walmart's 401k plan committee for choosing investments with excessive fees.  The case grabbed headlines as it bounced back and forth as the result of the trial court first dismissing the case and the Eighth Circuit later vacating that dismissal. After all the bouncing around, the parties reached a settlement, which was approved on a preliminary basis and will go to hearing for final approval in March.  Participants in the Walmart 401k plan will be paid $13.5 million (including attorney's fees) under the settlement, but perhaps more importantly Walmart's retirement plan committee will be required to: 1.  retain an independent fiduciary to provide advice and recommendations on selecting and monitoring plan investment options;  2. review the consultant or independent adviser for conflicts of interest on an annual basis;  3. continue to make available to participants web-based investment education resources, including a retirement planning calculator;  4. remove and preclude the addition of fund investment options that are retail mutual funds; funds that pay Rule 12b-1 fees under federal securities law; and funds that provide revenue sharing, per-position or per-participant subtransfer agent fees, or other fees, to any party-in-interest as defined in Section 3(14) of the Employee Retirement Income Security Act, including the plan's trustee or recordkeeper; and  5. consider adding additional low-cost index funds as plan options. In reviewing these requirements for the Walmart plan committee, I'm struck by how most of them reflect basic fiduciary principles of independence and avoidance of conflicts. And perhaps that is a good thing because the settlement will serve as an important reminder that process and substance are both important when fulfilling one's duties of prudence and loyalty under ERISA and fiduciary laws in general. This settlement falls in line with other similar cases claiming fiduciary breaches related to excessive fee cases and could leave many plan fiduciaries vulnerable to being sued in the future.  Those fiduciaries, however, can limit their liability by engaging in a prudent process that focuses on putting the participants' interests first and minimizes conflicts in order to promote sound investment decision making. 

Fiduciary Links: SRO will cost twice as much as SEC exam program

>>>Last week, The Boston Consulting Group released the results of a survey revealing, an SRO for investment advisers to likely cost at least twice as much as adequately funding an enhanced SEC exam program. The study was commissioned by the CFP Board, FPA, IAA, NAPFA, and TD Ameritrade Institutional in response to the SEC’s study under Section 914 of the Dodd-Frank Act.

Below is a list of key findings from the study:

1. “Creating an SRO for IAs would likely cost at least twice as much as funding an enhanced SEC examination program.”
2. “The startup costs of an SRO alone could fund an enhanced SEC examination program for an entire year.”
3. “More than 80% of IAs said they preferred the SEC over a FINRA-IA SRO.”

For more information visit the links below:

• Advisory firms would pay twice as much with Finra as regulator: Study [InvestmentNews]
• Advisor SRO Would Cost Twice as Much as Funding SEC Exams [AdvisorOne]
• Boston Consulting Group Report: FINRA Twice as Costly as SEC for Investment Adviser Oversight [RegisteredRep]
• Creating an SRO would cost 100% more than SEC exam program, study shows [RIABiz]

>>>Also released last week was a state registration web tool by SROIIA. This tool was created to “help independent investment advisers by providing information concerning registration for each of the 50 states.” View the new tool here.

An article by AdvisorOne discussing the new tool, says the tool was created in anticipation of the “switching” of advisors. Advisors can find a summary of any state’s registration requirements, and a link to any necessary forms using the tool.

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

Fiduciary Links: Going independent with patience

>>>>A piece from Registered Rep last week gives some good insights on what the process for “going independent” looks like for most advisors. In short, it is a deliberate process that needs to be carefully considered and may take several years to complete entirely. Factors that go into the decision include marketing advantages, compliance requirements, practice management concerns, such as technology upgrades, and, perhaps most importantly, knowing how your clients will react. Once an advisor has decided to make a change to a fee-only model, a course for converting clients must be plotted and the short-term effects on revenue and cash flow must be accounted and prepared for. In the end, the article suggests that any decrease in revenues is usually made up for after the first year and almost never do advisors regret the decision.

>>>>Just one more reminder that from 4:00 – 5:00 p.m. ET on Thursday, we’ll be hosting our last Resources webinar of the 2011. Join us for a discussion on asset allocation for volatile markets with two of the preeminent authorities on the subject: Harold Evensky and Roger Gibson. Fi360 CEO Blaine Aikin will moderate. We will be taking some questions and producing a follow up blog post to answer the questions we don’t get to. Attendance at the session will be reported for one hour of CE for your CFP, AIF and AIFA designations. Of course, the best part of all is that the session is free.

For more information, and to see the archive of previous webinars, visit the webinars page on fi360.com.

>>>>Finally, on the regulatory front, a few updates highlighted in this week’s news coverage:

• Mary Schapiro made comments that a new fiduciary rule will be business-model neutral, allow commissions and proprietary products. Of course, this doesn’t tell us a whole lot more than we already knew. As Harold Evensky commented in this reaction article, we’ve been hearing comments like this all along and only time will tell what that actually means.
• While we had been expecting a draft and discussion on SRO legislation before winter recess, reports now are that it isn’t coming until 2012.
• InvestmentNews has a nice ten-point summary on the legislative and regulatory requirements that advisors need to be aware of.

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

Howdy Neighbor! Welcome to the ’40 Act

Recent coverage of SEC enforcement actions by the trade press highlights a crackdown on compliance deficiencies by investment advisers.  One former SEC attorney predicted an ‘enforcement wave’ was coming soon for advisers.  Robert Khuzami, director of the SEC’s Division of Enforcement, in a news release featuring three settlements with advisers, tempered his remarks by saying that while not all technical violations result in fraud, “many frauds take root in compliance deficiencies.”

Overlooked by the press in these particular cases were the affiliations of the parties to the brokerage industry.  Of course, that is nothing new.  In recent years a wave of stockbrokers, coincidentally, has moved into the neighborhood.  Dual registrants now comprise nine out of 10 investment adviser representatives on both the federal and state level.  Thus readers should not jump to conclusions about adviser misconduct when brokers are now likely to be one and the same.  However, missing from the news reports and the SEC is an important context – a client-first culture under the Advisers Act that oftentimes is an awkward fit for brokers working in a sales environment at the same time.

In these particular enforcement cases, all three were associated with broker-dealers, two of the three as broker-dealer executives.  A common deficiency found by SEC examiners was a distinct lack of attention to written compliance policy and ethics codes under investment adviser rules adopted in late 2004 and early 2005.  One would think that, as BD executives, they would have been accustomed to FINRA’s rules-intensive compliance requirements.  But for whatever reason, they did not carry over this over to the new fiduciary space.

Several years after the new SEC rules went into effect, these advisers’ books and records were examined by SEC examiners.  All three showed a purposeful or benign neglect of their ethics and compliance oversight requirements despite repeated requests by Commission examiners to update and customize what were sometimes generic, off-the-shelf compliance manuals.  In one instance, the advisor had no compliance manual, only learning about the SEC rules when examiners called to schedule a visit.  To aggravate matters, after a repeat visit several years later, the same advisor backdated records attesting to supervisory reviews the day before producing those records for the agency.

The details vary, but the results were all the same – technical violations of SEC rules that flow from an adviser’s fiduciary duty of loyalty to manage conflicts of interest, and a fiduciary duty of care to, among other things, implement programs designed to protect client privacy, disclose investment philosophy, and review staff compliance with the firm’s ethics code. 

Fiduciary Links: Asset allocation for volatile markets

>>>>Everyone has an opinion on where they think the economy is going next, and yet no one really knows for sure. It is a fiduciary's job to balance that short-term uncertainty with the long term goals of the client.

Join us for a discussion on asset allocation in today’s markets from 4:00-5:00 p.m. EST next Thursday, December 15 with two of the subject’s preeminent experts: Roger Gibson and Harold Evensky. We'll put the current environment into a historical context, discuss asset class correlations, look at the importance of understanding the client's risk tolerance and other behavioral concerns, and examine the relevance of Modern Portfolio Theory at a time of global financial crisis.

The session will be moderated by fi360’s Blaine Aikin and will include the opportunity for Q&A. The session is free and will be reported for one hour of continuing education credit for the AIF, AIFA and CFP credentials.

For more information and to register, visit the webinars page on fi360.com.

>>>>In last week’s Fiduciary Links, we highlighted an article in InvestmentNews that pointed out the potential for conflicts in fee-based advisory services. The Wall Street Journal’s Financial Adviser blog followed that up with a partial rebuttal arguing that anytime money is changing hands, there are going to be imperfections. However, that doesn’t mean that the evolution to fee-based business models isn’t a huge improvement. The conflicts cited in the original IN piece are less significant, more manageable and, again, represent a significant improvement in advisory services that are good for the investor.

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