January 1, 2007 marks the start of a new era for advisors. The "fiduciary advisor" is a creation of the Pension Protection Act of 2006 (PPA) and has the potential to become one of the largest retail revenue models.
Unlike the traditional retail business where clients are acquired one at a time, employers present the fiduciary advisor to employees as the endorsed expert, retained to give guidance to all of a company's employees. Fiduciary advisors are paid to help employees with their retirement-plan investing and are free to present a suite of services that might be appropriate. In fact, the legislation requires that additional available services be disclosed to employees.
This market is expected to grow to over 100 million families as more employers abandon burdensome defined benefit pension plans and replace them with defined contribution plans such as 401(k) and 403(b).
This far-reaching opportunity for fiduciary advisors threatens to make current client-acquisition practices obsolete. Individual client prospects are likely to be already committed to a fiduciary advisor at their worksite and inaccessible through direct mail, cold calling and referrals.
The PPA also removes one of the fiduciary advisor's potential headaches through its automatic enrollment, automatic increases and default investment provisions. These provisions relieve the fiduciary advisor of the time-consuming task of managing large numbers of small accounts. The automatic and default features will serve the needs of most employees until their accounts are large enough to warrant face-to-face advice.
The fiduciary advisor need not be a specialist in pension plans, but there are a number of hurdles that must be overcome. These include accepting the responsibilities, meeting the requirements and overcoming competitive threats.
Fiduciary advisors must take personal responsibility for the advice that is given to employees. Unlike fiduciaries of a retirement plan, fiduciary advisors are only responsible for the advice they give and do not become fiduciaries for the entire plan. This limited fiduciary responsibility requires a disciplined approach that is properly documented.
Employers are required to make prudent selection of fiduciary advisors, which includes a review of the advisors' regulatory history, quality of results for existing clients, knowledge of the subject and of potential conflicts of interest.
The Pension Protection Act specifies that employers evaluate prospective advisors based on:
o The advisor's affiliations and contracts that could represent a conflict of interest
o All fees and compensation that the advisor expects to receive
o Services that the advisor will provide to employees
After winning the business, advisors must meet two key standards to keep the business:
Employers are required to have an independent annual audit in which the performance of the advisor is examined to ensure compliance. An unaffiliated third party must conduct this audit.
Employers are required to conduct prudent periodic reviews. These reviews include the same factors used in the selection (regulatory history, quality of results, knowledge and potential conflicts of interest).
SEC rules (206-4) would require advisors to repeat these qualifications for each prospect or client. The rules prohibit advisors from publishing, circulating or distributing any statement of clients' experience concerning investment advice or other service rendered by the advisor.
However, Dalbar has been granted an exception that permits the advisor to make disclosures required by the PPA. This regulatory permission has been incorporated into the fiduciary advisor certification. Advisors with up-to-date certification are permitted to use their past performance as expressed by clients in promotion and advertising, subject to certain rules and disclosures.
Fiduciary advisor certification provides the documentation required for selection and for annual renewal to meet the standards of the Act. The certification permits the advisor to qualify for multiple employers at once instead of repeating the qualification process for each prospective employer client. Details of the certification process are available at http://advicealert.dalbar.com/.
The biggest challenge facing the fiduciary advisor is overcoming the easy decision for employers to simply offer a computer model from the current plan provider. There are four main reasons why the employer is better off with the un-conflicted personal advisor.
Fiduciary Relief: Computer models have notoriously low usage so that only very few employees will actually be served. Since the employer only has fiduciary relief for those employees that use the computer model, there is very little advantage.
Conflict of Interest: Compliance with the requirements that fiduciary advisors are prudently selected, reviewed and audited periodically are difficult if not impossible with computer models. These conflicts must be disclosed to all employees.
Unproven Technology: There is no proven way to establish that computer models will produce satisfactory retirement income. While these models have been back-tested, there is no record of actual long-term performance that can be compared.
Where to Turn: The employer is in a no-win situation if employees object when they are informed of the conflict of interest. These objecting employees must remain un-served or the employer will have to secure an un-conflicted advisor.
Taking Responsibility for the Advice That Is Given
For fiduciary advisors, responsibility is a personal guarantee that the advice is competent and in the best interest of the employee being advised. The fiduciary advisor is required to meet standards of:
o Prudence, which requires the fiduciary to act with the care, skill, prudence and diligence that a prudent man acting in a like capacity and familiar with such matters would use. This standard does not hold the fiduciaries responsible for the outcome of the advice but only for the process used in giving the advice.
o Loyalty, which requires that when fiduciaries advise ERISA-regulated retirement plans, advice must always be in the best interests of the participating employees and retirees. This does not exclude loyalty to self or to employers, but it does say that the interest of the employee is primary.
o Diversification, which requires advice to be consistent with the principles of diversification so as to minimize the risk of large losses, unless under the circumstances it is shown to be imprudent to diversify.
o Adherence, which requires advice to be in accordance with the documents governing the plan and consistent with ERISA. This standard requires a good faith effort to follow the plan and forgives an erroneous interpretation if made in good faith.
The introduction of the un-conflicted fiduciary advisor presents a unique opportunity for advisors to provide a wide range of financial products to a market of over 100 million households. The fiduciary advisor benefits from the introduction by the employer and is paid by retirement plans to be the expert resource for this immense market.
Louis Harvey is the founder of Dalbar, a Boston-based financial services consulting firm.