More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
The Department of Labor's (DOL) newly proposed 408(b)(2) regulation, which mandates disclosures of compensation and conflicts of interest by plan service providers will, when finalized, require every registered investment advisor (RIAs) to have a written contract with client 401(k) and 403(b) plans explaining the services rendered, the revenue received, and potential conflicts of interest.
The impact of the rule for RIAs will require an "enhanced focus on fees, which will require a more detailed and thorough explanation of the value received for those fees, that is, of the services provided to the plan and participants by RIAs and financial advisors," says Fred Reish of Reish Luftman Reicher & Cohen in Los Angeles, which specializes in employee benefits law.
But the new rules will be much more onerous for broker/dealers to comply with, Reish says. After analyzing how 408(b)(2) would affect five groups--independent RIAs, broker/dealers, bundled providers, independent recordkeepers, and independent third-party administrators, Reish says he and his colleagues found that independent RIAs were the closest to being in compliance with the new regs while broker/dealers were the least prepared of the five groups. This is interesting, Reish notes, "because RIAs and B/Ds compete directly with each other by providing investment advice and consulting to 401(k) plans."
Why are B/Ds so far behind? First, B/Ds lack the ERISA-specific advisory agreements that RIAs already have in place. RIAs are "not just taking their regular advisory agreement and using it [with 401(k) plans]; they have ERISA-specific advisory agreements. So they are used to getting an ERISA-based agreement signed by their clients," Reish says. B/Ds, on the other hand, "generally don't have an upfront agreement at all with 401(k) plans," he says. "So one big change [B/Ds will] have is not just having agreements, but ERISA-specific agreements with 401(k) plans where many of them have not done that in the past." RIAs will have to do some tweaking to their existing written contracts once the new rule takes effect, which is expected to be January 1, 2009, Reish warns. So it's wise for RIAs to seek legal help and start revising the agreements now, Reish says.
Also, the new 408(b)(2) requires plan service providers to state if they are fiduciaries. B/Ds are "going to have to make a decision about whether or not they will allow their advisors to be fiduciaries," Reish says. "That includes [being] a functional fiduciary"--not just naming yourself a fiduciary, but acting like one. "You have RIAs who are used to acknowledging fiduciary status, and B/Ds who have tried to avoid [fiduciary duties] in the past."
The new rule also requires that all compensation and potential conflicts of interest must be disclosed prior to entering into an arrangement. "B/Ds have done a good job of providing prospectuses to plan sponsors," Reish says, but under the new rule, "when they provide the prospectus they're going to have to explain that the prospectus describes their compensation. In other words, they'll have to do some explaining of their indirect compensation. When I say indirect, I mean all of their compensation is indirect."
Then there's disclosing conflicts of interest. RIAs are required by Part 2 of Form ADV to disclose conflicts of interest, so this is old hat to them. However, "there is no comparable document that B/Ds have delivered in the past, and because their compensation can vary so much from investment to investment, they have more potential conflicts," Reish says. "They don't have a document so they have to create one, and they have a lot more potential conflicts of interest to disclose."
The comment period on 408(b)(2) has closed, but DOL plans to hold hearings soon on the proposed rule. Reish says he believes the final rule will look much the same as the proposed one, estimating a final rule will likely come out between June and August. DOL "can't get it out any later" than that, he says, because with an effective date of January 1, 2009, there won't be time to comply. If the rule comes out after Labor Day, he says, the compliance date should be pushed off another year.
Washington Bureau Chief Melanie Waddell regularly covers retirement, legislation, and other issues. E-mail her at email@example.com.