More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
In 2012 two new fee disclosure regulations will take effect for 401(k) and similar retirement plans. These new regulations were issued and will be enforced by the Department of Labor (DoL) and the IRS.
The first to go into effect requires plan sponsors to evaluate mandated disclosures from their service providers. The second requires plan sponsors to make certain other disclosures to employees and plan participants. These regulations are intended to result in better decisions by plan sponsors and participants through completeness and greater clarity of information.
The response from the industry to these new regulations has varied widely, largely driven by the interests and motivation of the firms involved. Many firms have focused on supporting the goals of the regulations while others seek ways to circumvent them.
Advisors who are educated about these regulations and practices are in a position to guide clients through the maze of new requirements and defeat the efforts to circumvent their intent.
Certain firms treat the new fee disclosure regulations as being no different from previous experiences, but many others recognize fundamental differences that will reshape the retirement industry during the next decade. Consider some of the differences:
Existing methods cannot be used to comply since regulations require that plan sponsors affirmatively evaluate the sources they usually rely on for compliance. Current sources are therefore disqualified and plan sponsors must find new ways to comply.
The new regulations involve multiple communications with an estimated 72 million people. No other retirement regulation has ever affected so many people, not even Social Security. With all this activity it takes only a tiny percentage to cause big waves.
For the first time plan sponsors have a credible recourse if service providers are not forthright with fees and expenses charged to the plan. New regulations provide a vehicle to report service providers to the DoL/IRS. Plan sponsors can now leave it to the government to prosecute errant service providers.
Detection of failures to comply is virtually certain for any plans that are audited. Past audits could not deal with reasonableness because there were no specific rules to enable examination. Additionally, there is expected to be so much press that large numbers of plan sponsors will understand the requirements. There will be nowhere to hide.
New regulations and the threat of penalties give aggressive competitors the opportunity to win business from incumbents who are lax regarding the new regulations. Competitors will use every opportunity to win business.
The largest category of responses is broadly described as denials. Some firms deny the onset of a fundamental change. They are often motivated by the desire to maintain the status quo in which plan sponsors and participants are blissfully unaware of the compensation being paid for the services received.
Denial is often evidenced by the argument that fees are not hidden and that plan sponsors and participants know what fees are paid. This argument is contradicted by vast amounts of research and the fact that fees are presented in a way that makes it difficult if not impossible to answer the simple question, “What is the cost?” with a single dollar figure. For the most part, fees are hidden in plain sight!
Just as concerning is the assertion that plan sponsors need not act on the disclosures received. This view is based on the false assumption that plan sponsors and participants currently have a process in place to evaluate the fees paid for services to the plan, arguing that if evaluations are currently being done, then no further action is necessary. Unfortunately, there are very few cases where evaluations required by ERISA regulations are being performed. Furthermore there are very few plan sponsors who even know what all the requirements are.
Deception is far more insidious than denial, but fortunately occurs less frequently. In this case firms deliberately misinterpret regulations for plan sponsors, omit requirements or make disclosures difficult to use.
Frequent misinterpretations include defining which firms or relationships are covered by the regulations or that no disclosures are required for non-participating employees. In some cases these interpretations are needlessly burdensome, while in others can result in non-compliance.
The most frequently omitted requirements are plan sponsor duties and liabilities. For example, under the regulation, a prohibited transaction occurs if a plan sponsor fails to receive a proper disclosure or fails to make disclosures to participants and eligible employees. Also often omitted is the regulation that permits the plan sponsor to exempt itself by reporting the service provider failure to the DoL/IRS.
Yet another frequent deception is presenting disclosures in an unusable form. With this deception, the service provider takes advantage of a labyrinth of exceptions and work-arounds to create unintelligible disclosures. Regulations require that disclosures are usable so this approach clearly violates the intent.
Threats in various forms await firms that deny or deceive with respect to fee disclosure. Discovery of denials or deception can seriously damage the image and reputation of a firm, thus creating the potential of losing existing clients and failing to win new ones. Discovery can also lead plan sponsors to initiate regulatory action by filing complaints against service providers.
The threat of discovery can arise from a variety of sources, but primarily: (1) competitors that target clients of firms known to use poor disclosures, denials or deceptions; (2) participant reaction that causes plan sponsors to examine the service and take action that injures the service provider; (3) plan auditor’s discovery of compliance failures that can be traced back to a service provider.
Threats also exist where compensation is out of line with the services provided and in cases where services are considered to be expendable. Revenue losses can be expected once plan sponsors become aware of what level of compensation is paid for such services.
The poor response to fee disclosure regulations by certain firms creates opportunities for well intentioned service providers and advisors to enhance their own business.
Service providers can take advantage of new regulations to:
- Create an image of openness and support for plan sponsors & participants;
- Capitalize on the required disclosure communication to deliver their firm’s marketing messages;
- Reposition fee disclosure as enhanced employee benefit;
- Replace existing plans and features with more desirable alternatives;
- Use fee disclosure as a business retention and acquisition tool.
Advisors who become trained in fee disclosure can:
- Increase the level of trust, respect and appreciation for the importance of the advisors role;
- Discover which service providers are in denial or are being deceptive and keep clients informed;
- Provide new fee disclosure service for a fee or as a value-add to existing service;
- Use fee disclosure as a tool to win new business.
Louis S. Harvey is president and CEO of Dalbar, the financial services market research firm.