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January 13, 2002 at 07:00 PM
The Financial Planning Associ-ation is backing an ERISA reform bill that is derided by many as anti-consumer, and by supporting the legislation the trade group is helping financial services giants compete more effectively for financial planning clients.
In backing H.R. 2269, the Retirement Security Advice Act of 2001, the FPA says it is reluctantly backing a law that will permit mutual fund companies to give advice to consumers that is tainted by a potential conflict of interest. But because the change in the law would also permit advisors to “double dip”–get paid a 12(b)-1 fee for advising a fund sponsor on which funds to include in its plan and another fee for advising plan participants on which funds are best for their individual financial plans–FPA is backing the legislation.
A trade association must first and foremost protect the interest of its members. If the FPA is doing things right, however, the interests of advisor members should be aligned with the investing public. However, by throwing its support behind a bill that would permit advice dripping with conflicts of interest, the FPA is letting down consumers. It’s opposing AARP, AFL-CIO, the Consumer Federation of America, and other groups who have the best interests of plan participants at heart. And for what? To allow independent advisors to give advice to a customer one time and get paid a 12(b)-1 fee in perpetuity, or to allow advisors to get paid a finder’s fee for selecting funds for the plan as well as the ongoing 12(b)-1 fee. The group is backing a law that is very likely to encourage advisors to gouge their customers.
It gets worse. The giants of the financial services industry are pushing H.R. 2269 because they want to get their hands on IRA rollovers. They can’t do that now. But if this bill becomes law, the fund complexes, insurance companies, wirehouses, and banks will suddenly be able to provide retail advice to plan participants as well as be the advisor to the plan sponsor. That’s bad for independent financial planners.
In other words, the FPA is supporting legislation that is bad for consumers so that its members can double dip along with the rest of the industry. But in doing so the FPA is making it easier for the financial services giants to compete with its members by backing a law that will let the Prudentials of the world convert plan participants into financial planning clients.
H.R. 2269 basically rewrites the “prohibited transaction” section of ERISA that prohibits fund companies from giving “particularized” advice; i.e., advice to individuals.
Under current law, T. Rowe Price, Fidelity, Vanguard, Merrill Lynch, Prudential, and the other companies that are providers of the funds in 401(k) plans at large- and mid-sized companies cannot also give advice to individuals. That’s a prohibited transaction. Under H.R. 2269, the prohibited transaction rules would no longer be an obstacle and the giants would be allowed to tell plan participants which funds to buy.
“2269 would allow people with an inherent conflict of interest to profit by rendering advice,” says Marcia Wagner, who heads an ERISA and employee benefits boutique law firm in Boston. “This will be bad for plan participants.”
Duane Thompson, director of government relations at FPA, says the entire financial services industry has been pushing to get H.R. 2269 through Congress.
Thompson, who spent over an hour on the phone explaining the law and the FPA’s position, concedes that H.R. 2269 is not perfect, and he points out that the FPA’s support for the bill is conditional.
In a letter posted on the FPA Web site supporting the legislation, Thompson says the FPA would like the exemption from the prohibited transaction rule to extend only to Registered Investment Advisers. The letter notes that the agents at banks, brokerages, and insurance companies are not subject to a competency exam, which is required of those who act as IA representatives. The bill, by the way, would bestow a new title on agents offering individual advice to plan participants, Fiduciary Advisor, a credential with no educational or competency standards. But the FPA, you can safely assume, knows that is it unrealistic to believe that the legislation would be altered precisely to suit its members, who typically are RIA reps, or RIA reps affiliated with broker/dealers. This is so especially since the backers come from the big fund companies, banks, and insurance companies that contribute mightily to political campaigns and stand to benefit the most from the bill.
“We support it very reluctantly because we have members in a situation where they are prohibited from taking 12(b)-1 fees,” says Thompson. He says that supporting a bill that would enable collection of those fees for independent advisors makes sense because advisors currently collect 12(b)-1 fees on non-ERISA assets.
“Getting 12(b)-1 fees, as long as they’re disclosed, is legal now,” says Thompson. “So what’s wrong with doing it on ERISA assets? There are two different standards in federal law for providing advice on identical portfolios.”
12(b)-1 Fees and ERISA
To understand the rules on 12(b)-1 fees in ERISA plans, I turned to Lowell Smith, president of Service Provider Solutions of Pittsburgh, an ERISA consultant to plan providers such as Invesmart. Here’s what I learned from Smith and other experts.
Some independent financial planners work as consultants to plans, typically a plan put together for a group of doctors or other professionals. The planners get paid a 12(b)-1 fee for selecting a group of funds to be included in the plan. The plan sponsor remains the fiduciary responsible for selecting the funds and the planner acts as the broker of record, which allows for collection of the 12(b)-1 fee.
This isn’t a great deal for the plan sponsor, who essentially relies on the planner to pick the funds but is still liable for the investment selection process as a fiduciary. Worse still, 12(b)-1 fees do not oblige a rep to provide any ongoing advice beyond making the initial recommendation, allowing the planner to get paid a 12(b)-1 fee in perpetuity for a one-time recommendation.
The other way a rep can get a 12(b)-1 fee is when guiding (but not advising) a participant in a self-directed 401(k) account.
What is not allowed under current law is getting 12(b)-1 fees for advising the plan sponsor on which funds to include and at the same time getting paid for advising an individual plan participant. You can either decline to receive the 12(b)-1 fee for advising the plan or offset the individual advice fee with the 12(b)-1 fee. Offsetting a 30- to 100-basis- point advice fee to plan participants with a 20- or 25-basis-point 12(b)-1 fee for advising the plan sponsor on fund selection, for instance, is permissible and common. But you cannot receive both fees under the prohibited transaction rule.
H.R. 2269, sponsored by Rep. John Boehner (R-Ohio), chairman of the House Committee on Education and the Workforce, is thus a good way for an independent planner to collect embedded 12(b)-1 fees as well as an advice fee for assisting plan participants. The trouble is that it will tempt a planner to direct plan participants toward more expensive funds, funds that pay higher 12(b)-1 fees, and leave the planner open to compensation influences that ERISA has so far kept out. It will also deal a competitive blow to independent advisors.
FPA Foulup
Brian Tarbox, a former executive at Trust Company of the West who now consults to senior policy makers at the Department of Labor, which enforces the ERISA rules, says the FPA is making a bad business decision as well as an ethical misstep.
“The FPA should know better,” says Tarbox. “What should differentiate a trade association from the financial services industry at large is the ethical manner in which it operates.”
Beyond the ethics, there is the practical business issue that needs to be considered. The big financial services companies are pushing to see this bill get adopted because their business model is in trouble, say Tarbox, Smith, and other consultants. They have learned that managing fund assets is not the best business plan. The name of the game now is managing the money when individual plan participants roll it out of their plan to an IRA. There is more money now in IRAs in aggregate than in 401(k)s as a result of such rollovers, says Smith.
Tarbox says that companies providing plans to corporate America are capturing somewhere between just 5% and 30% of plan assets when they’re rolled over. The rest is going to a trusted personal advisor–brokers and financial planners with whom a participant has an existing relationship.
“Plan providers have been ineffective in capturing the majority of rollovers,” says Tarbox. “Instead of having a great franchise, they have a dwindling asset.” Under the proposed law, “the plan providers would be in an optimal position to capture rollovers,” says Tarbox. And the FPA is playing along.
Once the large financial services firms get the legal right to provide individual advice to plan participants, they will become much better at keeping the assets under their management. If the Boehner bill becomes law, the giant plan providers will probably forego the fee for providing advice to individuals. They’ll bundle it in their record-keeping fees or in their fund fees.
