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.