The Search for Better 401(k) Advice

According to Ron Rhoades, fiduciary law expert and Alfred State assistant professor: “If I were called upon to testify as an expert, I would opine that the use of a non-fiduciary advisor by a fiduciary plan sponsor is a breach (by the plan sponsor) of its fiduciary duties, with very rare exception. In other words, it is NOT ‘prudent’ to ‘depend’ upon non-fiduciary providers of funds for ‘assistance in the selection and monitoring of funds.’” Of course, plenty of non-fiduciary advisors make recommendations that are in the best interest of the participant. But not being a fiduciary gives an advisor more latitude to make suggestions that aren’t.

Having Ron Rhoades on the wrong side of an ERISA lawsuit should strike fear in any employer who might consider creating a retirement plan for themselves and their employees. But many of the small employers don’t have much choice. Martha Tejera, a search consultant at Tejera & Associates and a retirement plan expert, notes that “the cost of hiring an independent advisor in a fiduciary capacity can be prohibitive for many small employers and/or small plans.” Small companies need an inexpensive plan and they don’t have the money to hire a fiduciary advisor. And many of them do get high quality, personalized services from these advisors that would be difficult to find elsewhere.

In fact, many of these non-fiduciary advisors aren’t making much by dealing with small employers. According to Tejera, “the cost of acquiring new clients, establishing the investment structure, then monitoring the investment managers, will often exceed the related compensation in the early years.” Retirement plans can be a way for an advisor to establish a relationship with the employer and their employees, and brokers hope to capture revenue as assets increase and eventually move into IRAs. But the fact remains that Yale professor Ian Ayres’ recent analysis of 401(k) plan costs show that they are significantly higher for employees in smaller plans.

Unexplored Territory

Although the retirement industry has been moving toward fee neutrality over the last decade, it is this business model in which a non-fiduciary advisor is compensated by a plan provider that is most vulnerable to changes in the current DOL fiduciary rules. Swisher refers to 12b-1 compensated advisors in a fiduciary world as a “case study of a potential prohibited transaction in my book” that would “require some legal gerrymandering” to justify. Swisher thinks that won’t happen—advisors will need to move to a fee-based model.

Brokers who are paid by providers may be going the way of the dinosaur one way or another. Even if the DOL is stalled, attorneys could apply pressure on employers, and on advisors and plan providers, by questioning whether the model is really in the best interest of employees. That’s not happening right now since most attorneys are targeting larger plans.

Will the exit of non-fiduciary advisors lead to the tragic consequences envisioned in the Greenwald Associates report? Rhoades is more optimistic: “Fiduciary advice nearly always results in lower-total-fees-and-costs mutual fund selection, even taking into account the compensation of the fiduciary advisor (however paid).” Tejera isn’t so sure. Although she is “uncomfortable” with the conflicts of interest in the way these advisors are compensated, she does believe that the DOL proposal will raise costs and reduce the number of advisors willing to take on a plan below $10 million.

Who is going to pick up the slack when non-fiduciary advisors go away? Nobody knows. The Treasury Department’s new myRA plan can help small employers get started, but putting employees in T-bills and providing no advice and then transferring them into IRAs outside the reach of fiduciary rules doesn’t sound like a solution. Will new low-cost, online platforms make it easy for employers to set up a plan? Maybe, in a world where employers don’t need a human being to guide them through the process, or in a world where the DOL provides safe harbor for employers who select simple, efficient plans.

How do we maintain access to high quality, personal financial advice so that employers and employees can get help when they need it? Does it even make sense to provide retirement savings through employer plans? Swisher believes that it is still the best solution. “Is the employer based retirement system the right model for the U.S.?” asks Swisher. “The answer is unequivocally yes. Should employers have to be the named fiduciary, trustee and administrator of their plans? Not if they don’t want to be.”

Some in the industry believe that the death knell of the non-fiduciary advisor will take advice away from millions of employees and employers who badly need it. Others point to the rapid efficiencies that have resulted from fiduciary responsibility among large employers who continue to look for ways to provide retirement plans whose quality can be defended in court. Tejera believes we should focus first on a compensation model that is generous enough to keep advisors in the game while minimizing conflicts of interest. “To me, the whole shell game of ‘blame the fiduciary’ is a legal construct that will enrich lawyers and only make the system ever more costly.”

Will the market provide a solution if all advisors become fiduciaries? I’m not sure if I would bet against the nimble and creative financial services business coming up with a solution, but it may be a bumpy ride.