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Retirement Planning > Retirement Investing

Lou Harvey: Obama Just Blew Up Your Business Model; Here’s What to Do

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If you’re an advisor focused on retirement planning, the Obama Administration has just blown up your own retirement plan, and your continued viability will require nothing less than a complete revamping of your business model.

So says Lou Harvey, the CEO of Boston-based consulting firm Dalbar, which has long counseled advisors, broker-dealers and retirement plan administrators on fiduciary compliance.

“Everybody and his brother on the street have heard about the baby boomers retiring and that big pot of retirement money” whose swelling assets are still years from peaking, Harvey tells ThinkAdvisor. “This proposal materially impacts advisors’ ability to obtain that rollover money.”

So if you’re a typical wirehouse advisor whose business model has been to cultivate pre-retirees and roll over their 401(k)s to IRAs as they seek financial advice over the next three decades of retirement, you now ostensibly face significantly reduced income for your services.

That is because the administration’s proposed rules will require that advisors providing retirement advice be held to a fiduciary standard whose definition is likely to be at odds with standard industry practices regarding advisors’ management of IRAs.

Harvey is convinced that IRAs (under final rules not yet hammered out) will not withstand the fiduciary redefinition, and will thus utterly destroy existing business models.

“How are you going to act in the best interest of your client if you’re going to double the fee the client is paying?” he says, noting that advisor-managed IRA fees are routinely twice as expensive as employer-sponsored plans, and will thus increase from, say, 80 to 160 basis points.

What’s more, while the industry is geared to fight the proposal, Harvey views such opposition as unlikely to succeed in the present instance.

“Unfortunately, what we’re looking at here is literally an out-of-control administration,” Harvey says.

“This administration doesn’t care about following Congress, and Congress has been ineffective at stopping administration [overreach]. This administration — they literally don’t give a damn; they’re not being re-elected again. I see no effort to support the party, to say ‘I don’t’ want to do this because it will alienate the donor sources,” he adds, noting that Democrats and Republicans alike are recipients of Wall Street contributions.

“How do you stop a suicide bomber?” he asks, saying the president has exhibited a pattern of forging heedlessly ahead.

“Take the Netanyahu speech [when the Israeli prime minster voiced his opposition to the administration’s plans to conclude a nuclear pact with Iran]. The press coverage was laudatory, but Obama says ‘there’s nothing new here, folks.’ He doesn’t care; it doesn’t matter to him. In that context … none of the lobbying or congressional pressure will have any effect.”

If that is the case — that the administration is months away from making advisors’ current practices illegal and that politicians and industry representatives will be unable to resist that effort, then advisors will need to take matters into their own hands.

What they will need to do in effect is establish a structure that mitigates the new risks of doing business.

“The big risk on Wall Street is conflicts of interest,” says Harvey. “If XYZ Mutual Fund Company is paying me $50,000 a year to put their fund in my client’s account, that becomes a prohibited activity under the fiduciary standard.”

The Department of Labor, Harvey says, will still allow advisors to earn commissions, but advisors must “levelize” the compensation, “so that a mutual fund company or any other product manufacturer can’t buy their advantage.”

In other words, go ahead and use American Funds products, so long as you don’t earn any more than you might with a Vanguard fund.

Harvey describes one way to neutralize the threat — to the advisor at least; it will be unwelcome news to many mutual fund companies.

“Go to the client and say, ‘Right now we are making $500 out of your account being paid to me by American Funds; I want to change the arrangement and act as your fiduciary with your best interests in mind. Therefore I don’t want you to pay $500 to American Funds; I want you to pay that $500 to me; the net loss to you will be zero.’”

The investor’s return will go up — since his fund investment is not reduced by the amount of the commission. And so too will the esteem in which the advisor is held by the client.

“Folks who have moved in that direction have not gotten any pushback from the client,” says Harvey, adding that it actually presents advisors with an opportunity to align their compensation with fiduciary advice.

That said, the change will likely adversely affect less-well-to-do clients, says Harvey, in agreement with industry critics of the administration’s proposed rule change.

Under the current system, advisors often serve less-profitable clients because they’re still getting that upfront commission.

The fee-based system encouraged by the new rules will steer advisors to concentrate on their more profitable clients, he says, joking:

“You can’t go to that [less profitable] client and say: ‘That 5% I’m getting from American Funds: I’d like to raise it to 7%.’ It’s just not possible.”

The new rules challenge not just advisors and fund companies, but broker-dealers as well.

The Dalbar CEO says firms that adapt, and adopt his recommended posture, will attract “every advisor who would like to operate this way.”

“Merrill Lynch or Wells Fargo had better change or lose those advisors,” he continues. “There’s no question about it. Merrill Lynch or whatever firm cannot afford to take the risk to openly violate the standard…Major firms will literally have to retool their rollover strategies.”

At issue is more than just current revenue, but “the rollover bandwagon [set] to take off in the next five to 10 years; it’s that future bonanza that is going to be compromised” if action is not taken.

While Harvey sees a great opportunity for advisors quick to respond to Washington’s rule changes, the devil is in the details.

For example, the insurance that most brokers carry doesn’t protect against breaches of fiduciary duty, so advisors will need to update their policies.

They will also need to document their processes, define their services, institute fee offsets to eliminate potential conflicts of interest and more.

Dalbar offers self-study online training for advisors seeking to make the shift: Its wealth management course for advisors predated the fiduciary mandate and is designed for advisors who see an advantage in offering a superior standard of care.

Harvey says the course costs $350 and takes some seven to eight hours of study.

Dalbar offers a similar course for advisors who manage 401(k) plans and need to make sure they are compliant with increasingly tough, and at times ambiguous, regulation.

Dalbar offers a third course directed at compliance officers, priced at $650.

Harvey advises brokers against piecemeal changes in their business models — for example, putting IRAs in a fiduciary account but keeping the rest of the client’s business in a regular brokerage account because they want to keep the commissions.

“How do you explain that to the client?” he asks. “On this [the IRA] I’ll be really careful, but with the rest of your money I’ll just roll the dice.”

That model will be hard to defend, Harvey says, at a time when breach of fiduciary is consistently the No. 1 issue arising in arbitration panels.

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