Fiduciary Responsibility and its relationship to Self Directed Brokerage Accounts in Qualified Plans

Transcription

1 Fiduciary Responsibility and its relationship to Self Directed Brokerage Accounts in Qualified Plans Under the time honored premise of Trust me, I m with the government and I m here to help!, there has been a sea change in the group qualified retirement plan market that has sparked a figurative firestorm over the definition of fiduciary for the financial services industry. When President George W. Bush signed The Pension Protection Act in 2006 (PPA06), he initiated a host of changes in the qualified group retirement plan arena that are still going on today. At its foundation, the new law sought to clarify the fiduciary responsibility of employers regarding what investment options they offered to plan participants. With its passage, the new rules joined the already immense body of laws, rules and regulations of the Employee Retirement Income Security Act, commonly referred to as ERISA. The Pension Protection Act itself was well over 600 pages long when the President signed it and while it addressed a host of issues the primary focus was to stipulate that employers were obligated by their Named Fiduciary status, the highest level of fiduciary responsibility, to conduct due diligence on the various investment options offered to participants in the retirement plans they sponsored. While some were under the impression that ERISA had already charged employers with that responsibility, various events like Enron, WorldCom and some other questionable corporate scandals made it evident that clarification of the Named Fiduciary role was warranted. This has triggered several actions in the retirement plan sector including but not limited to the ongoing challenge by the industry and various regulatory bodies to define the term fiduciary. I have little doubt that the debate over fiduciary definition and the ensuing actions and obligations of the various levels of plan fiduciaries will continue for quite some time with the usual definitions and re-definitions that we witness with this scope of legislative oversight. I don t presume to define fiduciary as it applies to these various areas, but rather to present why the Pension Protection Act and its development of the fiduciary debate has led to the growth in plan sponsors offering self-directed brokerage accounts (SDBA s) as an additional investment option in plans. Let s look at three major groups that are affected by the growth of SDBA s, Employers, Employees and Financial Advisors, and how this option applies to each one. Employers The initial reaction of employers was to approach their various retirement plan providers and request that they take this new fiduciary liability and responsibility off of their shoulders. After all, they argued, performing due diligence on various investments was not their core business or expertise. The plan providers however, correctly responded that since the employer is the Named Fiduciary and therefore has the highest level of fiduciary obligation and responsibility, the plan providers could not take that liability off of their plate. The plan sponsors did offer to provide a list of investment options that they, in their role as plan provider, had already performed due diligence analysis on and the employer could accept this list by signing off on those investments. This initiated several changes in the appearance of plans in regards to their investment menus. Since employers were seeking to limit their liability, they began offering investment menus that were significantly truncated from those that many participants were used to seeing over the past few decades. Many times it was not unusual to sit down with a client and see 40, 50, 60 or even 100 investment options in a 401(k) plan. Of course monies were still

2 generally invested in the Money Market option because participants couldn t decide where to invest. Today s plans generally have far fewer options, usually a handful of mutual funds that are large cap, small cap, international, bond and the ever popular stable value fund. Along with these are target date or so called life style funds which are actually mandated by Congress to be offered and quite commonly are designated as the qualified default investment alternative (QDIA) to be used for those participants who don t select an investment allocation themselves. So now, many participants that were used to having 50 investment options suddenly find themselves limited to maybe 15 selections. Employers realized they were still exposed to some liability even on the reduced menu of selections they had approved and now they also had employees who were dissatisfied with the new limited options they had in their plans. At this point, the legal advisors for many of the largest employers proposed that selfdirected brokerage accounts be added to investment menu options. SDBA s are certainly not a new investment tool inside of group plans. Indeed, State Street is generally credited for the development of what we use as SDBA structures going back to What the legal advisors pointed out to employers was that in offering a SDBA option it gave them two significant advantages. First, when faced with a participant that expressed dissatisfaction with the core menu of investment options, they could point out that the SDBA option is available. Secondly, and more important in regards to employer liability, when a participant chooses to utilize the SDBA option in a plan they sign an indemnification that essentially says they will not hold the employer or plan provider liable for the choices they use in that account. For this reason alone, we ve witnessed the growth of SDBA options in group retirement plans from just a few thousand plans a few years ago to over 80,000 plans today. Employees The development of SDBA options subjected plan participants to an odd dichotomy of opportunity and a seemingly black hole of information. Initial utilization of SDBA accounts in many employer plans appeared to be limited to certain employee classes that were construed to be separate from the general employee population of a company. In the early years, we witnessed SDBA popularity in plans for physicians and attorneys and consequently SDBA use developed an aura of exclusivity for owners, executives, professionals and those generally viewed to be financially savvy. Early statistics showed SDBA use to be in the 2% to 3% range and even though usage of this option has increased dramatically in recent years it is still among the least understood facets of a plan for participants. This lack of education is not surprising since for decades Human Resource or Benefits departments at employers have been strictly cautioned over not providing anything that can be interpreted as investment advice in the offered retirement plans. A significant part of the issue regarding the underutilization of SDBA s lies in the access to professional guidance for plan participants. The Pension Protection Act that the President signed into law does have a section stipulating that participants have to have access to financial advice regarding their investment allocations in the plan. Interpretation of how to provide this access has varied broadly across plan providers and has led to the predominant use of computer based models and more recently the optional offer of robo-advisors for an additional fee. With so little information and education available to plan participants regarding SDBA options, very few understand that often they may be able to access an advisor of their choosing with this option. In fact, as we will discuss later, some employers have compounded this problem by prohibiting the access to a

3 professional advisor inside an SDBA account even though this is policy is juxtaposed to the indemnification that a participant signs to activate their SDBA option. Of significant advantage to participants that elect to utilize the SDBA option is that the monies never leave the plan itself. Unlike an in-service withdrawal which is generally limited to those who have attained a certain age, or some other rollover provisions, the monies in an SDBA account can always be rolled back into the core plan offerings if the participant chooses to end their usage of the SDBA. In addition, the SDBA is like any other selection on the plan menu in that it is not an all or nothing requirement. If a participant chooses to only put a portion of their account into an investment in the SDBA they are allowed that flexibility. Indeed, some plans have limits defined by the plan document, which we can assume was approved by the employers, which regulate the use of SDBA accounts in the plan. Aside from the ability to work with a professional advisor of their choosing, the significant advantage for employees who use SDBA accounts is being able to acquire the types of investments they need in their account to help achieve their investment goals. In the face of today s plans offering fewer and fewer investment options in the core, many employees are face with a dearth of viable options to allocate their accounts. In part this has led to the uptick in usage of target date portfolios which may work for some participants, but consider the 65 year old employee who chose the 2015 fund for his or her retirement account. Believing that this was the appropriate option and lacking what they feel is personalized advice, their account has been invested in a strategy that has been allocating into more and more bonds over the last 5 years until today that employee is faced with the realization that with the poor performance of bonds over recent years they do not have enough built up to realize their dream of retirement in Financial Advisors For financial advisors the furor over fiduciary definitions and qualified group plan regulations has been both a blessing and a curse. The rules governing how you can work with clients regarding their group retirement plans have been nebulous at best and far too many advisors have put themselves in positions where they had all of the liability and none of the revenue advising clients on their plans. The current debate has clarified some of the rules which effectively raise the bar to the point where some advisors either cannot or will not venture into advising clients on retirement plan allocations. The argument over fiduciary definition alone has not been the issue for most advisors. I ll admit that I have a tendency to work with highly ethical advisors and not the Suze Orman s of the world, but when the difference of a fiduciary standard where the client s best interest is first and foremost as compared to a suitability standard, most advisors furrow their brow, kind of cock their head like the old RCA Victor dog and say But I always put my client first. I firmly believe that the fiduciary standard itself is not the issue that gives so many advisors pause, but rather the operational and regulatory requirements of a fiduciary status that has so many advisors withdrawing from the qualified plan market. For some the requirements of proper E&O insurance coverage for fiduciary activity in combination with finding a possible broker/dealer relationship that will allow such activity and then of course the increased operational requirements to meet a fiduciary standard makes it an easy decision to keep their distance from the qualified plan market where compensation and profit margin have been undergoing contraction for decades. But for those advisors who are positioned to work as fiduciaries or partner with firms who act in a fiduciary role, the increase in SDBA options in plans has become a key in

4 managing long term client relationships that allows client advice and management in a compliant manner. Indeed, in light of the regulatory changes to the role of advisors of record in qualified plans, an SDBA option in many cases is the only way that an advisor may be able to provide sound fiduciary advice to a valued client. In spite of many in the popular media denigrating the role of the financial advisor, more and more legitimate studies are showing that clients who work with financial advisors experience better net results than those who attempt the DIY technique. Tales from the trenches It was nearly thirty years ago that I began my career in financial services with a large proprietary insurance company and their advice to me was to go out and sell 401(k) plans to prospects. They said you won t make much money at first, but service the heck out of the plan and then you ll get the rollover accounts. I shake my head sometimes when I think back to those days when I didn t even need a securities license to sell a retirement plan, much less have to worry about fiduciary responsibility. After ten years in private practice I was lured to the dark side helping manage the corporate RIA of a large independent broker/dealer and then helped start up an independent B/D before spending the last ten years working with advisors across the nation introducing the services of an independent 3 rd party investment manager. I know thousands of advisors who built their practice model on what was originally proposed to me when I was starting out. Many of them have had long successful careers, but with the stroke of a pen the Department of Labor effectively broke that model at the end of 2013 by making it virtually impossible for an advisor of record on a plan to receive the rollover account of a plan participant. I m a strong believer and supporter of the fiduciary standard, but I recognize the frustration of advisors who realize if they give a specific fund recommendation to a client then they have just become a fiduciary and may well be in violation of several rules. I understand the thinking of the regulators and the need for rules of activity that define the standard, but I remember the frustration on the face of a client who was a welder who said, Scott, I don t understand what a large cap value position is or a multi-cap strategy, please just tell me where to put my money. Fiduciary responsibility means different things to employers, employees and financial advisors. For employers, their goal is lawsuit protection while offering a competitive benefits package. Just a few short years ago a major player in the plan provider market alluded to employers that the Department of Labor felt brokerage windows actually increased their fiduciary liability and they would not recommend offering that option. This company had so many of their field wholesalers telling that party line to employers that the Department of Labor felt compelled to release a special memorandum to make it clear that they had never made such a position statement and indeed the Pension Protection Act of 2006 simply stated that the employers fiduciary responsibility in regards to a SDBA option was to assure that pricing was reasonable for participants to have a window. Still today, we find plans where the employer offers a SDBA option, but then tells participants they cannot work with a professional advisor in the account. That s a bit like giving participants a blank signed prescription pad. Remember, it s called a SELF directed brokerage account and the participants sign an indemnification when they activate the account stating they will not sue the employer or plan provider for anything they do in that account. This is a dichotomy that in all likelihood would negate that indemnification agreement when an employer doesn t allow a participant to work with a professional of their choosing. I ve been

5 involved in two situations where in one case a hospital had updated their plan and installed a SDBA option, but when employees asked their benefits department about it they responded, Oh, we don t recommend anyone use that! Not only did the benefits department likely cross the line in making a statement like that, but if they understood why the hospitals legal advisor had added the SDBA option they would have at the least told employees to speak with their advisor or the plan provider for more information. After all, who knows more about getting sued than a hospital? In another instance I spoke to an investment committee of a large power company stressing the importance of considering a SDBA option for their plan. Their response as they looked down their collective noses at me was that they had the gold standard of plans, but when I stressed that adding a window at the very least could reduce the chances of a participant lawsuit the room suddenly got very quiet and the meeting came to an abrupt end. The next week it was front page news in their local paper that the company was being sued by a participant over failing to fulfill their fiduciary obligations. With employers seeking to lower their fiduciary liability, participants frustrated over the lack of personalized advice and financial advisors seeking to advise their clients in a fiduciary manner on as many of their assets as possible, I m confident that the scrutiny over fiduciary responsibility, especially as it pertains to group qualified retirement plans, will continue to rage for several years to come. But I do see a gradual clarification of rules and guidelines that while they don t please everyone, at least it s providing us a framework to finally work with clients to provide the professional advice they so badly need.