The Birth of an Industry Leads to the Need for Specialization
Introduction: Advocating for Higher Standards
Any advisor that gets paid from employer-sponsored retirement plan assets should have specialized training as a condition of selling or servicing retirement plans. This opinion is based on personal experience, research, and a commitment to what’s in the best interests of the client.
Twenty years ago, a retirement plan client didn’t seem very different than other clients that needed investments. The advisor role was limited to selling the investments, running an investment analysis report, and educating the employees on basic investment concepts. The retirement segment of the financial industry was not formally carved out and there were no sales or service standards. This outdated service model has evolved into much more by independent advisors and retirement specialists but unfortunately is still in practice in the broker world today.
With the introduction of the “F” word by fi360 in the early 2000’s, followed by the Pension Protection Act of 2006, the 408(b)(2) and participant disclosures, and now the proposed amendment to the definition of an ERISA fiduciary, the competency threshold for selling retirement plans should no longer begin and end with the ability to select and monitor investments.
Specialization is now needed in the retirement industry, which has been informally carved out over the last decade.
The Birth of an Industry
Blame it on fi360.
Perhaps that should read “Give credit to fi360”.
While the Employee Retirement Income Security Act (ERISA) is not new, (nor is the Uniform Prudent Investor Act, the Uniform Prudent Management of Institutional Funds Act or the Uniform Management of Public Employee Retirement Systems Act), in 2003, fi360 published the Prudent Practices series of handbooks and opened the eyes of the investment community by interpreting these regulations and making us all aware that they actually required practical application.
Fiduciary duties are generally presented as distinct obligations substantiated through law and regulation. Many of the duties are accompanied by documentation and review obligations. As a practical matter, a comprehensive framework is needed to ensure that all applicable fiduciary practices are fully and effectively addressed on an ongoing basis.” – Prudent Practices for Investment Stewards, 2011 U.S. Edition
Their interpretation of the regulations (substantiated by legislation, case law, and/or regulatory opinion letters), introduced many to the reality that certain actions make a person a fiduciary; along with the “F” title comes personal responsibility AND liability; and documenting regulatory compliance is critical. Over the next several years, magazines, newspapers, newsletters, and conversations were flooded with “F”-this and “F”-that and while it seemed like an overused and often misunderstood word, its integration into the mainstream media caused many to take notice and evaluate their investment management practices, especially in the wake of the ENRON debacle.
According to a January 30th 2006 USAToday.com article titled Enron’s Trials, “Twenty thousand former employees and retirees in Enron’s pension and 401(k) retirement plans that held Enron stock suffered $1 billion in losses. The former employees agreed to four settlements totaling $482 million with Arthur Andersen and Enron.”
As would be expected, on the heels of the ENRON scandal cries for retirement reform are heard and President Bush called for an analysis of the nation’s retirement and pension system. On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006. The President declared, “This is the most sweeping reform of America’s pension laws in over 30 years.”
This new legislation created tremendous opportunities for advisors that specialize in working with employer-sponsored plans. It opened the doors for plan design changes, participant advice programs, and solutions that could make a positive impact in helping participants towards more successful retirement outcomes. Generalists, however, offered little value in helping plan sponsors interpret, understand, or benefit from the changing regulations.
With the new legislation also came increased enforcement initiatives by the Department of Labor, escalating their audits of retirement plans.
The Employee Retirement Income Security Act of 1974 (ERISA) provides DOL with the authority to conduct civil and criminal investigations of employee benefit plans. In turn, DOL audits usually focus on violations of ERISA, including fiduciary issues, prohibited transactions and reporting/disclosure problems.
And the trend continues…
According to a March 12, 2012 article in Pensionsbenefitslaw.com, “A recent report of U.S. Department of Labor (DOL) audit results contained some surprising statistics: almost 3 out of 4 audits find violations of the Employee Retirement Income Security Act of 1974 (ERISA) and the average cost for a plan to correct them, including fines and penalties, is $450,000. The DOL’s ERISA audit force will (continue to) expand to include over 1000 investigators and audit activity will be increasing.”
Along with the increase in audits, benchmarking became the buzzword and new plan benchmarking tools started to pop up.
SearchPro 2.0, Improved Retirement Search Tool is Launched Asset International and Exa Infosystems announce the launch of SearchPro 2.0 – a next generation plan provider analysis & benchmarking tool, which promises to be an exceptionally strong performer in the retirement industry space.
An increasing number of advisors became acutely aware of the importance of understanding the changing retirement regulations and the need for specialization. The evolving retirement industry saw a sharp increase in the number of training programs being developed to help advisors and in the last 10 years, almost 20 new programs have been launched.
In 2006, Financial Service Standards published the Retirement Credential Comparison Chart that included 11 available certification programs that could help advisors working in the retirement plan space become more knowledgeable (4 of which were developed between 2002 and 2006).
In 2012, The Retirement Plan Professional’s Designation & Certification Guide published by Financial Service Standards found more than 26 different education and certification programs designed to help advisors specialize in various aspects of retirement plan consulting, sales, and service.
More and more advisors have now started offering fiduciary support services to plan sponsors to help them understand and adhere to the regulations. This further specialization of the retirement plan market continues to make it more difficult for generalists without ERISA or fiduciary training and services to compete beyond the small plan segment.
The recent participant and provider disclosures regulations further carve out the retirement plan business as a distinct industry in which advisors need much more than basic investment training in order to practice competently and compete effectively.
Investment Stewards, Investment Advisors and Investment Managers who do not foster and promote a culture of fiduciary responsibility are going to lack the sensitivity and awareness to identify the fiduciary breaches of others. When a fiduciary has its own conflicts of interests, then that fiduciary will be marginalized at best; corrupted at worst.” – Prudent Practices for Investment Stewards, 2011 U.S. Edition
The Blind Leading the Blind
The reality is this: most non-fiduciary advisors servicing plans in the micro and small plan market have no formal retirement plan training and limit their services to providing investment reports and participant education. It’s like the blind leading the blind. Only in the mid and large market do we find specialization among competing advisory firms, leaving a huge gap in the level and quality of services being provided in the smaller market.
The regulations surrounding retirement plans are complex. Regardless of plan size, there are clearly defined roles and responsibilities for investment fiduciaries spelled out in ERISA. However, when a company decides to offer a retirement plan or when an individual is appointed to sit on an investment committee, a full understanding of ERISA and fiduciary responsibility isn’t automatically conferred. There is no packet handed out with the adoption agreement that explains what an individual needs to know before taking on the personal liability associated with managing a retirement plan. Furthermore, ERISA doesn’t include any provisions that indicate as long as the plan assets don’t exceed a certain threshold, the rules don’t apply; or just because the risk of litigation is small, plan sponsors should only comply with the rules they’re aware of or have the time to implement.
While I don’t believe a government mandated solution is the answer, in other countries, such as the U.K, retirement plans are regulated by a Pensions Regulator that requires specialized training at the plan level to help fiduciaries understand and comply with the applicable laws. Below is an excerpt from the thepensionsregulator.gov.uk website:
I do believe that all plan sponsors need to be educated on the requirements of running a successful and compliant plan. It would be difficult, however, to require training for all plan fiduciaries since fiduciary status is not limited to a named trustee, fiduciary roles at the plan level are rarely clearly defined, and most plan sponsors rely on the professionals they hire to understand and interpret what’s necessary to run a plan effectively.
Many plan sponsors mistakenly assume that by hiring an advisor to help them with the plan investments, they’ve hired professional who is looking out for their best interests. They often believe they’ve hired an individual knowledgeable on retirement plan matters that will help them (or handle for them) the many responsibilities of running a retirement plan. Unfortunately, this is seldom the case. As Harvey Pitt, a former chairman of the U.S. Securities and Exchange Commission was quoted as saying in a recent Bloomberg Article discussing fiduciary status, “We ought to make the reality comport with what people think they’re getting.”
I believe the evolution of the retirement market into a distinct and specialized industry has caused a shift in what is needed and expected from the advisor community. Since the fees paid to the advisor on a retirement plan can often be more than 50% of the total plan costs, the advisor is the most likely provider to be perceived as the expert or individual best positioned to help the plan sponsor understand and meet the myriad of regulations surrounding retirement plans. Hence, whether an advisor acts in a fiduciary capacity or not in providing retirement plan services, all advisors should be certified and trained on ERISA matters and meet a minimum level of specialization in order to get paid from ERISA plan assets.
In a recent article by Dale Magner, the VP of Retirement Product Sales at Guardian Retirement Solutions, published by RPMI’s Weekly Exchange, Dale noted that the Department of Labor’s focus on fiduciary status during the past year has illuminated the fact that many financial professionals have been unknowingly acting as ERISA fiduciaries.
Investment training is not enough. Designations that indicate a comprehensive investment analysis course of study is not enough. 401k specialization is needed. Advisors need a baseline understanding of the different types of employer sponsored retirement plans available, they need to understand the roles and regulations defined in ERISA, and they should have a solid grasp of what resources are available to help plan sponsors meet the regulations surrounding their particular type of retirement plan.
Without this baseline knowledge, advisors:
- Can’t help plan sponsors understand and comply with the regulations;
- Would be hard to demonstrate value beyond basic investments selection and monitoring services and compete effectively;
- May be unable to assist plan sponsors in basic plan design changes that could have a large impact on the success of their employees to reach a financially secure retirement;
- May inadvertently cross the line in becoming an ERISA fiduciary, exposing themselves, their practice, and their firm, to liability far beyond the scope of services hired to perform;
- May, as an inadvertent fiduciary, unknowingly engage in prohibited transactions when soliciting or accepting rollovers if the compensation outside of the plan is higher than the compensation received inside the plan;
- May unknowingly engage in prohibited transactions if providing participant advice while receiving unlevel compensation from plan investments;
- And the list goes on…
The advisor role must evolve to include professional certification in order to provide a minimum level of competency and value. Professional certification provides the public assurance that the certificate holder is educated and competent.
With each new regulatory change, approved retirement legislation, or opinion letter issued, it becomes clear that the retirement industry needs advisors with specialized knowledge, capable of helping plan sponsors navigate the multitude of rules and responsibilities.
Many broker dealers are now revisiting their retirement business and allowing some advisors to become ERISA 3(21) fiduciaries once they’ve met certain experience, plan asset, and training requirements; which I firmly believe is a step in the right direction. However, NOT requiring minimum training by non-fiduciary advisors leaves the liability gap open. Advisors who are unaware of the prohibited transaction rules, ERISA’s definition of fiduciary or potential conflicts of interest, can’t protect themselves, their clients, their business, or their broker dealer. And as I’ve heard many times in this industry, ignorance is not a valid defense in the case of an ERISA audit or participant lawsuit.
In an Article on AdvisorOne.com in February of this year by Melanie Waddell, it’s noted that “the Employee Benefits Security Administration has significantly raised its enforcement efforts in what Andy Larson, director of the Retirement Learning Center, said should serve as a wakeup call to advisors who advise retirement plans and plan sponsors.”
Larson warned that “many advisors are surprisingly still unaware that the DOL has jurisdiction over them”.
The biggest area the EBSA seems to be zeroing in on according to this article is fiduciary negligence. “The EBSA is seeing very high levels of non-compliance with fiduciary duties. And when the EBSA releases its proposed fiduciary rule in the first half of this year, the rule will affect advisors and their fiduciary role, not plan sponsors.”
Specialized training for retirement advisors is a no-brainer in my opinion. Clients would be better served, advisors would be more valuable, and broker dealers would be better protected against the potential liability of uneducated advisors working in a high-value industry.
With specialization clearly in the best interest of all involved, and an abundance of ERISA and retirement certification programs available (see the Retirement Professionals Designation and Certification Guide), there’s no reason firms shouldn’t begin to implement a risk management strategy for their retirement business that includes specialized training prior to allowing advisors to receive fees from a retirement plan. In addition to ERISA training, retirement clients would be better served with an advisor whose service model is robust enough to help plan sponsors understand and reduce their personal liability; but that topic deserves another article in its own right.
My final thoughts on this topic can be summed up perfectly with a quote found on the back of the 2011 U.S. Edition of the Prudent Practices for Investment Stewards Handbook by fi360:
Society depends upon professionals to provide reliable, fixed standards in situations where the facts are murky or the temptations too strong. Their principal contribution is an ability to bring sound judgment to bear on these situations. They represent the best a particular community is able to muster in response to new challenges.” – Dr. Robert Kennedy, University of St. Thomas