Data & Research January 11, 2017

Defining Reasonable Compensation Is a Team Sport

A new series of white papers from Fiduciary Benchmarks asks the challenging question, “Who has the job of determining whether an adviser’s compensation is reasonable?”
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Fiduciary Benchmarks, provider of fee-benchmarking solutions, has published the first in a series of white papers authored by Employee Retirement Income Security Act (ERISA) attorneys Fred Reish and Bruce Ashton, of Drinker Biddle and Reath.

The analyses will be published quarterly and the first is available now, asking the question, “Who has the job of determining whether an adviser’s compensation is reasonable … the plan sponsor or individual account owner or the adviser?”

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As the pair explains, ERISA and the Internal Revenue Code have always required the use of suitable products and the assessment of only rational compensation for financial advisers and investment managers regardless of their contractual fiduciary status or service offering. However, the pending implementation of the Department of Labor’s (DOL) strengthened conflict of interest standard, paired with the rash of retirement plan fee litigation filed in recent years, has added even more significance to the question: Who is responsible for determining whether an adviser’s compensation is reasonable?

Just as important, Reish and Ashton warn, is determining what type of a process can be deemed reliable for determining fee reasonableness under ERISA’s tighter standards, as well as what type of records will be satisfactory?

“The ‘reasonable compensation’ requirement is highlighted by the Department of Labor’s expanded definition of fiduciary advice and the related prohibited transaction exemptions,” the pair explains. “As a result, an adviser’s responsibility for determining and having evidence of the reasonableness of its compensation has been heightened.” 

Ashton and Reish observe that the fiduciary rule’s exemptions raise an issue that financial advisers, “by which we mean broker-dealer representatives, investment adviser representatives and insurance agents,” may not have addressed in the past: Who has the job of determining whether an adviser’s compensation is reasonable, the plan sponsor or IRA owner or the adviser? “The short answer is, it depends.”

NEXT: Process, process, process 

According to the Fiduciary Benchmark’s analysis, what has changed under the new DOL standard is the obligation of a fiduciary adviser to a plan or IRA, whose firm (referred to as a financial institution) will receive variable compensation or third party payments.

“These advisers must rely on the Best Interest Contract Exemption (BICE), which requires the financial institution to warrant that its and the adviser’s compensation is reasonable,” Reish and Ashton write. “Other exemptions contain a similar requirement … For plans, this creates a dual obligation to make sure that compensation is reasonable. The plan sponsor retains its ERISA obligation to do so, and the adviser and the financial institution have the BICE obligation.”

Pertaining to IRAs, the analysis suggests the prohibition against an adviser receiving unreasonable compensation remains as in the case above, “but the obligation to make sure (and to warrant) that the compensation is reasonable is heightened under BICE (and other exemptions).”

According to Reish and Ashton, advisers will likely have to defend fees if challenged, but it is important to point out that the adviser’s obligation is actually to make disclosures, “not warrant that his compensation is reasonable.”

“It is still up to the plan sponsor to make the determination of reasonableness,” they conclude.

The first white paper can be downloaded (after free registration) here. 

In Practice January 10, 2017

RIAs Anticipate Another Gainful Year for 2017

With the amount of advances in 2016, RIAs anticipate 2017 to see even more increases—despite rules that lie ahead. 
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A recent TD Ameritrade RIA Sentiment Survey found that independent registered investment advisers (RIAs) see a strong future of success during 2017, as they plan to increase marketing, business development and technology spending while implementing growth strategies.

The optimism appears on several fronts concerning the economy, whether it be national or global. According to the survey, nearly seven in 10 RIAs are bullish about the U.S. economy—the highest number since the survey’s commencement in 2009—and more than half (55%) are positive about the prospects of the global economy. Also, the survey found that 53% expect the U.S. stock market to rise in 2017, and an additional 35% believe the market will hold onto improvements achieved in 2016.

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Anticipated Increases for 2017

2016 was an advancing year for advisers, as 70% had assets surge on an average of 17%, and 60% saw revenues increase by a median 16%. Furthermore, 56% had new client growth on an average of 17%. Due in large part to the advances achieved, four out of five believe their firms’ assets will grow further in 2017, and half predict firm assets will increase at a higher rate than last year.

“These are good days for independent RIAs, yet we can’t expect market tides will always rise. RIAs need to deliver a great experience, build firms that are more scalable and make sure they are compensated for all the services they provide,” says Tom Nally, president of TD Ameritrade Institutional. “By investing in themselves, embracing technology and articulating all the value they deliver, RIAs can increase their firms’ chances for sustainable growth.”  

NEXT: Despite Industry Pressures, Confidence Remains High

With the Department of Labor (DOL) conflict of interest rule potentially underway this year, along with the growing use of robo-advisers and the Securities and Exchange Commission’s (SEC) proposed Rule 206(4)-4 requiring business continuity plans, advisers may anticipate 2017 to intensify industry pressures. However, responses from the survey indicate that despite potential pressures, RIAs continue to feel confident.

Eighty-two percent reported minimal to no concerns over robo-advisers as a competitive threat, while the majority of responding advisers are not concerned over the DOL fiduciary rule. In regards to the SEC’s rule on business continuity plans, 57% of advisers have plans finalized, 31% are in the process of developing plans, and eight in 10 of advisers are aware of the requirement.

“RIAs have been the fastest growing channel in the financial advice marketplace in large part because they offer investors a personalized, client-first approach. At the same time, they have to find ways to navigate the myriad market forces converging on the industry if they want to keep growing,” Nally says. “RIAs can continue to grow by facing challenges head on, whether that means developing a robust retirement plan business, attracting a new generation of clients or embracing new technology to deliver a better digital experience.”

More information about the survey findings can be found here.  

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