Compliance February 23, 2015

President Fires Warning Shot in Fiduciary Rule Debate

The Obama Administration is strongly backing the Department of Labor’s ongoing fiduciary redefinition effort, with the president advocating for a strengthened fiduciary standard amid a flurry of industry reports that new rule language is imminent.
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The Obama Administration today published an outline of remarks that the president would deliver to the AARP, in which he argues financial advisers are subject to serious conflicts of interest that hurt millions of working and middle class families.

“The rules of the road do not ensure that financial advisers act in the best interest of their clients when they give retirement investment advice, and it’s hurting millions of working and middle class families,” the administration says. “A system where Wall Street firms benefit from backdoor payments and hidden fees if they talk responsible Americans into buying bad retirement investments—with high costs and low returns—instead of recommending quality investments isn’t fair.”

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The administration says these conflicts of interest are costing middle class families and individuals billions of dollars every year. On average, they result in annual losses of about one percentage point for affected investors, the remarks suggest.

“To demonstrate how small differences can add up, a one percentage-point lower return could reduce your savings by more than a quarter over 35 years,” the administration notes. “In other words, instead of a $10,000 retirement investment growing to more than $38,000 over that period after adjusting for inflation, it would be just over $27,500.”

The remarks explain that many advisers do in fact work through different business models that put their customers’ best interest first. “They are hardworking men and women who got into this work to help families achieve their dreams and want a system that provides a level playing field for offering quality advice,” the remarks continue. “But outdated regulations, loopholes, and fine print make it hard for working and middle class families to know who they can trust.”

Reacting to President Obama’s planned speech to the AARP, and to his suggestion that delivery of a new version of the fiduciary rule proposal by the Department of Labor (DOL) to the Office of Management and Budget (OMB) would soon occur, industry groups strongly rejected his claims of widespread adviser impropriety. 

The National Association of Plan Advisors (NAPA) issued the following statement in response to the Obama Administration’s remarks: “Today the White House launched an attack on advisers and so-called ‘hidden fees’ and ‘backdoor payments’ by moving forward with a regulation that has its own hidden backdoor effect —keeping many Americans from working with the trusted adviser of their choice, even in the critical decision regarding rollovers from their 401(k) and 403(b) plans.”

Brian Graff, executive director of NAPA, says investors should be protected from unfair and deceptive practice, “but all indications are that this rule will block Americans from working with the financial advisers and investment providers they trust simply because they offer different financial products—like annuities and mutual funds—with different fees.”

“This rule could even restrict who can help you with your 401(k) rollover,” he adds.

Graff’s warning encapsulates the other side involved in the fiduciary redefinition fight. Like NAPA, other advisory industry advocacy groups point back to the failure to reach consensus on a previous version of the controversial regulation, which was withdrawn in 2010 following harsh bipartisan criticism of its potential impact on access to professional investment advice, particularly for lower- and middle-income workers. 

“The best way to address concerns about ‘hidden’ fees is through better transparency, not by blocking 401(k) participants from working with the adviser of their choice,” Graff says. “If the administration moves forward with this proposed rule, American savers will be forced to pay out-of-pocket for their financial advice, or be limited to financial products with identical fees. Tens of millions of American savers who cannot afford to pay out-of-pocket will lose access to their financial adviser or be severely restricted in their choice of financial products.”

For its part, the DOL says it is still getting ready to issue a notice of proposed rulemaking at some point in the months ahead, “beginning a process in which it will seek extensive public feedback on the best approach to modernize the rules on retirement advice and set new standards, while minimizing any potential disruption to good practices in the marketplace.” According to the DOL, the rule language must first be reviewed by the Office of Management and Budget, which can take up to 90 days but can be expedited.

Given the controversy, it remains unclear what the path forward will be for the new fiduciary rule. Some have speculated swift Congressional action could follow the proposal or adoption of the rule, which would require the DOL to merge its rulemaking effort with a similar but lesser-developed effort ongoing at the Securities and Exchange Commission. 

The administration’s remarks are here. 

Data & Research February 23, 2015

Automation Trends Going Strong in DC Plans

Advice has taken on new dimensions in the retirement space, according to Cerulli Associates, and is often implemented automatically and without requiring input from the recipient.
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Advice in defined contribution (DC) plans is mostly delivered through automated plan design features, according to a new Cerulli Associates report finding that plan sponsors have increasingly embraced auto-features as a means to improve plan performance and engage younger investors.

Once thought of as a radical approach to supporting positive retirement plan participant decisionmaking, auto-features include automatic enrollment and deferral escalation, as well as things such as automated portfolio rebalancing, Cerulli says. Plan sponsors are also paying particular attention to their plan’s qualified default investment alternative (QDIA)—the investment option into which plan participants are defaulted should they decline to make an investment selection during the enrollment process. QDIAs are often target-date or target-risk funds that automatically adjust participants’ market exposure over time.

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Jessica Sclafani, senior analyst at Cerulli, says this shift in plan sponsor attitudes comes largely in response to the overall lack of participant engagement in the defined contribution system. Plan sponsors are particularly concerned about getting younger investors more engaged in the retirement planning process.

“Retirement advice begins with auto-enrollment, which informs employees they should save for retirement,” Sclafani says. “Auto-enrollment is a crucial first step in auto-advice that captures the most vulnerable population of the work force that isn’t saving at all.”

According to Cerulli’s 2014 Plan Sponsor Survey, 73% of plan sponsors have incorporated automatic features into their plan design. Nearly 90% of this group uses auto-enrollment, with the majority of automated flows directed toward target-date funds (TDFs), Cerulli finds. The report suggests that widespread adoption of auto-enrollment is a step in the right direction, but participants defaulted at a deferral rate below 5% or 6% are still unlikely to achieve retirement security through the DC plan alone.

For this reason, Cerulli says, plan sponsors implementing more comprehensive and holistic automation are seeing better outcomes for plan participants. For example, coupling auto-enrollment and auto-escalation with a quality QDIA is an effective way to counter the strong inertia present in defined contribution plans, Cerulli says. Under this scheme, a participant’s lack of engagement with the plan will not prevent him from moving toward a sufficient salary deferral and from keeping his investments well-diversified.

“Where traditional advice may be heard but not acted upon, auto-advice ensures that the advice is implemented or actively declined,” Sclafani adds.

Given that the participant bears the greatest responsibility in saving for retirement under a defined contribution arrangement, Cerulli says, the implementation of auto-features reflects a “realistic versus paternalistic approach to plan design.”

“DC providers should guide plan sponsors in exploring and expanding the use of auto-features to better prepare participants for retirement, and, ultimately, drive greater assets into their accounts,” the report continues. 

Cerulli’s analysis also takes a deep dive into the wants and needs of younger investors—and their perceptions of the value of different types of advice. Researchers liken the current trends in automation to the digital revolution that swept through the investing industry in the early 1990s, when the Internet made it possible for tech-savvy individuals to access real-time capital markets information.

This caused financial services firms to start rethinking their long-term consumer relationships, Cerulli notes. Brokerage and advisory firms could no longer charge a premium for delivering information and no longer represented the only option for facilitating trades.

“In contemplating how to address these changes, strategic planning executives started to re-segment their clients, with most firms settling on a paradigm that bucketed consumers into three categories,” Cerulli says.

These included delegators, willing to relinquish the management of their assets with complete discretion to a trusted adviser; do-it-yourselfers, who consulted the Internet but made their own financial decisions, working through direct firms such as Fidelity, Charles Schwab and Vanguard; and validators, who resembled do-it-yourselfers but differed in that they also sought validation for their investment decisions.

These categories largely hold true today, Cerulli says, but a new kind of automation-supported financial consumer is emerging—which Cerulli calls the collaborator.

“Collaborators tend to be age 35 or younger, what is often called the Millennial generation,” the report says. “This generation seeks a new way of interacting with financial advisers that involves greater use of technology-mediated communications, planning for modular goals, use of electronic registered investment adviser (eRIA) techniques for smaller accounts, and co-planning.”

As Cerulli explains, almost two-thirds of people under 30 acknowledge that they need more financial and investment advice. Further, more than 81% in this age group want to be actively involved in the day-to-day management of their investments. This spells opportunity for sponsors and advisers to work together on driving plan success, Cerulli says.

“This need to be a direct participant, coupled with the desire for advice versus guidance, puts the requirements of the collaborator somewhere between those of the validator and the delegator,” Cerulli says. “Unlike validators, collaborators do not simply want their decisions affirmed; they want to be advised. And unlike delegators, collaborators are not content to hand over their assets to an adviser with minimal oversight; they want to work side by side with the adviser.”

These pressures have allowed eRIAs, also known as robo-advisers, to appear on the financial services landscape, targeting young consumers and challenging the way traditional firms interact with Millennials. Cerulli believes that advisory firms should develop a more collaborative planning process with these consumers and enhance their use of technology to communicate with them—especially Web-based dashboards and other tools.

These findings are from the February issue of “The Cerulli Edge – U.S. Edition.” More information on obtaining Cerulli research reports is available here.

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