Post-Election
Several critical issues are on the table as President Barack Obama embarks on his second term, including the expansion of the fiduciary standard and regulation of retirement income projections. In addition, advisers must keep in mind the effect current market conditions will have on their clients’ portfolios. Here, we provide an overview of what advisers can expect in the coming months and years:
Expansion of ERISA’s Fiduciary Standard
A crucial issue raised by Obama’s re-election is what impact it will have on the recent push by the Department of Labor (DOL) to expand the definition of fiduciary under federal retirement law. “There’s a clear expectation that the DOL will move forward with their [fiduciary] proposal,” said Joel Oswald, principal at the Washington, D.C.-based law firm of Williams & Jensen, during a TD Ameritrade postelection webinar.
The DOL’s original fiduciary proposal was opposed by members of the financial industry, in part because of concerns about 401(k) rollover rules, as well as its potential to increase costs by imposing Employee Retirement Income Security Act (ERISA) fiduciary standards on brokers selling individual retirement accounts (IRAs). The potential to become a fiduciary under ERISA by providing guidance to an individual taking a distribution from his retirement plan might make advisers hesitant to help participants roll over assets once they leave a plan, many said. If participants who are leaving a plan do not receive help, this may also decrease sales for rollovers. The DOL’s Employee Benefits Security Administration (EBSA) withdrew the proposal and announced it would solicit more information before creating a new definition.
The DOL has openly struggled with its reproposal, citing challenges such as determining what constitutes advice. “The line between advice and education is among the most difficult [fiduciary issues] we have had to answer,” Michael Davis, former deputy assistant secretary for the DOL, said during the June 2012 PLANSPONSOR National Conference. “It’s the most difficult philosophical question we are dealing with.”
Brett Hoffman, executive vice president and principal at The Insurance Exchange, CIC Wealth Management’s retirement team in Rockville, Maryland, says advisers should get ready for what is expected to be a fiduciary environment. “I think it’s a good thing,” Hoffman says. “It puts the adviser on the same side of the fence as the plan sponsor.”
Advisers should be prepared to act in an ERISA fiduciary capacity and formalize all services being offered to plan sponsors, Hoffman says. “If you’ve been providing investment consulting and meeting with employees, that’s great,” he says, “but advisers need to make sure they are helping their clients document these activities.”
Sponsors also need to ensure they have a documented process for managing their retirement plan: investment reviews, fee benchmarking and employee education, Hoffman says. In addition, he counsels sponsors to make sure they have a retirement-plan-focused adviser and, if they do not, to interview qualified advisers and document the process.
The new fiduciary proposal will likely include prohibited transaction exemptions—such as the ability of broker/dealers (B/Ds) to engage in principle transactions, said Bradford Campbell, counsel at Drinker Biddle & Reath LLP’s Employee Benefits and Executive Compensation Practice Group in Washington, D.C., and EBSA’s former assistant secretary of Labor, during his firm’s postelection webinar. However, Campbell doubts the DOL will provide “meaningful” exemptive relief from the rule for IRAs. The DOL views IRAs as “essentially” unregulated, he says, which is why he anticipates that the department will propose additional restrictions around rollovers.
“I agree that we’ll see some activity in that area, both in the regulation of IRAs through prohibited transaction exemptions and in the regulation of advice that participants receive about rolling over to IRAs,” said Fred Reish, Los Angeles-based partner and chairman of the Financial Services ERISA team at Drinker Biddle & Reath, during the firm’s webinar.
Although the DOL has yet to indicate a clear date as to when it will reintroduce the fiduciary proposal, sources expect it will happen early this year.
On the other side of the fiduciary issue, it appears the needle will also move forward on the Security and Exchange Commission (SEC) proposal for a uniform fiduciary standard rule, according to the agency’s 2012 financial report. News sources have speculated that the SEC’s new chairman, Elisse Walter (who replaced Mary Schapiro in December), will follow a similar path on the adoption of a uniform fiduciary standard.
This uniform fiduciary standard would have the biggest influence on broker/dealers, says Jim Allen, head of capital markets policy for the CFA Institute in Charlottesville, Virginia. “Under current rules, brokers have only to meet a suitability standard that provides great leeway on what meets that test,” he explains. “While there are many brokers who take their obligations to their clients seriously, sadly, there are some who have other motivations.”
However, a number of things the SEC is considering would create varying degrees of changes for advisers, he says. For one, advisers will soon see an increase in their examinations, be it by the SEC, their state securities commissioners (for small advisers) or, depending on how Congress decides to handle adviser oversight, by the Financial Industry Regulatory Authority (FINRA) or another self-regulatory organization. “Even though [Bernie] Madoff was not an RIA [registered investment adviser], that scandal shone a very bright light on the commission’s low level of adviser oversight,” Allen says.
Allen says he also hopes the SEC will carefully consider trading market structures, most notably high-frequency trading. “Our primary concern is not with the rapid-fire trading so much as it is the potential for market abuse and systemic failure that accompanies this type of market activity,” he says. “Given what happened with a couple of electronic trading venues and firms this past year, we are certain the commission is carefully monitoring these activities.”
Overall, the SEC says that in 2013 it will “continue to embrace its ever-increasing regulatory and oversight responsibilities while further improving performance in the functions that have traditionally defined the agency in the eyes of the financial markets and American investors. These include aggressive enforcement actions, thorough examinations, proactive disclosure efforts and robust rules focused on investor protection.”
Retirement Income
Phyllis Borzi, assistant secretary for the DOL’s EBSA, and Mark Iwry, senior adviser to the secretary of the Treasury, have been collaborating on addressing retirement income issues, namely to produce a regulation that will list participants’ defined contribution (DC) account balances in the form of income when they retire.
It is unclear whether the income projection would be a requirement or merely be encouraged, but Reish predicts the former. He also expects it would be based on current balance versus future projections, which, he says, could be discouraging for young workers who may have a smaller 401(k) account balance. If the projections end up being based on future values, Reish says, private-sector providers must step up and provide other information to participants, such as the advantages of saving more.
Some recordkeepers have already begun listing yearly or, more commonly, monthly retirement income projections on participants’ 401(k) statements, using detailed assumptions such as annual salary, contribution rate, current balance, Social Security and other outside income.
“What we would hope to see is [that] whatever DOL proposes provides maximum flexibility so plan sponsors and providers can continue to innovate in this area,” says Bob Holcomb, head of regulatory and legislative affairs at J.P. Morgan Retirement Plan Services in Overland Park, Kansas. “We want to have as broad of a playing field as possible.”
It is important at this point for sponsors to ask their providers what actions are in place to help participants reach their retirement income goals, CIC’s Hoffman says, and then to ask what they have done to ensure provider statements are compliant with legislation. “I would expect most providers to have a good response to these questions, but, if the provider doesn’t have a good answer, it may be time to consider other options,” he says.
Postelection Investing
As the Obama administration was working at press time toward a solution to avoid a leap over the fiscal cliff, experts were telling advisers to help their clients keep a long-term outlook.
Although current market conditions will likely lead to high volatility, investors must remember that the market tends to bounce back quickly, said Anthony Brown, a St. Louis, Missouri-based partner at Mercer, during the company’s postelection webinar. Brown cited last year’s debt-ceiling crisis, in which the market fell 20% but quickly rebounded.
Investors should think of the long-term horizon rather than just headlines in the short-term, Brown said, even though, overall, he predicts the investing environment will probably remain “very tough.”
It is important to remind people that, even if the presidential election failed to produce the results they wanted, logic—not emotion—is what is needed to make wise investment decisions, agrees David Kelly, global chief strategist at J.P. Morgan Funds. At the moment, the biggest drawbacks of investing are uncertainty and fear, he says. But, if the economy is seen as growing, investors’ outlook should improve. He notes that, from an investment perspective, the economy can grow under a number of circumstances.
Looking back at the last 75 years of stock market returns, the average return is about 10%. But, Kelly points out, in those years with a Democrat in the White House and Republicans controlling at least part of Congress, the average is 15.4%. In other words, investors should not view Obama’s re-election as dire financial news.
The re-election means the stock market will likely be more positive than the bond market, Kelly adds. “As we go into 2013, the way to go will be overweight with equities and underweight in fixed income,” he says.
Low-volatility equities are a good option right now because they keep pace over the long term, Brown says. Diversifying growth assets into hedge funds and private equity should be a continued trend, he says.
Kelly cautions that the worst thing for investors to do is sell out amid the market angst and then see the market soar. “The lesson is, don’t buy into it,” he says.
Health care
Health care reform is among the biggest changes employers face under the Obama administration. Industry experts caution that employers that were waiting until after the election to take action about health care changes under the Patient Protection and Affordable Care Act (PPACA) must not delay their preparations. “This is it. … We all have to have a plan for 2014,” said Tracy Watts, Washington, D.C.-based partner at Mercer, during the company’s postelection webinar.
With the election behind us, Watts anticipates an “avalanche of guidance” regarding questions such as:
• What are the specifics of the reporting and disclosure requirements?
• What are the nondiscrimination rules?
• How should “essential” health benefits be defined?
• Will a cap on deductibles apply to all employer plans in 2014?
• What will fees be under the Transitional Reinsurance Program?
• What are the public insurance exchanges going to look like in 2014, and will they be ready?
Although employers should have already started preparing for these changes, sources realize it is difficult to begin with so many questions looming. “Until employers get all of this guidance, it’s hard to know how to react and how to act accordingly,” says Geoff Manville, Washington, D.C.-based principal of government relations at Mercer.
According to Watts, the best thing employers can do at this point is prepare now for changes under the current law.