Weighty Measures

The days of 401(k) plans being thought of as “free”  are fast coming to an end. The 401(k) plan industry is gearing up for probably its most dramatic change since its birth in the late 1970s, and advisers will have to adapt. Starting this summer, plan sponsors and participants will know just what their 401(k) plans cost and what their plans’ service providers are charging as fees.

Advisers will have to benchmark the fees they charge and how much they are being paid for services rendered. Previously, because the traditional structure of 401(k) plans frequently provided advisers’ fees through revenue sharing, plan sponsors put little thought toward benchmarking adviser fees. Fees were essentially hidden from sponsors, and plans were often marketed as “free,” so the concept of benchmarking never came to the forefront.

With the advent of the new disclosure rules, however, that will change. Plan sponsors will now not only know what fees the plans pay to advisers but be required to benchmark those fees and determine whether they are reasonable in light of the services provided. It therefore behooves advisers to be proactive and know, in advance, how their fees and services stack up to competitors’.

By virtue of the new rules coming out over these two months, advisers will be under the microscope, says John Resnick, director of advisor development at The Advisor Lab LLC in Philadelphia. No one knows what the outcome will be, he says, but there is much speculation. Participants who for decades thought they were getting things free will likely be shocked to discover just how much of their savings went to plan investment, administrative and advisory fees, he says.

The new fee transparency will also mean that, to remain competitive, advisers will have to proactively benchmark their own fees and services to determine: 1) whether they are reasonable and 2) how they compare with those of other advisory firms providing similar services. In addition to being proactive about this, advisers should fully educate themselves to what kinds of fees and services similar plans receive, Resnick says.

The drive to benchmarking  is being propelled by new fee ­disclosure regulations and rules under Employee Retirement Income ­Security Act  (ERISA) sections  
408(b)(2) and 404(a)(5). Currently, there is much indirect compensation built into expense ratios in separate accounts, insurance products and even mutual funds, Resnick says; therefore, it is difficult to know who is receiving those fees. It’s a big ­challenge because of the way advisers were historically compensated, he says.

Department of Labor (DOL) regulations under ERISA, and specifically section 408(b)(2), require that plan sponsors obtain fee disclosures for their plan and that all such fees be “reasonable” for the services provided. Under the new 408(b)(2) rules, all vendors servicing the plan will have to send disclosures to the plan sponsor, says Ron W. Hagan, executive vice president of Roland/Criss.

The new disclosure rules mean that many plan sponsors, for the first time, will have a clear idea just what the plan is paying for services and to whom, says Hagan. It will then be up to the sponsor to identify whether those fees are appropriate and reasonable.

The new 408(b)(2) rules also require a written agreement. The rules state that the contracts have to explicitly identify what services are supplied. Traditionally, registered representatives have operated sans written contracts but, instead, had themselves declared the broker of record, says Hagan; this will not meet the written contract requirement under the new rules, he warns.

Registered investment advisers (RIAs) already operate under contracts that specify their services to the plan, Hagan says, but registered representatives generally do not. Creating a written contract could be a good thing, he says, because it will force registered representatives to identify and specify what services they provide and to show their value.

Where to Turn 

In response to the new disclosure rules, vendors are creating new products, services and tools to aid plan sponsors in benchmarking and evaluating adviser fees. “There are [already] service providers out there that benchmark fees at the plan level, to see what they are paying and if it’s reasonable,” says Resnick.

However, right now, adviser fee benchmarking services are really geared toward the plans, experts note. “No one is providing benchmarking services specifically for the adviser firms,” says Resnick.

Blaine Aikin, CEO of fi360, agrees. “The current products on the market are really geared towards plans, to do comparison of service providers.” Although the current crop of products in the marketplace targets plan sponsors, advisers can nevertheless use these same tools to evaluate themselves against other providers, Aikin says.

Resnick notes, too, that advisers can use the data to see the competitiveness of their fee schedules or whether they are charging correctly for a particular service, for just two examples. “Advisers need a handle as to what’s going on in the market,”  he says. “They need to learn what is average.” Reviewing the plan-sponsor-driven data can provide advisers with this critical knowledge. Additionally, Resnick says that his firm, The Advisor Lab, is working with open architecture shops—typically fee-transparent—that cater to the RIA market.

While vendors are creating fee benchmarking products for plan sponsor use in evaluating the reasonableness of adviser fees, Hagan fears that initially these new benchmarking products will place too much emphasis on the level of fees and not enough on the quality of services those fees purchase. An unintended consequence could be, he says, that advisers who provide a high level of service will at first appear to be overpriced.

Part of the fault may be in how the data is derived. Right now, there are two benchmarking camps, says Resnick. The first camp believes that they can rely solely on Form 5500 data to evaluate whether fees are reasonable, and the second camp asks service providers to look at the 5500 data and compare the services of vendors. “We think that Form 5500 data should be used in conjunction with service providers,” he says. True benchmarking of fees requires blending Form 5500 data with analysis from a service provider, to get an accurate picture of how one adviser compares with another, he says.

Hagan also believes that the current methodologies for benchmarking adviser fees need to be tweaked. “They’re not perfected yet,” he says. “The data still needs to be refined.” 

The next generation of tools will better capture value, agrees Aikin. The plan tools now available are not as robust as they may be a year from now, he says, but it’s a start. Like with anything else, he says, trial and error will be needed before the situation gets smoothed out.

Additionally, though fees are important, advisers might also consider evaluating and benchmarking themselves in other areas, as well. “Fee benchmarking is getting all the attention because understanding fees is now a hot topic,” says Andy Frommeyer, fi360’s director of products and services. However, he says, it is one thing to understand the fees being paid but another to understand the corresponding value of the services provided. He says fi360 has software that advisers can use to benchmark client plans. The software allows plan sponsors to make appropriate comparisons to ensure their plan is run efficiently and that they are paying reasonable fees for the services received. Advisers should also consider benchmarking their practices and their plan data and fees against those of other advisers, Frommeyer says.

Fi360 identifies fiduciary obligations of advisers under the applicable laws and regulations and then publishes handbooks to help advisers conform to best practices, Aikin says. The handbooks provide checklists, enabling advisers to perform self-assessments of their fiduciary practices—such as doing due diligence on securities and avoiding conflicts of interest—thereby benchmarking their advisory firm, he says.

If the next few months will be all about fee disclosures, with providers scrambling to get them completed and distributed, Aikin says, the next focus will be on what to do with the information.

Hagan says that, for one thing, advisers charging fees more than the benchmark will need to demonstrate their value; advisers will need to define their service well. There is no ERISA requirement that plan sponsors have the lowest-priced advisers but that fees are reasonable for the services provided, he says.

Advisers will need to become more competitive, because plans will be able to compare adviser charges. Fees will be disclosed on the Form 5500, so plan sponsors will see what the expense ratios of funds are and be able to do an apple-to-apple analysis.

The message to advisers is to know who you are and what differentiates you, says Hagan. Advisers, he says, need to help plan sponsors value their fees. If fees exceed a benchmark but services justify this, help clients understand why. Do not just rush to cost-cutting alone, says Hagan, but define the value you add to clients.

Advisers should look at the services, fees and compensation competing in the marketplace, and identify fiduciary status, then assess how their services, fees and compensation compare, says Aikin.

Advisers must become more aware of where they sit in the industry. The way to strengthen their relationship with plan sponsors is to highlight the services they provide for the fees they receive, he says.

Uses of Benchmarking Data 

Once advisers benchmark themselves to their competitors, the information can be used for many purposes. Having a third party provide an objective benchmarking report can yield many benefits to both the adviser and his plan sponsor clients. Here are some ways to employ the findings:

• For fiduciary documentation to your clients, as part of the annual review process
• To show clients your cost and value in relation to the marketplace
• To prospect for new clients
• To help clients meet their own fiduciary obligations
• To help reduce the probability of litigation over plan fees for clients
• To help meet best practices, and potentially lower insurance costs
• To provide clear documentation of an objective fiduciary process
• To provide a “real-plans data” framework to manage plan fees and services with the recordkeeper
• To support plan design and benefits marketing decisions