Compliance December 30, 2016

SEC Offers Guidance on DOL Fiduciary Rule Compliance

Since the DOL conflict of interest rule’s publication, mutual fund providers and their adviser-intermediaries have also been asking the SEC extensive questions about sales loads, fee schedules, etc. 
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The Securities and Exchange Commission (SEC) will not be in charge of applying the stricter conflict of interest standards being introduced for retirement plan advisers and the investment providers supplying them with products to sell, but many of its own rules and regulations will interact intimately with the Department of Labor rulemaking.

According to the SEC’s latest guidance, since the DOL rule’s proposition and finalization, representatives of mutual funds have been considering a variety of issues related to its implementation, including “contemplating certain changes to fund fee structures that would, in certain instances, level the compensation provided to a financial intermediary for the sale of fund shares by that intermediary and facilitate intermediaries’ compliance with the rule.”

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SEC notes that some funds are considering streamlined sales load structures to simplify costs for investors and to help address operational and compliance challenges that can exist for intermediaries that sell shares of multiple funds. Thus, its guidance is focused on disclosure issues and certain procedural requirements with offering variations in fund sales loads and new fund share classes.

For example, the guidance reminds readers that, concerning variations in sales loads, a fund may sell shares at prices that reflect scheduled variations in, or elimination of, sales loads, as long as each sales load variation is disclosed in the prospectus.

“Under the Investment Company Act of 1940 and item 12(a)(2) of Form N-1A require that each variation be applied uniformly to particular classes of investors or transactions and disclosed in the prospectus with specificity,” the guidance explains. “We understand that funds are considering new variations to sales loads that would apply uniformly to investors that purchase fund shares through a single intermediary (or category of multiple intermediaries). In these circumstances, item 12(a)(2) of Form N-1A requires that the prospectus: (1) briefly describe the arrangements that result in breakpoints in, or elimination of, sales loads; (2) identify each class of individuals or transactions to which the arrangements apply; and (3) state each different breakpoint as a percentage of both the offering price and net amount invested.”

NEXT: More from the SEC guidance 

According to SEC, under this approach, investors who purchase through a designated intermediary would be a “class” under item 12(a)(2). Therefore, the disclosure should specifically identify each intermediary whose investors receive a sales load variation.

“This information must be presented in a clear, concise, and understandable manner, and should include tables, schedules, and charts where doing so would facilitate understanding,” the guidance states. “In addition, the narrative explanation to the fund fee table must alert investors to the existence of sales load discounts or waivers and provide a cross-reference to the section and page of the prospectus and statement of additional information that describes these arrangements.”

SEC acknowledges that some fund firms are concerned that if a provider creates multiple scheduled variations, it could lead to lengthy prospectus disclosure that may be difficult for an investor to navigate and comprehend. “Given the Commission and staff focus on improving disclosure, we would not object if lengthy sales load variation disclosure for multiple intermediaries is included in an appendix to the statutory prospectus,” SEC says.

The guidance lays out a number of requirements fund firms and intermediaries must follow in order to use an appendix under this approach. These requirements may seem complicated but they are all constellated around doing the right thing, transparently, for investors.

Also covered are a series of questions firms are asking about the creation and distribution of new share classes. According to the SEC, many funds are considering offering new share classes that differ with respect to sales loads, transaction charges, and certain ongoing expenses.

“As with the scheduled variation procedures … adding a new class to an existing fund requires a filing under rule 485(a). When reviewing a rule 485(a) filing that adds a new share class, we focus on the disclosure of fund fees, performance, and distribution arrangements. If only certain disclosures about the fund are changing, such as to describe the new share class, we encourage funds to seek selective review of the filing as described below. Also, because share class specific information is often substantially identical across Funds within the same fund complex, funds should consider whether it is appropriate to request Template Filing Relief as described below.

The full guidance is available for download here. 

The Markets December 30, 2016

DC Plan Sponsors See Reason for Caution in ESG

Retirement plan advisers expect a steady stream of new ESG/SRI investment products in 2017, but it is less clear that sponsor clients are interested. 
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2016 was an effective year for providers and recordkeepers searching to incorporate socially and environmentally conscious investment themes; yet fear of fiduciary risk and industry jargon are slowing progress among defined contribution (DC) plans.

Within impact investing comes Environmental, Social and Governance (ESG) investing; Socially Responsible Investing (SRI); and Economically Targeted Investing (ETI); several terms that can cause enough confusion for sponsors to turn their heads.

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Sri Reddy, senior vice president and head of full service investments at Prudential Retirement, explains that each word offers a different foundational way for people think about the broad category of impact investing.

“Within these labels there are investments that are exclusionary, meaning they won’t invest in certain industries, practices or types of companies,” he says. “There are investments that are more inclusionary, in that they seek out companies with certain behaviors, standards or causes.”

While the high-level terms ESG, SRI and ETI do share a connection, their meanings hold differences that are absolutely crucial for plan sponsors to understand. For example, according to labels used in a study by Prudential, SRI may involve avoiding certain businesses or sectors out of political or social concerns. ESG investing turns to the environmental, social and governmental stance within businesses; and ETIs are investments selected for the benefits they create, and the investment return to the employee benefit plan investor. According to The Case Foundation’s recent publication, “A Short Guide to Impact Investing,’ impact investments were traditionally made with the hopes of achieving a social or environmental impact, but increasingly these strategies are all being touted for their potential to boost financial return.

Financially beneficial or not, one can see how different perspectives and beliefs among plan participants may make it tougher for DC plans to move down the path of impact investing, especially within ESG and socially responsible investing, says Matt Cirillo, senior analyst for retirement at Strategic Insight in Boston. (Strategic Insight is the parent company of PLANADVISER.)

“There’s so many different viewpoints on what it is, and it varies with individual investors—what sort of impact they may want to have. So, a plan sponsor almost needs to balance two different competing priorities here,” he says. “If you’ve got an initiative to try and streamline a plan menu and provide the most effective lineup for your participants, how do you balance that with all of these options out there? How do you balance the desire of each individual participant with the overall goals of the plan?”

NEXT: Impact investing requires balance 

Beyond uncertainty around jargon, worries of fiduciary risk continue to turn plan sponsors away from impact investing. Even though the fairly recent Department of Labor (DOL) Interpretive Bulletin 2015-01 opened the door to the chance of impact investing within workplace-sponsored retirement plans, the threat of litigation towards plan sponsors attempting new approaches still strikes fear.

“Fear of litigation has led to a lack of innovation in plan menu design, so unless everybody’s doing it, it’s hard to get the ball really rolling on something new,” says Cirillo. “If you look at all the court cases that have been brought recently against plan sponsors, it’s not because they’ve been doing the same thing that everybody else has. It’s because they’ve tried to do something different.”

However, Reddy believes the revised bulletin can go a long way to soothe the qualms of plan sponsors, enabling them to take the same cautious-but-assured approach they would seek with any other investment.

“The DOL essentially told plan sponsors they thought many were not using these investment styles because of worries about a heightened sense of fiduciary responsibility. They said, this bulletin is here to tell you that you do not have a heightened sense, you have the same fiduciary responsibility you would have for any other investment. So, be cautious, but don’t take on more worry than you otherwise would.”

The comfortability in utilizing target-date funds (TDFs) and other traditional investments that have not yet widely embraced ESG makes it even tougher for plan sponsors to embrace impact investing. In addition, at least in the current market, financial outperformance of ESG/SRI/ETI is often marginal.

“Socially responsible funds generally perform on a relatively consistent basis with traditional investments, so if you were to compare a socially responsible large-cap index to say the S&P 500, over the long term you’re going to get comparable returns,” Cirillo says. “There’s not a tremendous amount of performance advantage that you’re going to get today. You’re also not going to be disadvantaged by investing that way, it’s really geared towards appeasing investors overall desire to do good.”

NEXT: Designing and delivering ESG and SRI

While plan sponsors are still weighing whether to employ traditional or impact investments, several firms are looking to combine the two. Recently, Natixis Global Asset Management filed a registration statement with the Securities and Exchange Commission (SEC) to roll out one of the first series of TDFs in the U.S. with investments focusing on ESG responsibility, expected to launch in the first quarter of 2017. Anticipated considerations for the investing strategies include labor standards, corruption, human rights, fair business practices and mitigation of environmental impact, according to the firm.

Cirillo believe Natixis’s inclusion of ESG investing in their TDFs is a positive and innovative move towards newer trends in the general market.

“In the target-date space, there are only so many ways that you’re able to differentiate yourself. You’ve got active/passive, you’ve got to/through, but besides that, there’s only so many ways that you can spin your story,” he says. “Up until this point, the presence of ESG in target-dates has been minimal to say the least.”

As impact investments are pooled with TDFs, they are also seeing a gain in popularity among younger demographics. According to the Schroders Global Investor Study 2016 released in November, which surveyed 20,000 end investors in 28 countries, the Millennial generation ranked ESG factors as equally important in outcomes when considering investments decisions. Along with scoring the highest rating on the importance of poverty and climate change (7.2 out of 10), the study also found that Millennials were most likely to pull funds from companies with low ESG records; those associated with weapons manufacturing/dealing; or linked to oppressive political regimes.

Cirillo believes that for plan sponsors looking to incorporate impact investing, appealing to the Millennial age group may be the best option. For Reddy, whether it’s through Millennial impact or TDFs, impact investing serves as a force in achieving financial, social and environmental improvements. 

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