Compliance Headaches Coming for 401k Plan Sponsors Due to New Fiduciary Regs in 2014?

Christopher Carosa, CTFA

It’s that time of when all good industry journalists peer into the crystal ball and foretell to the masses what exactly will happen in the coming year. Of course, this makes for great copy just like some conversation makes great water cooler talk. The trouble is, most of these predictions are just that – predictions. There is little reporting on the practical consequences should said prediction materialize or fail to materialize. For readers of FiduciaryNews.com, the real world ramifications can greatly impact both the amount of and nature of one’s work as well as one’s personal fiduciary liability. It is precisely this impact that the typical 401k plan fiduciary has the greatest interest in discovering. This article hopes to at least begin to answer that question.

Brian Graff, CEO of American Society of Pension Professionals & Actuaries (ASPPA) and Executive Director of National Association of Plan Advisors (NAPA) expects “2014 to be the year of the advisor/adviser from a government affairs perspective because most of the regulatory efforts will focus on that industry. The definition of Fiduciary Rule and the Uniform Fiduciary Standard will impact both fee-based advisers and wire-house advisors. What’s interesting to me is that this is first time that the advisor side of the industry has been squarely in the sites of the regulators. Everyone knows what’s coming so most won’t be surprised, but sometimes the regulatory process upsets everyone.”

To that end, we surveyed a broad range of financial service providers from across the nation for their thoughts. We also interviewed key members of a couple major industry associations – you know, the folks who really have their fingers on the pulse of the regulators. What we found in the range of responses just might surprise you. Of course, we’re counting on this since one of the questions we asked was “What will be the most surprising event for retirement plans in 2014?”

But before we get to that, let’s review where the fiduciary world stands right now. “The SEC is interested in, and will likely issue a Uniform Fiduciary Standard but right now there is no time table to do so,” says Braden Perry, a partner in the Kansas City-based law firm of Kennyhertz Perry, LLC and former federal enforcement attorney and veteran in government compliance. Perry further adds, “In its 2014 priorities, the proposed Uniform Fiduciary Standard is described as a ‘long-term action,’ essentially meaning that the proposed rules stage and final rule stages are a higher priority. It would be highly unlikely for the agency to adopt such a significant rule change anytime in the near future, especially with it slated so low.”

Agreeing with Perry, Duane Thompson, Senior Policy Analyst for fi360 in Washington, D.C., says, “Most parties are in agreement that a Uniform Fiduciary Standard is needed for brokers and advisors. However, given the likelihood of a legal challenge, it’s possible that the SEC will wait for the Department of Labor to move first on its own rule. (The DOL’s latest estimate for public release is August 2014.) If the SEC wants to see how that plays out in court, we might not see an SEC rule until 2016.”

As Thompson states, there’s a growing consensus that the SEC will wait for the DOL before acting. Shane Brethowr, Chief Operating Officer and Chief Compliance Officer at Lockton Retirement Services in Kansas City, Missouri says any move on the part of the SEC is “not likely in 2014. I would be shocked to see anything new prior to the DOL regulation in August. Then, add on another 90 days (typically) for the Q&A period, which would put us into November. Despite the leadership energy that SIFMA has put into the topic, the SEC has seemed content to defer to FINRA, and now the DOL. The proposed DOL regulation that is on path to be released in August will certainly cause the issue to escalate, but it appears the SEC’s strategy is to see how the Q&A period goes for the DOL, and address as needed.”

Gerald Wernette, principal and director of retirement plan consulting at Rehmann in Farmington Hills, Michigan also agrees with Thompson and Perry. He says, “I think the SEC eventually will issue a fiduciary standard, but not in 2014. I don’t see it being high on their priority list. As it stands, from their perspective on what they feel they need to tackle, they have too many other items in front of them right now.”

John McAvoy of Waterstone Retirement Services in Canton, Massachusetts is more sanguine. He says, “I don’t think that the SEC will issue a fiduciary standard mainly because of the politics. The SEC’s funding comes from Congress and lobbyists are likely to be successful in preventing a fiduciary standard from being issued.”

Don’t discount the power of lobbyists. Ron Rhoades, Program Director, Financial Planning Program at Alfred State College in Alfred, New York says, “After speaking with SEC insiders over the past year, and observing the huge influence of Wall Street and the insurance companies both in Congress and at the SEC, I am more and more convinced that the SEC will continue to act as Wall Street’s whipping boy. Congress and the government agencies are visited by anti-fiduciary advocates more than 20 times the visits seen by pro-fiduciary advocates. Wall Street’s investment banks have committed to each other to spend hundreds of millions of dollars, if that is what it takes, to defeat the application of the fiduciary standard to the investment advisory activities of broker-dealers.”

Still others believe the issue more pressing and one that the SEC will address this year. Stephen Rischall, Vice President at 1080 Financial Group of Los Angeles, California believes “the SEC will issue a fiduciary standard in 2014. As Americans continue moving forward from the recession, government and industry organizations alike are more serious about implementing protocol intended to protect consumers. Additionally American investors are wising up, they are weary of fees and costs and have more information available to evaluate their decisions. Simply put, people are finally asking the important questions (not who or what). They want to understand the why.”

Finally, there are those who see 2014 as just the beginning, with the SEC recognizing the fiduciary issue by taking “baby steps” towards resolving is. Todd Zempel, ERISA Operations Manager for Gordon Asset Management, LLC in Durham North Carolina says, “I suspect we’ll see baby steps towards a fiduciary standard in 2014, but I’m not anticipating a sweeping overhaul. Given that the SEC’s 2014 agenda focuses primarily on addressing ‘resource challenges’ within the organization, it is probably safe to assume that the SEC doesn’t have the capacity to tackle the fiduciary issue this year. However, something needs to be done and the SEC knows it. With the DOL’s assistance, I think we’ll see a disclosure/notice requirement before the year is over.”

Ultimately, most professionals believe the SEC will have no choice but to adopt some form of Uniform Fiduciary Standard. Heather Hooper, VP of Retirement Strategies at Loring Ward in San Jose, California says, “As an industry we’ve taken strides in this direction for many years and the public has also become more informed to the point where many demand this type of accountability. Ultimately, I believe the standard is inevitable given these trends and because acting in the best interest of investors helps us get one step closer to solving the retirement crisis.”

That’s the SEC side of the equation. Perry mentions the other side when he tells us, “The Department of Labor has indicated that a 2014 priority is to re-propose the Fiduciary Rule in August. Unlike the SEC, it has a firm date that it will revisit the issue. However, the US House of Representatives passed a law in October 2013 requiring the DOL to delay any Fiduciary Rule until the SEC has acted.”

Will the DOL cede its obligations and abide by the intent of Congress, or will it faithfully carry out its duties? Thompson says, “Many observers expect the DOL to do so. An April 2013 GAO report on the rollover process reviewed the issue of conflicted advice and urged greater coordination between the IRS and Department of Labor on sponsor practices. A revised fiduciary rule would provide the DOL with a ready-made forum to respond.”

Whatever the outcome, it is clear what’s driving the DOL on this matter. Robert Richter, Vice President at SunGard’s Wealth & Retirement Administration Business in Jacksonville, Florida says, “It’s difficult to predict where the DOL will end up on this. Based on the initial proposals, however, it’s fairly clear that the DOL would like to cover IRAs under the same guidelines. This is because there are some key DOL leaders who believe that individuals saving for retirement are not being adequately protected due to practices of the financial services industry.”

Wernette says, “Yes, I think the DOL will end up back-dooring this or going directly after it. I think they see a direct connection from the standpoint that a lot of money that is going into IRAs is coming directly from retirement plans and the DOL wants to stay involved. They want to tie that into the fiduciary standard process.”

McAvoy agrees but sees a role for exemptions. He says, “I think that there is a chance the DOL will have some sort of fiduciary guidelines for IRAs. If they do I don’t think it will be as strict as under ERISA. My guess is that they will carve out an exemption for smaller accounts.”

Still, there is a purpose to the DOL intent. The regulations are concerned some brokers may be trying to secure higher fees by rolling over employee assets into IRAs they then manage. Samuel Henson, Vice President and Senior ERISA Counsel at Lockton Retirement Services in Kansas City, Missouri says, “I think that if the DOL has their way, then certainly come August, they will put forth a rule that will place IRAs under many of the fiduciary obligations that 401k plans face. Absent some sort of Congressional intervention, the DOL has indicated its clear intent to apply the ERISA fiduciary standard to IRAs. The DOL believes that IRAs generate large broker fees and that the mutual funds and the brokers selling them don’t always have the participant’s best interest at hand, and there is ineffective consumer protection here. If this happens, broker-dealers who are selling IRAs are going to have to change the way they operate and the way they get paid in connection. I don’t believe the industry’s cry for help, that it will push brokers out of the business and close access to 401k participants. There is still money to be made and the DOL will allow commissions. At the end of the day, consumers should have their retirement savings protected from conflicted advice from the first dollar in a 401k to the last dollar out of an IRA.”

But not everyone agrees the DOL will make this move. Rischall says, “I highly doubt the DOL will move forward with fiduciary guidelines on IRAs. The retail investor isn’t their market to protect (unless an employer/plan sponsor is involved) in the first place and they are only addressing the issue due to a technicality. The DOL should remain focused on labor issues and allow other regulatory bodies to make decisions without additional contention.”

Finally, we must recognize that even as some remain conflicted regarding the DOL’s proposal, they see the overall positive public relations impact the new Fiduciary Rule can have. Hooper says, “I would like to see IRAs held to the same standards as 401k plans to ensure appropriate and prudent solutions become the standard. However, this is a disruptive change that could have a significant impact on many financial institutions’ business models. Lack of fiduciary oversight is one more element fueling the distrust many investors have for financial services overall. Any steps we can take to remove these barriers will help restore faith in the system and encourage people to save for the future.”

FINRA, the wire-house brokerage industry’s self-regulatory organization, appears to be moving ahead in anticipation of a possible DOL decision. Perry says, “In a regulatory notice issued last month, FINRA warned its members that they should refrain from recommending changes from a 401k company plan into an IRA if there is no benefit for the client to do so. The notice said that any recommendation must be suitable for the customer and fair, balance, and not misleading. One thing is clear, the industry is opposed to a uniform standard for advisors and broker-dealers, citing differences in the business models and the potential to run brokers out of the IRA business altogether.”

Wernette see this more as a preemptive measure. He says, “IRAs do not fall under ERISA and are therefore on FINRA’s turf and not the DOL. I think FINRA is looking at it in the same way and they feel that there should be a fiduciary standard.”

But does this move by FINRA really represent a capitulation, or is it merely a clever ruse to create a de facto watered-down fiduciary standard? Thompson adds, “FINRA appears on the cusp of moving ahead of the federal agencies on a fiduciary standard. However, it has to be careful in its approach. Given a limited regulatory mandate, FINRA has instead resorted to encouraging or mandating fiduciary-like practices, such as strengthening its suitability standard and calling for avoidance or disclosure of a broker’s conflicts.”

Brethowr feels the FINRA notice is really no change at all. He says, “It’s no coincidence the subtitle was ‘FINRA reminds firms of their responsibilities concerning IRA rollovers.’ Given the SEC’s lack of involvement I’m not surprised to see FINRA issue a notice to re-enforce the suitability standard. It simply felt like a notice to say, ‘it’s business as usual until further notice.’ The fact that it’s an examination priority for 2014 also leads me to believe there won’t be any change until 2015, and gives both FINRA and member firms an opportunity to prepare for the higher DOL standard.”

Richter is even more to the point when he says, “FINRA did not actually make any changes – it’s speculation at this point that their report will trigger voluntary action. One key factor that seems to be overlooked in the debate is, ‘what does a fiduciary standard really mean?’ Even if the SEC or FINRA were to create a ‘fiduciary’ standard, the DOL does not believe that its standard will be as stringent as the fiduciary standard under ERISA.”

Regardless of intent, in terms of the practical implications of FINRA’s notice, Rischall says, “FINRA’s decision is very interesting and will likely have a larger impact on brokers and advisors working on proprietary platforms and with larger institutions. In general, investors should clearly understand the motivation and compensation that drives decision making for the firms managing their money. Conflicts of interest should be clearly communicated in plain English, as a whole the industry should drop the legalize if the goal is to benefit consumers.”

In terms of surprises, Perry says, “The most surprising event will be the inclusion of Bitcoin within the traditional retirement portfolio. In the traditional high risk/high reward asset category, exposure to alternative currency such as Bitcoin will likely increase. Equally surprising, the range of alternatives and likely the percentage of such products will likely increase as well.” If true, like any other new or alternative investment, this will pose a tremendous compliance burden for plan sponsors. While it’s unlikely 401k plan sponsors will have familiarity with Bitcoins, the greater question is “Do financial providers have enough experience with Bitcoins to justify their inclusion in retirement portfolios?” It is problematic in terms of carrying out one’s fiduciary duty if one lacks the expertise to judge a particular investment.

Zempel thinks 2014 will be the watershed year for benchmarking the value of service providers. He sees this as overtaking the undue emphasis on costs. Zempel says, “In 2014, many plan fiduciaries will be surprised to learn that merely benchmarking plan fees and/or seeking RFPs won’t give them a free pass on ‘fee reasonableness’ under 408(b)(2). Selecting and monitoring service providers and their respective fees should be a thoughtful and deliberate process. While benchmarking and RFPs should play an integral role in the process, they aren’t, in themselves, the solution. I think 2014 will also be a breakout year for the fee reasonableness testing cottage industry.”

Wernette feels the positive industry response to the anticipated new fiduciary rules will be the greatest surprise in 2014. He says, “I think the big news event will be the fiduciary standard, and a surprising event will be more of how the industry is going to ultimately wrap its arms around the standard and apply it. The DOL already issued their proposed standard, and there are a lot of people making guesses whether the new re-proposed standard will look different than the previously proposed standard. We think it’ll look very close to what we’ve already seen… with some prohibitive transaction class exemptions. It will be interesting to see the industry’s reaction to any type of fiduciary standard and what ripple effect it will have as it moves its way through the broker/advisor world.”

Plan sponsors are in for a pleasant surprise, according to Henson. He says, “I don’t think the most surprising event will impact employers. The new definition of fiduciary will have a minimal impact on an employer’s administration of their plan, but it will affect the service provider industry if it comes to fruition. To me, it’s another prong of a spear the DOL started forging back in 2009 with the introduction of Schedule C on the Form 5500, and continuing on to the regulations under 408(b)(2) and 404(a)(5), and moving into the future with the re-definition of fiduciary. All of these events are targeted to the service provider industry, a group the DOL has long since sought to take a much more significant enforcement role in. It should be no surprise that we could see a shift in DOL enforcement from employers to service providers in the future.”

Thompson feels the most positive event for retirement plans in 2014 “will be greater transparency of Target-Date Fund holdings under new SEC and DOL guidance, allowing fiduciaries greater ability to undertake due diligence.” Target-Date Funds continue to grow in popularity among 401k investors mainly due to the results of the 2006 Pension Protection Act. Unfortunately, these controversial funds are not managed by a consistent set of standards, making good fiduciary due diligence nearly an impossible task. (Indeed, some of the more conservative fiduciaries refuse to include these untested products in plans’ menu options, opting instead for the more seasoned Lifestyle Funds.) Should the SEC and DOL produce what Thompson suggests, 401k plan sponsors might find it easier to both include or even reject Target-Date Funds (depending on the outcome of any real due diligence that would then be able to occur).

In the coming year, Henson sees the most positive event as the “renewed interest in fiduciary education and improved process.” He says, “The fee disclosure regulations of 2012 really seemed to open the door to a myriad of fiduciary discussions with plan sponsors. We spend a great deal of time with our clients in preparing them to run a plan that is compliant, but we also take that opportunity to go beyond meeting the standard and using best practices. Plan sponsors and their plan committees are genuinely interested in the topic, probably due to fear to a certain degree, but it has opened the door to discussions on plan design and administration and how they can be improved, whereas in the past many sponsors felt that if it wasn’t broke, there wasn’t a need to fix it. The increased regulation has resulted in better retirement plans.”

Henson is quick to point out, however, fee disclosure has a dark side plan sponsors and their service providers must deal with. He says, “I think the shell shock of plan fee litigation will start to push employers into a defensive investment selection process. The conversation we are starting to have more often has shifted from ‘what is the best fund available’ to ‘what is the safest fund available,’ with ‘safest’ referring to avoiding getting sued or regulated. Fee scrutiny is good, but it’s only an opportunity to see where you can improve, it was never meant to scare investment committees into an ultra-conservative thought process. We are spending considerable time consulting on the risks of revenue sharing, the risks of proprietary mutual funds, the risk of not choosing the lowest fee share class, all of which are valid conversations, but shouldn’t dictate the investment selection on their own. I don’t see an end to this any time soon, and I don’t see making investment decisions out of fear as a good thing.”

Rischall also sees fee disclosure as a continuing negative for plan sponsors and participants – at least until the DOL clarifies and simplifies the disclosure requirements. He says, “The fallout from 408(b)(2) and 404(a)(5) will continue to haunt us. Recent research suggests that the disclosures have not been effective in communicating the intended message to 401k participants, and a large portion of these participants aren’t reading the notices anyways. The stigma of ‘fees’ is a turn off for most, the lengthy legal disclosures need to be replaced with a format that is easier for consumers to comprehend. These laws were intended to protect plan participants, not confuse them.”

McAvoy says, “The most negative event for retirement plans will be proposals which seek to allow more access to retirement funds so that people can spend the money now. Very bad idea.”

Hooper sees the still floundering economy, the growing regulatory burden and increased healthcare costs all contributing negatively to retirement plans. She says, “For participants, I’m concerned about a potential decline in deferral rates by those impacted by a rising healthcare costs, a changing economy or fear in general. For businesses, trends I hope not to see are those who choose not to – or no longer – offer a plan due to the costs, liability or administrative burden.”

When asked what he thought about whether 2014 will finally see a Uniform Fiduciary Standard, Phil DeMuth, of Conservative Wealth Management LLC in Los Angeles, California said, “It doesn’t make any difference. They might as well issue a proclamation telling Great White Sharks not to eat swimmers off Amity Island.”

Rhoades seems to recognize this. He applauds the DOL’s efforts to forge through their own process towards a new Fiduciary Rule, Rhoades says, “While this rule will be significant, it is not a universal application of a true fiduciary standard to the delivery of investment advice, which only the SEC has the power to effect.” In the end, he believes only the marketplace will settle this issue.

Perhaps it’s best to leave this subject of 2014 predictions with the following comment from Richter: “It’s too unpredictable to even speculate on what will happen due to the divisiveness on Capitol Hill and regulators being consumed with the implementation of the Affordable Care Act (ACA). What might be positive is a year of no surprises or major legislative or regulatory changes. Fee disclosure consumed so many resources over the past several years that the most positive event would be no event.”

Of course, we can’t leave it on this hopeful note, since, as Graff said, “Don’t underestimate the government’s desire to be relevant.”

This was one of our longest articles. If you’ve made it this far, you must really be interesting in learning how to build a better 401k plan. If this is the case, you may want to purchase Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. The book also contains a series of chapters on benchmarking, including how to create a plan “report card” to better evaluate its effectiveness.