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How Will New ADV Part 2 Help (or Hurt) 401k Plan Sponsors?

March 31
00:42 2011

For those not familiar, the SEC requires all registered investment advisers to file an annual update of their Form ADV. For several years, advisers have been able to file Form ADV Part I electronically. Form ADV Part II, a brochure advisers must furnish 1259959_50649113_hieroglyphic_writing_stock_xchng_royalty_free_300clients when they sign up and annually thereafter, remained off-line – until this year. Form ADV Part II must be updated at least annually within 90 days of the adviser’s fiscal year. For most advisers, the annual update is due by March 31st. This year adds a new twist – and it may have ramifications for 401k plan sponsors.

After almost a decade of deliberations, the SEC finally removed the old Form ADV Part II and it’s fill-in-the-blank forms and replaced it with a new Form ADV Part 2 “plain English” booklet. Among the changes, the SEC decided to call it “Part 2” instead of “Part II,” apparently to avoid confusion. In no doubt another attempt to simplify matters, the SEC issued an 81-page “Plain English Handbook.” Subtitled “How to create clear SEC disclosure documents,” the booklet is nearly 8 times larger than the instructions for the form. We’ll leave it to the reader to ponder the irony of the brevity (or lack thereof).

Most importantly, the instructions for the new Part 2 liberally refer to asking the adviser to explain answers in the context of the adviser’s “Fiduciary Duty.” Indeed, right on page one sits item 3: Disclosure Obligations as a Fiduciary. The SEC writes:

Under federal and state law, you are a fiduciary and must make full disclosure to your clients of all material facts relating to the advisory relationship. As a fiduciary, you also must seek to avoid conflicts of interest with your clients, and, at a minimum, make full disclosure of all material conflicts of interest between you and your clients that could affect the advisory relationship. This obligation requires you to provide the client with sufficiently specific facts so that the client is able to understand the conflicts of interest you have and the business practices in which you engage, and can give informed consent to such conflicts or practices or reject them. To satisfy this obligation, you therefore may have to disclose to clients information not specifically required by Part 2 of Form ADV or in more detail than the brochure items might otherwise require. You may disclose this additional information to clients in your brochure or by some other means.

Let’s be honest, if you’re not already obliged to assume this level of fiduciary liability, would you try everything you can to avoid this onerous requirement? Jim Young, Vice President, AFC Asset Management Services, doesn’t think it’ll be that difficult for current investment advisers. He says “There is no change in ‘fiduciary duty’ for advisers.” Maybe not, but we can begin to see why the brokers are fighting the SEC so hard on the fiduciary standard issue. After all, why take on this added burden when you can just leave it with the client? (N.B.: In order for 401k plan sponsors to reduce their fiduciary liability as it pertains to investments, they must hire another investment fiduciary – that would be a registered investment adviser, not a broker.) Of course, the broker industry’s real concern is whether it will be able to continue engaging in conflicts of interest. Clearly, despite the warning of academic researchers like Daylian Cain (see “Exclusive Interview with Yale’s Daylian Cain: Just a Sugar Pill? Disclosure’s ‘Ah-Ha!’ Moment,” Fiduciary News, October 18, 2010), the SEC appears willing to turn the other cheek as long as there’s disclosure.

That said, how will the SEC’s new emphasis on “fiduciary duty” help 401k plan sponsors? “We think it will help big-time,” says Skip Schweiss, Managing Director, Advisor Advocacy and Industry Affairs, TD Ameritrade Institutional.” He adds, “Many plan sponsors – especially those in the micro-to-small plan market – don’t know a fiduciary adviser from a broker. Some may think they are getting fiduciary advice when they are not.” Schweiss believes these new regulations “will shed new light on the services and fiduciary status of plans’ advisers.”

But the new Form ADV Part 2 might also place a greater fiduciary liability on the shoulders of 401k plan sponsors? First, by making conflicts of interest explicitly clear (whereas before they might have been unknown), the plan sponsor no longer has plausible deniability. As a result the 401k plan sponsor may be implicated along with the financial service provider should those conflicts of interest create a fiduciary breach that directly leads to material asset losses for plan beneficiaries. Secondly, by relying on free-form text, it may be more difficult for 401k plan sponsors to compare advisers in a side-by-side manner. Young says, “The new ADV Part II format allows firms to write a little or a lot, depending on their level of sophistication and openness. This may be problematic for investors as they try to compare [a large firm’s] 100 page ADV with a boutique RIA’s 20-page document.”

Comparing the new form to the old one, Schweiss says, “if it’s more informative to clients, then it’s an upgrade.” But, he adds, “The previous ADV was probably a quicker read.”

Young, on the other hand, points out, in his experience “The main issue is the average individual investor does not read the ADV at all. The 401k plan sponsors are more likely to skim it or give it a thorough read. I have not, however, ever had a client (plan sponsor or otherwise) ask me a single question about anything in the ADV. Either we have Hemingway’s writing skills or the ADV is not an important aspect of the advisor evaluation and selection process.” He sanguinely concludes, “Since the document does not seem to be important to sponsors or individual investors, does it matter if the old form or the new one is better?”

In the end, Young feels some people will like the new Part 2 while other will continue to prefer the old Part II. “It’s like asking whether you like Google’s simple user interface or’s busy one,” he says. “I like the simple Google (and old check-box ADV) look because I hate clutter. Our Ops Manager likes the Amazon (wordy, lengthy detail) look.”

Schweiss thinks the new emphasis on “fiduciary duty” will have a positive impact the industry, although not without some initial confusion. “The SEC and DOL are working this from different angles,” says Schweiss. “They say they are talking, but will not come out with a single definition of fiduciary. And the DOL is moving forward more aggressively with its rulemaking process. So we will have a continuation of disparate definitions and regimes around the fiduciary concept for ERISA plans vs. non-ERISA business.” Still, Schweiss foresees an evolution in the industry because “the new rules will tilt the playing field strongly in the direction of fiduciary advisers providing advice to retirement plans, over the traditionally-dominant players from the brokerage and insurance industries.”

In the end, whether the new Form ADV Part 2 helps or hurts 401k plan sponsors will depend on their ability to sift through and really understand what this new pile of paperwork is telling them.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

1 Comment

  1. Tim Wood
    Tim Wood April 01, 14:15


    As usual, outstanding work!

    I agree with those you interviewed as well as your own thoughts, primarily due to fiduciary indifference. When we distribute those documents to our new clients, we encourage them to read them. We have even taken the opportunity to briefly walk our clients through them. However, to a person, no one is particularly interested.

    Is the average broker or product provider doing this? It is hard to say. That notwithstanding, it is akin to being served a subpoena, you do not have to read the subpoena to be legally bound by it.

    If a broker or other conflicted salesperson is able to continue to engage in conflicts of interests, and now it is “disclosed” to the responsible fiduciary, 100% of the burden of liability for investment selection now rests squarely on the shoulders of the responsible fiduciary. Investment selection and all its antecedents, revenue sharing, too much revenue sharing, poor investment performance, investments too costly, is where all the lawsuit activity is.

    For plan sponsors working with a conflicted salesperson, this new requirement significantly increases the perils of sponsoring a plan.

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