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Fiduciary Standard: Backdoor Solution to 401k Plan Sponsors’ 12b-1 Problem?

April 14
00:52 2011

In January, we reported a story on a new research paper where one of the lead researchers said “it is reasonable to conclude” 401k plan sponsors – and the participants of their plans – on average will tend to benefit from hiring a fiduciary 791216_13121796_backdoor_stock_xchng_royalty_free_300charging an asset based fee of less than 1% compared to buying funds through a broker, (“Does New Study Seal the Deal for Fiduciary Standard – or Just Warn Plan Sponsors?Fiduciary News, January 19, 2011). The article specifically cites 12b-1 fees as one of the attributes of broker sold products. Last week’s comments – both public and private – reveal one possible strategy for addressing the 12b-1 dilemma.

On April 8, 2011 in Dallas, Texas, Chairman Mary L. Schapiro, in her remarks before the Society of American Business Editors and Writers said the following of the Fiduciary Standard study released this past January:

“The report noted that few investors are aware of or understand the difference between the fiduciary standard required of investment advisers and the less strict ‘suitability’ standard observed by broker-dealers. As I have long advocated, the report recommended the establishment of a uniform fiduciary standard of conduct for all financial professionals when they provide personalized investment advice about securities to retail investors. I believe that investment professionals’ first duty must be to their clients, and I look forward to beginning work soon to codify the report’s recommendations.”

But just days earlier she told the Securities Industry and Financial Markets Association “budget and resource constraints meant some issues, like changes to 12b-1 mutual fund fees paid to brokers, would not be addressed until 2012 at the earliest,” according to John Taft, chairman of SIFMA.

Given the research study cited in the lead paragraph, are these two statements – putting clients first vs. delaying changes to 12b-1 fees – incongruous? Or, is the fiduciary standard a potential backdoor solution to the dilemma posed by 12b-1 fees?

Marcia S. Wagner, an ERISA attorney at the Wagner Law Group recently wrote, given the proposed changes in the fiduciary standard by the SEC and the new definition of fiduciary offered by the DOL, brokers would “undoubtedly need to change their service model and redefine their role as plan advisers.” Wagner suggests it would be very difficult for non-fiduciary brokers to continue to accept 12b-1 fees as doing so “would trigger a non-exempt prohibited transaction under the Employee Retirement Income Security Act (ERISA).”

Rich Lynch, Chief Operating Officer of fi360, agrees with the 12b-1 fee problem cited by Wagner. He says, “These fees create conflicts for advisers and fund company directors, and they complicate the comparison and control of costs across funds.” It’s possible moving forward with these fiduciary changes would automatically remove the conflict of interest issue of 12b-1 fees, at least in the ERISA realm. Still, others see 12b-1 fees remaining – despite the acknowledged conflict of interest and the study showing they’re likely not in the best interests of the client – simply by disclosing their limitations.

Ron Butt, Senior Partner at the ARGI Financial Group, feels the issue has less to do with the actual 12b-1 fee and more to do with both disclosure and the nature and structure of brokerage firms. Butt says, “how a financial professional is compensated is not important to the public. It is the non-disclosure of how and the amount that will make the difference.” He believes transparency might prove a problem for brokers providing little or no service. “Once the public finds out they have been paying for something they have not received,” says Butt, “they will request refunds or worse file lawsuits or arbitrations. The brokerage firms are more concerned about the latter than the former.” Regarding the structure of brokerage firms, Butt says, “They are set up to sell products and raise capital. It is only when these activities are not in the clients’ best interest and/or are not disclosed that the problem occurs.”

Not everyone, however, believes the industry can get by merely with more disclosure. T. Henry Yoshida, Principal at The Maresh Yoshida 401k Group, says, “If the SEC adopts a Fiduciary Standard, there will be no need to rule on 12b-1 fees since brokers/advisers will not be able to be compensated for managing a plan at all.” He says the reason for this “a provision of the Fiduciary Standard that states that the RIA or ERISA appointed Fiduciary must avoid conflicts of interest.”

Lynch is concerned disclosure won’t meet the objectives of the SEC. He says, “If the SEC does not move forward on its current 12b-1 proposal, even with disclosure and transparency of fees, investors still may not understand what those fees are.”

The fiduciary standard might be a backdoor solution, but the truth is we don’t know what’s behind that door.

Perhaps we should leave the last word to Chicago based financial planner Roger Wohlner, CFP®, who says, “If the 12b-1 goes away (and it probably should) my fear is what will replace it. Will the cure be worse than the disease?”

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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1 Comment

  1. Roger Wohlner
    Roger Wohlner April 14, 13:16

    Good article Chris, thanks for including my quote.

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