When the DOL’s Phyllis Borzi stepped into the House Subcommittee on Health, Employment, Labor and Pensions hearing room on a sweltering July 26, little did she realize she placed herself directly into the bipartisan sites of the best double-
barreled political pounding lobbyist money could buy. Congress demanded she “re-propose” the DOL’s new fiduciary rule. Republicans called it an “ill-conceived expansion” that would “drive up costs” of providing advice to retirement investors. Democrats promised the new fiduciary definition would “hurt the economy” and pointed to a “lack of evidence” supporting the need for the change.
Borzi, as she demonstrated when taking on industry advocated directly at the March DOL public hearing on the matter, deftly addressed the politicians and stood her ground. The anti-fiduciary advocates in financial industry, had more cards to play. Following on direct White House lobbying efforts in June, the Financial Services Institute (FSI) rallied its member to send letters directly to President Obama. In the last three weeks, 3,000 letters have arrived all claiming the proposed rule change would hurt the average retirement investor.
Oddly, those in favor of the new rule say the current rule hurts the average retirement investor. Clearly, both sides cannot be right – or can they? Let’s take a look at the most measurable position of those assailing the proposed rule – that of costs.
It is easy to understand the costs of shifting regulations will increase costs to those businesses falling on the wrong side of the regulation change. Today, both investment sales professionals (“brokers”) and fiduciaries (“RIAs”) currently provide investment advice to retirement plans. Under the proposed change in definition of fiduciary, in the worst case, brokers will have to transition their business to that of an RIA. There will be one-time start-up costs in doing this as well as different (not necessarily greater or lesser) ongoing costs for maintaining the new business model. This is a real issue to those brokers impacted by the rule change and it has the potential to impact their livelihood, at least during the transitionary period.
What about the costs to the retirement investors? Congress and the brokers lobbyists they work for appear to assume both the broker costs may increase as a result of the change in fiduciary definition and that those soon-to-be new RIAs (nee brokers) will pass on those increased costs directly to retirement plans and their investors. Truth be told, this is something we can actually test in the real marketplace. If this assumption is correct, then we should be able to find plenty of examples where brokers are able to win business from RIAs because they can provide advice at a lower real cost to the retirement investor.
Fiduciary News conducted a simple test. Using the HARO reporter query system, we asked 401k and IRA investment professionals to provide us with specific examples of winning business either from RIAs or from brokers based on offering lower fees. Mind you, this was an unscientific sampling and, at best, will merely deliver anecdotal evidence one way or another.
The results proved most interesting. Of all the respondents, not one provided an example of a broker winning business based on lower fees. To be fair, there’s no doubt there are some outliers that would show this, but we feel it significant the most immediate responses did not yield any examples. Here are some of the responses we received.
Paul McEwan, CPA, Principal/Director of Benefit Plan Administration at Rea & Associates, Inc., provides an overview of the basic dichotomy. He explains, “Brokers are compensated based on product commissions or transactions. RIA advisers are compensated based on a fee that is typically a certain percentage of assets. The difference between the two models is that one is being paid for investment advice and the other is being compensated for selling a product or executing a transaction. Being compensated as part of the deal means a broker is not independent and therefore cannot serve as a fiduciary, whereas an RIA adviser is only being paid for his advice and has no interest in the transaction, so can serve in a fiduciary capacity. Depending on how you frame the debate, you can make an argument either way that one way or the other is more costly.”
One way to frame the debate includes counting only out-of-pocket expenses as “fees.” In this view, brokers have the advantage over RIAs because brokers can receive compensation through commission paybacks directly from the products they sell. On the other hand, if one includes those commissions as part of the costs, RIAs tend to look better compared to brokers.
Joe Goldberg, Accredited Investment Fiduciary®, CRPS is a Principal and Director of Retirement Plan Services at The Buckingham Family of Financial Services. He’s “extremely supportive” of the DOL’s proposed new definition of fiduciary. “It will put more of the financial services industry on the same side of the table as the client,” he says. Goldberg goes on to say “the statement that broker sold IRA’s vs. Adviser managed IRAs are cheaper is a statement that I have never seen or heard any data that indicates this. It likely doesn’t take into account the actual investment expenses that are within the accounts as the broker gets paid by the fund company either in the form of 12b-1 fees or [commission] loads. Independent advisers charge a fee for the advice they give. Depending on the share class that brokers sell, brokers could be significantly more expensive than an adviser managed IRA even when you combine an advisor fee with the fund expenses.”
“Over the years I’ve taken on several clients who previously had worked with stock brokers who had them in expensive mutual fund share classes.” says Roger Wohlner, CFP®, a fee-only financial adviser from Chicago. “These include both individual and institutional clients. A typical example is moving the client from B shares into regular no-load shares at NAV and when possible into more advantageous share classes such as Institutional share classes. Even with my fees the client’s overall cost where significantly reduced.”
When asked to provide a generic example showing the level of the significance, Wohlner said, “I have an institutional client that was largely in B shares many years ago when I first started working with them. At the time there was maybe $4.5 million with this broker. If we assume a savings of about 150 basis points you are looking at something north of $60,000” per year. Depending on the type of business, that’s enough savings to hire one or two additional employees, not bad in an economy with excessively high unemployment.
McEwan adds it’s his opinion “investors will be better off if they are being served by an adviser serving in a fiduciary capacity because they will be receiving unbiased investment advice. So over time, their investment performance should be better, net of any fees paid.”
Academic research supports this. As reported by Fiduciary News earlier this year, (“Does New Study Seal the Deal for Fiduciary Standard – or Just Warn Plan Sponsors?” Fiduciary News, January 19, 2011) a new National Economic Bureau of Research (NBER) study concludes direct-buy funds outperform broker sold funds by about 1%. What this suggests is, even if one ignores the actual savings in fees, retirement plans utilizing funds selected by a fiduciary vs. those selected by a broker should see better investment results over the long-term.
This research, and the above anecdotes, calls into question claims by politicians and industry lobbyists who make statements suggesting the costs of the DOL’s proposed change in the definition of fiduciary may “hurt the economy.” While increased business costs may hurt brokers forced to comply with the same rules as RIAs, it’s clear the cost of not updating the definition of fiduciary entails far greater costs to retirement plan investors. In the end, who is the DOL charged to protect: the industry or the retirement plan investor?
Fiduciary News invites you to add your own “true-life” story in the comment section below. Do you have a real-life example of winning business based on fees – either as a broker or an RIA? If so, enter it as a comment. Remember, we’ll be monitoring the comments, so avoid any “fee savings” that incorporate mutual fund expense ratios (the impact of those are already including in the performance of the fund). Also, avoid mentioning fund performance at all. We’ll leave that to the academics. Instead, focus only on the out-of-pocket and sales commission (12b-1, loads, etc…) transaction-based fees of brokers as compared to asset-based fees of RIAs using a specific “before” and “after” example (see Wohlner’s example above). Who knows? If we get 3,000 comments, maybe we’ll send them to the White House.
Chris, an excellent article. There is no doubt in my mind that fiduciary duties, imposed upon all providers of investment advice to plan sponsors, will minimize fees and costs. Disclosure of fees and costs is always good, but nothing beats the fiduciary duty – which includes due diligence and spending wisely – to reduce fees and costs. Fiduciaries must control total fees and costs paid. There is a major difference between acting as a “purchaser’s representative” (i.e., fiduciary – with obligation to keep fees and costs reasonable) and “product manufacturer’s representative) (i.e., product salesperson, with no such obligation).
I would note that it’s not only about the “disclosed fees” of pooled income vehicles – i.e., the annual expense ratio, but also (with appropriate due diligence) that matter; it is also the “hidden fees” (as I call them) in funds – soft dollar compensation driving brokerage commissions (for trades within funds) higher, other transaction costs (bid-ask spreads, etc.), inappropriate sharing of securities lending revenue.
I predict that we will continue to see a “race to the bottom” as far as advisory fees go. Perhaps even a move toward flat or fixed fee arrangements, for advisors to plan sponsors. A good thing for retirement plan participants, but challenges for the AUM business model. This may take years to build momentum, but already evidence exists.
Again, a good article, and I hope others will share their stories and insights on this issue, in this discussion thread.
Chris, another great article, thanks for quoting me.
Chris, the PlanTools benchmarking statistics support your conclusions. In general, a plan managed by an RIA has lower net investment management costs (not necessarily lower OER) and lower recordkeeping fees than a broker sold plan. In addition, the RIA sold plan tends to have higher cost for the advisor services than the broker sold plan. This is not universal, as there are a number of brokers that have denied their fiduciary status while acting in a fiduciary capacity due to B-D restrictions. These brokers are the most likely candidates to adopt the RIA model with their existing B-D or jump ship if the B-D fails to accommodate the fiduciary model. The remaining broker sold plans are vulnerable to take over by more qualified RIA advisors. The country club good olde boy network is dying fast. 408b2 and 404a5 has struck a death blow to the relationship sold plans with inactive brokers that collect commissions and do nothing. Bottom line, RIA sold plans achieve measurable improvement in services, results and lower overall costs than broker sold plans. The cost shifting is justifiable based on fees charged for services rendered. The DOL has not gone far enough and it has taken them far too long to demand all advisors to adopt a fiduciary model to protect participants and the plan sponsor.