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5 responses to “Exclusive Interview with Ron Rhoades: Revenue Sharing – Two Hats are Worse than One”

  1. Stephen Winks


    Ron Rhoades as usual is brilliantly incisive.

    Wouldn’t it be great if Ron actually ran a regulator, he would save millions if not billions in overhead, bring uncommon clarity and would greatly simplify the unnecessarily complex business.

    Instead we have very little depth of understanding in Washington that is vastly overpaid, very easily swayed that have forgotten their principle mission is to protect the best interest of the investing public rather than the best interests of the industry.


  2. Pedant

    If there were no exemptions to the prohibited transaction rules (Dr. Rhoades’ stated policy preference in the first question above), no plan would be able to renew their contracts with his company, ScholarFi. Under ERISA Sec. 3(14)(B), a service provider is a party in interest, and under Sec. 406(a)(1)(C), a fiduciary shall not cause a plan to engage in a transaction that will result in the furnishing of services by a party in interest.

    I assume Dr. Rhoades actually meant the he opposed the administrative, rather than statutory, exemptions to the prohibited transaction rules. Even there, though, one does not have to look very hard to find an endless parade of perfectly necessary administrative exemptions. My guess would be that if Dr. Rhoades offers any employee benefit plans to his employees, he probably utilizes quite a few administrative exemptions or DOL policy interpretations that undercut the purity of the prohibited transaction rules “as written.”

    Regardless of one’s views on the proper legal constraints on conduct by a financial advisor to an ERISA plan (a legitmate debate), surely we can all agree that the prohibited transaction rules without any exemptions (administrative or stautory) would simply not work?

  3. Pedant

    I was making the broader point that the prohibited transaction rules are not divine moral rules handed down on stone tablets that if only followed would make life better for all–they are overbroad and unworkable creations of Congress, and “as written” “without exemptions” their strict application would bring normal plan operations to a crashing halt. They would put Dr. Rhoades out of business.

    However, reading your reply has caused me to reread Dr. Rhoades’ original comment more closely, and I’ve now reached the conclusion he is simply attacking a straw man to further his argument in favor of a more broad fiduciary standard, something that has nothing to do with the prohibited transaction exemptions he incorrectly asserts are unnecessary.

    His basic thesis in the first paragraph is that “revenue sharing” results in variable compensation to the advisor, which would lead to conflicted fiduciary advice. To put it in the vernacular–well, duh! That’s been the longstanding view of everyone. What’s more, such conflicted advice by a fiduciary is already prohibited and there is no exemption. Why is he discussing it all? He is doing so to incorrectly assert that broker dealers are violating this standard, when the reality is that they generally are not fiduciaries under the current rule. This rule, by the way, is the regulatory definition of the term “fiduciary” that has nothing to do with prohibited transactions and their exemptions! (Yes, the application of the prohibited transaction rules depends on fiduciary status, but the definition of fiduciary is entirely separate from the PT rules–modification of the PT rules has no effect on the definition.)

    The Frost Bank Advisory Opinion (AO 97-15A) clearly lays out the issues relating to receipt of mutual fund service payments (or “revenue sharing”) and DOL clearly says that you cannot receive such payments from funds about which you provide fiduciary advice to a plan unless you offset the fees to remove any economic incentive that would influence your fiduciary advice. (This, by the way, is not an “exemption” from a prohibited transaction–offsetting prevents a PT from ever existing rather than excusing a PT that would otherwise occur).

    The issue, then, is whether one is a fiduciary. And under current DOL regulations (not prohibited transaction exemptions, but regulations interpreting 3(21)) you are a fiduciary advisor if you regularly give individualized advice for a fee subject to a mutual understanding that the advice will form the primary basis for the plan’s decision-making.
    Broker dealers typically are not fiduciaries under this definition. That seems to be what is really bothering Dr. Rhoades.

    Thus, I’m back where I started. If you want to have a legitimate debate about the conduct of advisors, including when and how the fiduciary standard should apply, that’s a legitimate debate. But to couch this question in terms of exemptions from the prohibited transaction rules, or as a departure from the intended purity of those rules, is simply incorrect. If you want to fight about the regulatory definition of an ERISA fiduciary advisor (a current debate that is the subject of a DOL regulation likely to espouse Dr. Rhoades’ policy view that we anticipated seeing in May) then do so honestly.

  4. R. Rhoades

    While I thank my colleague for his comments, I believe they are misdirected and seek to obfuscate the advice I sought to provide to plan sponsors.

    The question posed in the interview concerned how plan sponsors can better protect themselves. To put it bluntly, plan sponsors should INSIST that the advisor to the plan, undertaking recommendations with respect to vendors or any forms of investment, be a fiduciary. The gravest mistake a plan sponsor can make is not insisting on fiduciary status – thereby opening the door to many types of “hidden” fees and costs.

    The basic issue is caused by the often-confusing use of terms such as “advisor,” “investment adviser,” and “financial consultant.”. No doubt my comments could have more accurately stated whether I was referring, in the context of each concept, to fiduciary or non-fiduciary advisors.

    One might try to opine that a “sophisticated” plan sponsor need not require fiduciary status. But if the plan sponsor were truly sophisticated, fiduciary status would always be bargained for.

    One might also try to opine that fiduciary status results in higher fees and costs, as greater liability to the advisor attaches. Yet in all my many reviews of plans it is the non-fiduciary “advisors” whose “solutions” result in higher fees and costs for the plan participants. Simply put, fiduciaries represent the plan (and have duties to its participants), and part of these duties include insuring that fees and costs are reasonable. Non-fiduciaries are free to recommend more expensive products – which product sales are more profitable for the non-fiduciary.

    One might try to argue that higher-cost products, because of the higher fees paid, perform better. But knowledgeable plan sponsors are well aware that higher fees are closely, and negatively, related to participant’s investment returns, on average. A great deal of academic research supports this conclusion.

    My colleague sought to infer that my comments were self-serving. Yet, I routinely refer (for no compensation) plan sponsors to fiduciary investment advisers, TPAs, and custodians who provide exceptional – and low-cost – services. My firm is not currently accepting any more clients, due to capacity constraints resulting from my desire to serve only a select few clients.

    Yes, (nearly) all those who provide investment recommendations to a plan sponsor should be a fiduciary. And when the DOL re-defines “fiduciary” more broadly, as I believe Congress originally intended, great care should exist to conform the conduct of broker-dealers to the fiduciary standard, NOT to conform fiduciary standards to the existing businesses practices of broker-dealer firms and insurance companies.

    The many issues surrounding the application of fiduciary status are complex and intricate. But for the issues of concern to plan sponsors – the subject of this interview – the solution to their need for protection is clear. Avoid variable compensation arrangements and the incestuous conflicts of interest created thereby. And yes – plan sponsors should insist on fiduciary status, which largely require the avoidance of such conflicts.

    I suspect that the only persons in this world who would argue against fiduciary protections for plan sponsors are the North Korean and Cuba dictators, and perhaps those non-fiduciary “advisors” whose excessive siphoning of the returns of the capital markets away from the retirement nest eggs of our fellow Americans is jeopardized by the expansion of the protections of the fiduciary standard of conduct.

    While my comments were originally directed to plan sponsors, there are larger issues at stake, as my colleague suggests.

    I implore the DOL to not, as the BD and insurance industries desire, grant exemptions from the prohibited transaction rules – when those rules and ERISA’s fiduciary protections are applied in full to those who are currently not fiduciaries (often inexplicably, given the plain language of the statute itself).

    Lastly, kudos to Ms. Phyllis Borzi and others at DOL for courageously standing up for plan sponsors and plan participants in the face of HUGE pressures bought to bear by Goldman Sachs, Merrill Lynch, and the other investment banks and monied interests of Wall Street. Powerful forces oppose the disintermediation (and lowering of fees and costs) which occurs when fiduciary standards are imposed upon providers of financial services.

    The future financial security of tens of millions of our fellow Americans is at stake. And if the returns of the capital markets remain largely diverted from consumers, due to often-hidden, high fees and costs, governments will be further strained as they try to provide for the needs of retirees.

    All that fiduciary advocates ask is that the interests of the consumers of financial services be protected from the greed of Wall Street’s investment banks and the giant insurance companies by the application of the true fiduciary principles. It is what consumers want. It is their reasonable expectation. It is what America needs, to restore trust in our financial services system, promote investments in our capital markets, and thereby provide the fuel for a new era of U.S. economic expansion.

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