Friday, January 8, 2016

2015 a Year of Mixed Blessings

When we were youngsters, one of the lessons our parents tried to teach us was that we were unlikely to get everything we wanted.  We were to be appreciative when things went our way, but not be whiners when they didn’t.  The 2015 year now ending was just that kind of year for those who serve the retirement industry.  We have some things to be grateful for, and some things we might have preferred to have turned out differently.  Our glass may not be full, but neither is it empty, so we won’t whine unreasonably.

For much of the year the dominant story was the DOL’s fiduciary regulations, renamed – some think – for public relations purposes as the “conflicted advice” regulations.  In my nearly three decades in the retirement industry I doubt there has been another set of regulations that has generated so much public comment, whether live in public hearings or in written comments submitted to the Department. 

The polarization between opponents and supporters has been profound.  Some within the certified financial planner (CFP) community have voiced support for the proposed regulations; these advisers already consider themselves fiduciaries.  There has also been support from some retiree, consumer advocacy and public policy groups.  Many financial industry firms, affiliated industry groups, and individual investment professionals on the other hand, have been extremely critical of a fiduciary standard they fear will ultimately deprive less affluent savers of badly needed assistance.  There was also an unprecedented level of bipartisan effort in Congress to delay or thwart implementation of these proposed rules.  Many do not think they will ultimately be in savers’ best interest.

Some opponents hoped the Consolidated Appropriations Act – the must-pass federal budget legislation enacted during the week before Christmas – would provide a vehicle by which Congress could intervene via amendment, but efforts to do so were unrewarded.  Advocates of this strategy reportedly may attempt to introduce stand-alone legislation aimed directly at delaying DOL’s issuance of the final regulations.  But overcoming an almost certain presidential veto is thought to have a less-than-an-even chance of succeeding.

Such preoccupation with the proposed fiduciary regulations left the industry open to a virtual blind-side when the DOL in November issued guidance on states establishing or coordinating retirement plans for private sector workers.  Many had expected that the guidance would begin and end with automatic payroll withholding IRA contribution programs, with some states mandating them for most employers that do not establish a recognized retirement plan – however sophisticated or simple.  Instead, DOL went well beyond this, handing states a playbook for assisting businesses in establishing qualified plans. 

Under either the IRA or qualified plan regimen sketched out by DOL’s proposed regulations and interpretive bulletin, states could readily find themselves involved in functions that put them in competition with financial organizations and service providers in the public sector.  DOL, by the way, in its interpretive bulletin created what many feel is an unprecedented and inexplicable exception to its past guidance limiting the creation of multiple employer plans (MEPs).
We understand the numerous states’ clamor for guidance so that they might confidently proceed in encouraging retirement saving by private sector workers within their borders.  This, in the face of inaction by Congress to legislate options or parameters.  But it’s hard not to view this DOL state-coordinated plan guidance as anything but legislation by regulation.

One area in which reason did prevail in 2015 retirement developments is in the requirements for annual plan reporting to the IRS and DOL, via the 5500-series forms.  Proposed for 2015 plan years was a new reporting regimen for filers of Form 5500, 5500-SF, and 5500-EZ, to provide detailed information not only on plan characteristics, but on operations, testing, amending and other elements of compliance.  Apart from an unprecedented level of intrusiveness and “audit mining” in the questions on draft 2015 forms and schedules, also to be required was disclosure of preparer/client relationships.  

Just as most audacious was the matter of timing, and the lack of lead time for plan sponsors and service providers to prepare for the capture, retrieval, and outputting of the information sought in the 2015 plan year reporting cycle.  Fortunately, IRS and DOL were ultimately convinced that plans and service providers needed more time to comply, and this compliance-related information will be optional on Forms 5500-, 5500-SF and 5500-EZ for 2015 plan years.   

Exactly one week before Christmas day, Congress and the President found themselves for once pulling in the same direction and enacted the Consolidated Appropriations Act of 2016.  Within this extremely full and complicated package were some provisions affecting qualified savings programs, including IRAs, SIMPLE IRA, church retirement and 529 college savings plans, and the new ABLE accounts for special needs individuals.

Worthy of special mention is the qualified charitable distribution, or QCD, option for those age 70 ½ or older with IRAs.  This option, which has been with us under numerous legislative extensions since 2006, allows a taxpayer to donate up to $100,000 of IRA assets annually to a qualifying charity, tax-free.  It was made permanent by CAA 2016.  Instead of such taxpayers generally being limited to a charitable tax deduction up to 50 percent of annual income, the amount contributed under QCD can be as much as 100 percent of income, but no more than $100,000.

One might guess that this option would be availed by only a limited number of taxpayers.  But based on evidence from our retirement consulting practice, it was the most-asked-about provision in this legislation.  Also based on our informal data, it’s certainly not the case that every taxpayer using this option gives the maximum amount.  Far from it.  Donating under the QCD program is not “a wash” tax-wise for the giver, either.  Keeping, rather than donating the amount, would still be a net cash benefit to the taxpayer.  While the tax break may be generous, so is the charitable giving! 

One can argue that this tax provision has a cost in tax revenue that must be borne by other taxpayers.  But that can be said of just about any of the several dozen tax benefits in the Act.  Very few of these have at their core the creation of an incentive to be generous.  Among these many so-called “tax extender” provisions, this is one that a taxpayer can be proud to have taken advantage of.

Have a happy and prosperous New Year!   

Friday, December 18, 2015

DOL Stretches Credibility and Precedent in New State Plans Guidance

Several months ago, when the retirement industry was chiefly absorbed in the Department of Labor’s proposed conflicted advice regulations, a colleague commented that many would be surprised by soon-to-be-released guidance on state-based retirement savings programs.  True to this prediction, the guidance issued on November 18th by the DOL’s Employee Benefits Security Administration (EBSA) has given us all something more to ponder, and – at the risk of being called alarmist – perhaps to be quite concerned about. 

As hinted at by Labor Secretary Thomas Perez shortly before the November guidance was released, the agency issued both proposed regulations on state-mandated payroll withholding IRA programs, and also sub-regulatory guidance – Interpretive Bulletin 2015-02 – on state-coordinated ERISA-type plans.  FAQs accompanied the release, as well.  

The more than two dozen states that have taken steps toward implementing state-coordinated retirement solutions have been overwhelmingly interested in payroll withholding IRA programs.  If they proceed, most are expected to mandate that all but the smallest employers must offer such a program if they have no conventional retirement plan.  But given the political divisions that exist all the way from Washington down to local levels, whether this will happen in any given state is anything but certain. 

A small minority of states, at least until now, have shown interest in becoming involved in ERISA-style retirement plans for private sector employers and their workers.  This may change as the new EBSA guidance is digested, especially given the DOL’s very accommodating stance in Interpretive Bulletin 2015-02, offering several options for state involvement in ERISA plans for private sector employers.  This prospect should be of major concern to practitioners and providers in the employer-sponsored retirement plan space. 

It’s hard to fault state legislators and policymakers for taking the initiative on behalf of “plan-less” private sector workers within their borders.  They’ve watched the senators and congressmen they sent to Washington unable to make progress in broadening or enhancing options for their citizens to have greater retirement security.  If something is going to happen, the states’ seem to be concluding that they will have to act on their own instead of waiting for Congress.

I have to remind myself that those in the Department of Labor who drafted this guidance no doubt have good intentions and defensible motives.  They want to see more Americans better prepared to enter their retirement years with adequate financial resources.  But intentions and motives do not by themselves make good guidance or policy. 

Reasonable minds may differ regarding the things government should manage in a free market economy like ours.  But – such philosophical differences notwithstanding – is there any reason to expect that a state will do a better job of managing a retirement program than the private sector?  A number of states’ and other governmental units’ pension systems are in woeful shape.  There also is no shortage of examples of unprincipled use of political power and influence at the state level.  Can we be assured that this will not spill over into the administration of a state-sponsored retirement plan encouraged by this guidance?  One of the reasons ERISA was enacted was to provide both fairness and uniformity in the administration of retirement plans, and there is little reason to expect that every state will do an equally good job of it.

But, even if we accept the premise that state government-coordinated retirement programs for private sector workers are a reasonable way to broaden coverage and participation, there are parts of this DOL guidance that don’t pass muster.  The industry is justifiably asking how the agency could have reached some of its conclusions about acceptable state plan structures.

For instance, DOL takes the position that a state government could set up what would be called an “open MEP,” a multiple employer plan for employers that have no common interest, purpose, or ownership.  This is something that DOL has expressly and aggressively forbade in such recent guidance as Advisory Opinion 2012-04A.  In that 2012 guidance DOL maintained that in order to establish a MEP, the participating employers must have “substantial common control, ownership or organizational connections,” or “substantial economic, business or representational purpose” in common.  

Advisory Opinion 2012-04A further asserted that an unrelated coordinator of a MEP – such as a third-party administration (TPA) firm – would lack legitimacy if the only interest it held in the arrangement was for the purpose of providing benefits to the participating employers.  In that guidance DOL did, in fact, deny just such a firm’s request for approval of a proposed open MEP, citing the fact that there was “no employment-based common nexus or other genuine organizational relationship between the employers.”  This sounds like the very role that a state might be playing under a MEP option blessed by DOL in Interpretive Bulletin 2015-02. 

In legitimizing its new state-coordinated MEP option, DOL relied on a different argument in Advisory Opinion 2012-04A, one which stated that those sponsoring or maintaining the plan had to be tied to the participating employers “by genuine economic or representational interests.”   DOL now declares in Interpretive Bulletin 2015-02 that “a state has a unique representational interest in the health and welfare of its citizens that connects it to the in-state employers that choose to participate in the state MEP.”  Done and done!

There are also legitimate questions to be asked about the alternative DOL-approved options for state-coordinated ERISA plans.  Such as, do we want state governments deciding which service providers they will favor by including then in a state-approved retirement plan “marketplace?”  Do we want a state to sponsor a prototype plan document and offer it directly to employers, essentially competing with private sector firms that offer prototype documents and the services that go with them?

Right now, there are more troubling questions than there are reassuring answers.

Thursday, November 19, 2015

Whose Responsibility is Socially Responsible Investing?

We sometimes complain when the federal agencies that oversee retirement plans drag their feet and fail to issue badly needed guidance.  Occasionally, however, the reverse is true, and we get an answer to a question that few – if anyone – has asked, or perhaps even anticipated.  Sometimes it’s an answer that makes things more complicated, rather than easier.  This may be the case with the Department of Labor’s recent issuance of Interpretive Bulletin 2015-01, released by its Employee Benefits Security Administration (EBSA).   It addresses the issue of retirement plans and investment options that might be considered “socially responsible” or “economically targeted.”  IB 2015-01 became effective on October 26th, the date of its publication in the Federal Register.

Socially responsible or economically targeted investments are loosely defined as those which, in addition to meeting the primary objective of generating sound returns for a participant or beneficiary, may have the potential to positively influence the growth of a community, or have a positive social impact.  EBSA’s clearly stated intention is that IB-2015-01 should make plan administrators more comfortable choosing plan investments that fall into this category. 

IB 2015-01 withdraws a prior interpretive bulletin on this issue, IB-2008-01, which EBSA now feels may have “unduly discouraged fiduciaries from considering so-called economically targeted or socially responsible investments.”  Notice 2015-01 notes that “Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.”   

What kinds of things could be considered socially responsible or economically targeted investing?  The range is probably wide, but it’s not hard to come up with several examples that many would find meet that definition.  Because mutual funds are such meat-and-potatoes investing options for retirement plans, particularly participant-directed individual account investing, I’ll focus on those.
The characteristics that define a mutual fund as socially responsible or economically targeted can be measured both in terms of what they include, and what they exclude.  Some funds may invest in alternative or renewable energy companies, such as wind generation, geothermal, biodiesel, or ethanol production.  These funds might, due to this focus, exclude holdings in fossil fuels, such as coal mining or offshore oil drilling.  Some exclude holdings in companies associated with the nuclear power industry.

Some such funds exclude defense contractor stock.  Others exclude the stock of such high-performing companies as Apple, because factory working conditions in some of the countries where certain Apple products are made are considered substandard.  Some of these funds are actually titled in a manner that touts their emphasis on social consciousness, including such terms as “social choice” or “social equity,” as part of their formal naming.

A little bit of EBSA interpretive bulletin history is called for here.  In 1994, EBSA’s IB-94-01 stated that socially responsible or economically targeted investments were not incompatible with retirement plan investment selections, as long as such investments have “an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics.”  As a follow-up in 2008, a brief clause in IB-2008-01 seemed to be a vote of no-confidence for socially responsible or economically targeted investing.  It stated that “consideration of collateral, non-economic factors in selecting plan investments should be rare, and when considered, should be documented in a manner that demonstrates compliance with ERISA’s rigorous fiduciary standards.”

EBSA now believes that its 2008 guidance may have put a chill on retirement plan fiduciaries selecting and offering such investments.  Actually, IB-2015-01 and an accompanying news release seem to have turned the 2008 guidance more or less on its head.  The news release states that while socially responsible or economically targeted investment considerations “may not accept lower returns or take on greater risks,” they are “more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.” 

Furthermore, an accompanying EBSA fact sheet addressing the documentation issue seems to directly counter IB-2008-01, stating that “no special documentation is presumptively required for such investments…” and that “the appropriate level of documentation would depend on the facts and circumstances.” 

Two things, at least, are troublesome here.  One is EBSA’s inconsistency over time in the emphasis it places on fiduciary caution, and the embrace of investment considerations that have little if anything to do with generating returns for participants and beneficiaries.   Second is the unmentioned, but no less real, matter of just what is “socially responsible.”  One need look no farther than America’s democratic political system to know that there is no fool-proof consensus on what is moral, ethical, or socially responsible. 

One citizen may think nuclear power is a destructive genie that should be kept corked in a bottle, and would shun any related investment.  Another, however, may believe that nuclear power should be made safer and promoted to help the nation move away from fossil fuels.  One investor may believe that only by maintaining a world-leading defense capability can the U.S. remain free and defend the interests of democratic peoples; therefore, invest in defense companies.  Another may believe that the military industrial complex bears responsibility for our involvement in conflicts around the globe, and owning an interest in them should be avoided.  I could certainly come up with more examples of such conflicting views.

Should a plan administrator or investment committee be encouraged to make such thumbs-up or thumbs-down decisions on investment availability?  Is it possible to be even-handed and take into consideration very divergent views on social issues when selecting an investment lineup?  Is it even fair to put plan fiduciaries in a position of feeling pressure to weigh issues of social responsibility in the selection of investment options? 


There are readily understood standards for selecting and continuing to monitor an investment for its financial suitability.  Picking investments that are compatible with a participant’s conscience is another matter altogether.  IB-2015-01’s suggestion that social responsibility considerations “are proper components of the fiduciary’s analysis … of investment choices” is quite likely to raise more questions than it answers.

Friday, September 25, 2015

Some Retirement Savings Numbers of Note

If ever there was an enterprise inextricably tied to numbers and statistics, it is our retirement industry.  Numbers are the bedrock of retirement plan operations and recordkeeping.  We continually analyze rates of worker access to retirement savings options.  We compare the U.S. savings rate with our counterparts around the world (sometimes unfavorably, at least by recent history).  We try to quantify such subjective things as worker confidence in a secure retirement.  Some federal agency number crunchers even think they can calculate how much retirement savers lose as a result of investment advisor conflicts of interest.  Stats and numbers: they are part and parcel of our business.

I recently came across a thought-provoking study compiled by the Transamerica Center for Retirement Studies, entitled Retirement Readiness Survey 2015.  The Center is a division of Transamerica Institute, a nonprofit private foundation funded by Transamerica Life Insurance Company and other third party funders.  This 15th annual survey is one of the longest-running of its kind, and polls American workers and their employers to explore attitudes and behaviors on retirement benefits and security.  Many of its queries were measured by level of interviewee education, which – like it or not – is often a predictor of both income and financial literacy.

One of the questions commonly asked in such studies concerns having a retirement strategy, generally meaning whether an effort has been made to calculate how much will be needed in order to have a reasonably comfortable retirement.  There are lots of variables affecting retirement security that can’t be fully known.  They include the ups and downs of securities markets, the general state of our U.S. economy, inflation rates, our health, or the age when we choose or are forced to leave the workforce.  But, in order to set savings goals, it’s imperative to have some idea of what the target is.

The Transamerica study may be overly generous in measuring the share of the U.S. population that has a retirement strategy.  It counts both written and unwritten strategies.   An “unwritten” strategy seems almost a contradiction in terms, and I’m inclined to discount its value in any serious effort to measure Americans’ self-assessment of their retirement preparedness. 

Only a small minority have made an attempt to create a tangible, written retirement plan.  Among those who have, a notable predictor is the education level of the survey subject.  Generally speaking, the higher the level of educational attainment, the more likely that the individual has made a serious attempt to develop a savings strategy.    

This may be the result of several factors that often intertwine.   Higher education levels commonly translate to higher lifetime earnings.  Higher earnings may not only lead to more disposable income that can be saved, but may also mean being employed where there is a retirement plan in place.  Access to a retirement plan generally brings with it at least basic information on investing, as well as encouragement to save through that employer’s plan.  Such individuals are the most likely to think about their future retirement security, and take action.

Among workers with a high school education, or less, only seven (7) percent had a written retirement strategy or plan.  In sharp contrast, 24 percent of those with post-graduate college attendance or a post-graduate degree had a written plan.  College graduates with a basic bachelor’s degree were found to have a written plan in 18 percent of interviews.  Among those with trade school or non-degreed college attendance, 13 percent could point to a written plan they had created.  Assuming similar numbers of interviewees in the four groups, an average of just 15 percent had a written plan or strategy.

There are other statistics in the Transamerica study that are worth sharing.  The use of a professional financial advisor to help with investment decisions and planning for future retirement security also showed a great disparity when measured against the education of the interviewee.  Forty seven percent of those with advanced degrees or graduate school exposure had used a financial advisor, while 25 percent of those whose education was limited to high school level did so.  In between were college graduates at 49 percent and “trade school/some college” interviewees at 33 percent. 

Asset allocation on the spectrum from conservative to aggressive also varied markedly by education.  Seventy-nine percent of those with a post-graduate degree were invested either in stocks or in a balanced mix of stocks, bonds and other investments.  Only 49 percent of those with high school level education were invested this aggressively.  College grads and trade school/some college folks were positioned in between; the higher the education level, the more aggressive the investing.  Rather alarming, Transamerica interviewers found that 35 percent of those with high school level education were unsure of what they were invested in.  One need look no farther than this to support the contention that Investment education is critically important, apparently more so for those with less formal education.
Participation rates for those who are actually offered such an opportunity varied similarly across educational lines.  Eighty-seven (87) percent of those with graduate school exposure – and those with bachelor’s degrees as well – participated when they were given the opportunity, while only 67 percent of those educated through high school or less education took advantage of the opportunity.  Those with trade school or less-than-degreed college exposure accepted a participation offer 79 percent of the time.

It should not be a great surprise that contribution rates of those more highly educated would be greater, given the generally reliable likelihood that higher education leads to higher lifetime income.  Obviously there are exceptions, but they mostly prove the rule.  The average plan participant with a post-graduate degree – and those with a bachelor’s degree, as well – contributed 10 percent of income to retirement saving.  Both those high school-level-educated and having trade school or non-degreed college exposure contributed six percent of income, on average. 


There are many other statistics of interest in Transamerica’s Retirement Readiness Survey 2015; these are among those that stand out.  Certainly there are facts and circumstances that make saving more difficult for some workers than for others.  Balancing basic financial needs against income is an obvious one; these needs differ at different stages of life.  But basic investment education and savings habit formation, with access to some kind of formal retirement savings, can have a positive impact on saving outcomes, even if the first steps are small ones.  For that reason it is critical that we preserve and expand access to retirement savings options, as well as to meaningful investment education and advice.

Friday, July 31, 2015

Is it Manpower Shortage, Intrusiveness – or Both – Behind New Form 5500-SUP?

Beyond the divisiveness and unwillingness to compromise that seem to have infected many of our lawmakers in Washington, D.C., there is also a growing distrust of some government agencies.  Actually, this distrust is encountered from Pennsylvania Avenue to Main Street, USA, and includes agencies and personnel responsible for implementing our laws and the regulations that spring from them. 

While the U.S. Department of Labor has recently been targeted for its proposed fiduciary regulations, the most consistently criticized and attacked government agency has undoubtedly been the Internal Revenue Service.  Some of the animosity comes from lawmakers’ dislike for the complex Internal Revenue Code, which – they may be forgetting – is a creature of the Congress itself. 

Being the police force tasked with enforcing this Code has made the IRS an available and visible target, including for grandstanding politicians wanting to score points with their constituents.  It seems that in every Congressional biennium some lawmaker proposes legislation to eliminate the IRS altogether.  While such proposals are rarely taken seriously, and there are functions performed by the IRS that are vital, the proposals are an indication of how disliked the IRS is.

The IRS didn’t do itself any public relations favors when some of its staffers allegedly targeted for special scrutiny a number of conservative groups seeking nonprofit status, a controversy that is still being played out.  However limited, or extensive, such practices might actually have been, given the hostility some politicians have for the IRS it was like pouring gasoline on a fire. 

Realistically, politicians’ attitudes do matter, because one way they can attack the IRS is by cutting the agency’s funding.  One can argue endlessly over whether the IRS or other federal agencies spend their taxpayer-funded annual budgets wisely.  But stagnating IRS funding has led to the loss of about 8,000 of its employees since 2010, this at a time when responding to landmark court decisions and complicated legislation – like the Affordable Care Act – is placing even greater demands on the agency.

Cuts in IRS funding have left fewer field staff available to perform audits of individual taxpayers, businesses, and retirement plans.  It has been estimated that there is now less than a 1% probability that an employer-sponsored retirement plan will be examined.  Another indication of IRS staff resource scarcity is the elimination of most plan determination letter reviews, except in the year of plan establishing and year of termination. 

To make its auditing resources more efficient, the IRS is focusing on plans it believes have the greatest probability of compliance problems.  Such information has come to the IRS in surveys it has conducted, the most high-profile occurring with some 1,200 401(k) plans in 2010.  The IRS sought information on plan design, contributions, nondiscrimination testing, employer demographics, loans, and more.  With a gun to employers’ heads warning of potential audits for non-response, the IRS got the data it wanted.

There is also information contained in Form 5500 filings that identifies plans with 401(k) features, plans with automatic enrollment, with participant-directed accounts, that use a default investment option, etc.  While most Form 5500 filings go to the Department of Labor, it is generally understood that some information is shared between the two enforcement agencies.

The IRS has proposed a way to collect detailed plan-specific compliance data on a regular basis, via new Form 5500-SUP, Annual Return of Employee Benefit Plan Supplemental Information.  A draft of the form was released in March, and the IRS envisions its use for 2015 plan years.   

Many, if not most, feel that the process of plans and service providers gearing up to report this information for the first time could take significantly longer than the 2015 plan year Form 5500 filing deadline, which – for calendar year plans – would be July 31, 2016.  In many cases the information sought is not maintained in a place or format that is readily obtained, especially not capturable or transferable by electronic means.  Given the fact that many plans are presently in the throes of restatement for the Pension Protection Act of 2006 (PPA), the timing for a 2015 Form 5500-SUP is very problematic, at best. 

Some feel that a plan that provides data on its methodology for conducting coverage and nondiscrimination testing, its amending history, opinion or advisory letter information, etc., is making itself an all too convenient target for an IRS audit.  The flip side of the argument  is that the IRS is attempting to do its compliance oversight job with diminishing personnel and budget resources, and that in its design of Form 5500-SUP the Service has taken a logical step in trying to take a more “rifle” – rather than shotgun – approach to monitoring plan compliance.  Reasonable minds may differ!

Ambiguity, however, is not reasonable.  For example, a plan is asked to declare whether it passed 410(b) coverage testing by the ratio percentage test or by the average benefits test.  Eligibility need not be determined by just one or the other across the board; some plans use both.  Another question asks for the date of the most recent “plan amendment/restatement for the required tax law changes.”  Is this question limited to full restatement events only?  Is it intended to capture dates associated with interim amendments?  If interim amendments, the IRS should be providing plans with a list of interim amendments appropriate to the particular year’s Form 5500 filing. 

There are questions on Form 5500-SUP the answers to which will come from other providers, which the preparer may be in no position to authenticate or verify.  Is the preparer potentially on the hook for the work of others over whom it truly had no control?  Mandating that the preparer of the Form 5500-SUP be identified will result in a public record disclosure of the client/preparer relationship; something not required of preparers of Form 5500 itself.   Is this really necessary?  As a matter of public record, I don't believe it is. 


We should probably expect that some level of compliance self-reporting is in all retirement plans’ future.  We are also aware that new procedures have growing pains.  But this initial attempt could and should be improved greatly, both in terms of content and in terms of timing.  

Tuesday, July 21, 2015

Battle Lines Are Drawn in Fiduciary Regulations Fight

Long ago, in distant elementary and junior high school days, some of the most galvanizing words on the playground or in the neighborhood were heard in the battle cry “Fight…fight..”  Brawls major or minor have always had the power to stir the blood and draw a crowd.  Back then, the motivation was likely to be nothing more serious than someone’s wounded pride, pecking order conflicts, or the mistaken belief that the opposite sex was impressed by such macho behavior

Times change, and we hopefully outgrow the need for those juvenile tests of strength and will.  But that doesn’t mean that the appetite for combativeness goes completely away.  It’s a part of everyday life, from the competitiveness of business to the sparring of politics and policy making.  We’ve been treated to a classic demonstration of this combativeness in the aftermath of the Department of Labor’s April release of proposed regulations on – how apropos – “conflicted investment advice,” much better-known as fiduciary definition regulations. 

The avowed intent of these regulations is to assure that those saving for retirement receive investment advice that is in their best interest, not advice biased in some manner that favors the advisor over the saver.  Proponents believe some version of these regulations will do this.  Opponents believe the rules as proposed will result in such advisor anxiety over possible fiduciary liability that smaller investors – particularly IRA investors – will be left without the investment advice they need.

Most of the shots in the minor war that has ensued have been fired from a distance, in newsletters, speeches, editorials and the like.  Some also in Congress, including legislation to halt or defund the regulations, and lawmaker pleas to Secretary of Labor Thomas Perez.  A dramatic exception, perhaps worthy of comparison to a Las Vegas fight card, occurred in a hearing held June 17th by the Health, Education, Labor and Pensions (HELP) subcommittee of the House Committee on Education and the Workforce. 

That hearing bore the unambiguous title “Restricting Access to Financial Advice: Evaluating the Costs and Consequences for Working Families and Retirees.”  Unambiguous, in that it clearly expressed the organizers’ judgment that unless the proposed regulations are significantly modified, their effect will be to deny many retirement savers the guidance they critically need to prepare for life after their careers.

It might be overstatement to call the hearing and the testimony of lead witness Perez and private sector witnesses a “pitched battle.”  But some who witnessed it have characterized the testimony as intense and spirited.  As one put it, “Secretary Perez vigorously defended the proposal and the need for its adoption.” 

Secretary Perez repeated a previously-presented example of a couple that invested IRA rollover assets in an annuity investment whose fees he characterized as excessive.  He stressed that this was not illegal, because advisors in such circumstances operate under an investment “suitability” standard, rather than a best-interest fiduciary standard.  This the Secretary characterized as “flawed,” expressing his belief that the compensation interests of the advisor are almost inevitably in conflict with the best interests of the investor.

There seemed to be little disagreement on whether the best interest of the retirement saver is the appropriate standard of conduct for those who provide investment advice.  But there was little agreement that the regulatory formula proposed by the DOL can be successfully adapted to the actual investment marketplace, particularly where IRAs are concerned. 

While the proposed regulations allow variable forms of advisor compensation, they do so at the price of a binding contractual relationship – a “best interest contract” – between advisor and client.  That contract was described by Secretary Perez as necessary to enforce a best interest standard.

But a number of witnesses believe that the proposed regulations are unclear in defining just when in the advisor-client relationship this contract would be necessary, and fear that those who do not want to become fiduciaries will stop short of giving savers even basic investment education, to avoid being ensnared in a fiduciary net.    

Secretary Perez expressed his belief that these proposed regulations do a much better job than the long-since-withdrawn 2010 regulations in carving out and allowing advisors to provide investment education without giving themselves fiduciary liability.  But there was significant disagreement from other witnesses, to which Secretary Perez sharply asked for “chapter and verse” language on how they would improve it. 

Witnesses also expressed the belief that the best-interest contract, now commonly referred to as “BIC,” and the education-versus-advice conundrum, together will lead to more litigation in the form of breach-of-contract lawsuits.  To which the Secretary responded that binding arbitration language in the proposed regulations was intended to resolve such conflicts.  Many advisors, however, are unlikely to be cheered by the prospect of arbitration any more than they would welcome litigation.  Both have costs in time, expense, and uncertain outcomes.


As summers always seem to do, this one is flying by.  The deadline for submitting written comments on these proposed regulations, July 21st, is already upon us.  It’s now less than a month to the public hearing scheduled for August 10th through 12th, with an additional day in case it is needed.  Based on the combativeness we have seen so far, it would surprise no one if this bout goes that extra round.

Thursday, June 4, 2015

Many Ifs, Ands & Buts in EBSA’s Fiduciary Solution

When we were young, we may have been told that beginning a sentence with the word “but” was inappropriate.  We believed it because the people who said so were adults, and were supposed to know such things.  Later, we learned that “but” is a “coordinating conjunction,” and many good writers properly begin sentences with it.  Perhaps we had been intentionally misled because “but” is a word of protest often used by children.  “But I don’t want to eat my broccoli!” “But I’m not sorry!” 

Appropriate or not, “But” was the first word that came to mind when I had digested the Department of Labor’s “conflicted advice” – formerly fiduciary definition – proposed regulations, issued in April.  (Some other words that came to mind are less charitable.)  “But how can you propose,” I wondered, “a solution that seems generous to the present advising environment, but sets a snare that can spring future litigation and fiduciary liability even on principled and conscientious advisers?” 
I’m certainly not unsympathetic to the need for retirement savers to receive principled advice when making critical investing decisions.  They deserve no less.  But the most prominent solution being prescribed by the Department’s Employee Benefits Security Administration (EBSA) – the proposed Best Interest Contract – has some ingredients that beg the question of whether the remedy is worse than the malady.

To the genuine relief of many, EBSA’s proposed regulations did not narrowly limit the types of compensation that can be received by advisers or brokers serving retirement savers.  Some had feared that a fee-only approach might be required to avoid prohibited transactions and their inherent liability, which many believe might have caused advisers to flee the small investor market.   On the contrary, EBSA’s proposed regulations make clear that compensation that may vary depending on the investments chosen – like commissions, 12-b1 fees, revenue sharing, etc. – can continue to be a part of the adviser or advising firm’s compensation structure.
But – and it’s an important “but” – the price for this freedom in compensation arrangements is the Best Interest Contract, or BIC, as it is becoming known in industry shorthand.  If variable compensation structures are used to compensate for investment advice, something normally prohibited, an adviser or advisory firm must agree to enter into this arrangement.  It is a contractual one, make no mistake.  In EBSA’s own words, “It would require retirement investment advisers and their firms to formally acknowledge fiduciary status and enter into a contract with their customers in which they commit to fundamental standards of impartial conduct.  These include giving advice that is in the customer’s best interest and making truthful statements about investments and their compensation.”  Fail to meet either general or specific conditions of the BIC, and an advisor could be exposed to potential EBSA prohibited transaction enforcement, IRS excise taxes, and client litigation. 

There are a number of things that stand out as problematic with EBSA’s proposal, but for now we’ll focus on just two.  One is subjectivity.   “Best interest” may be in the eye of the beholder.  How much emphasis should be given to the lowest possible fees?  Are higher fees justified by facts and circumstances, such as a more expensive fund whose manager has a track record for outperforming others?  Would advice that looks questionable today be considered acceptable in the historical context of the time and options available when it was given?  Will those with enforcement and judicial authority have the expertise and the impartiality to make these and other judgment calls?

Another problematic issue is the potential for litigation if a client does not feel that an advisor has lived up to expectations.  An advisor or advisory firm must warrant that it has not only identified possible conflicts of interest, but has adopted measures to take them into account and prevent financial harm to the investor.  Based on such warranties, clients will have a contract law basis for seeking legal remedies, including class actions, and – specific to IRAs – bringing a case under state law without the benefit of ERISA preemption.   

There is nothing new about risk and return; it’s fundamental to investing.  In the case of EBSA’s BIC it now applies to the advisor, as well.  The potential for legal exposure may prove to be an unacceptable risk for some advisors and advisory firms.  Some might say it is appropriate that risk of a fiduciary nature find its way to the doorstep of folks who dispense investment advice to retirement plan participants and IRA owners.   But how much is “too much?”

A major concern of some who question EBSA’s approach is that instead of conflicted advice, some retirement savers will get little or no advice.