New DOL Fiduciary Rule – Butchers and Dieticians
We were talking to a client last week and he asked about the new Department of Labor (“DOL”) Fiduciary Law he recently read. We explained, in a nutshell, the new regulation requires all retirement plan advisors to put the best interest of the plan sponsor and the employees first. To which he immediately asked, “Wait, you mean they didn’t already?” The short answer is “It depends.” (This is rarely the beginning of a short answer.)
Let’s start with the definition of a fiduciary. Investopedia defines it as follows:
A fiduciary is responsible for managing the assets of another person, or of a group of people. Asset managers, bankers, accountants, executors, board members, and corporate officers can all be considered fiduciaries when entrusted in good faith with the responsibility of managing another party’s assets.
Read more: Fiduciary Definition | Investopedia
When acting in a fiduciary capacity, you are required by law to put the best interests of the party you are acting on behalf of before your own. One of the basic tenants of care when acting as a fiduciary is that you must eliminate or minimize conflicts of interest. It is both an ethical and legal position of trust with the highest legal standard of care.
401k advisors currently fit into one of two basic categories: Broker or Fiduciary Advisor
Today, many of the 401k professionals function in a sales capacity under a brokerage arrangement. Their compensation is in the form of commissions and varies from product to product. In some cases, the compensation can be affected by the investment selections within the product. A broker’s job is to sell a product that is within your means and meets your needs. The standard they must meet is called “suitability.”
A Fiduciary Advisor receives no compensation from the plan’s vendors and works on a revenue neutral basis – meaning they receive no differential in compensation based on product selection, this is commonly called a fee-based arrangement. A fiduciary’s focus is primarily on process rather than product. The process of vendor selection and monitoring must be well thought out and documented so that the plan sponsor can provide product(s) selected to meet the specific needs of the plan and its participants on an ongoing basis.
Butchers and Dieticians
Full disclosure on this analogy – we like butchers and we like dieticians, but for different reasons. Think of it this way…if we go to the local butcher shop, their job is to sell us the meat they have in their store. The meat is most certainly regulated by the US Food and Drug Administration (“FDA”); however, the FDA does not require the butcher to disclose that the same meat is on sale at Price Chopper, nor do they have to reveal that Hannaford may have a better quality burger. We don’t expect the butcher to do this either. Additionally, unbeknownst to us, the butcher may have an incentive from the manufacturer to sell more of a certain meat this month. We would never expect them to tell us to “lay off the red meat and opt for the grilled veggies at the farmer’s market.” That’s not their job and it’s not what they get paid for.
Conversely, if we go to the doctor or a dietician, their job is to look at all the facts and recommend a diet which is in our best interest to keep us healthy. That’s why we go to them. They don’t receive an incentive from the local grocery store for promoting fruits and vegetables. We pay our bill for the office visit or consultation, but the amount we pay is not impacted by the food recommendations they make.
While the brokerage world is more like the butcher, fiduciary advisors are more are like the dieticians. The advisor’s compensation is not based on the product that is used, rather it is based on the advice and services they provide. This idea is not new in any way. In fact, firms like ours have operated this way for years.
Holding all advisors to a higher standard
With the passing of the new regulation by the DOL, all 401k professionals will have to meet the fiduciary standard. The broker / salesperson role will no longer be an option. Moreover, the criteria to determine whether or not they are acting as a fiduciary has been broadened significantly.
So, back to our client’s question. No – professionals operating in a sales capacity under a brokerage arrangement are not currently required to put your best interest first – at least until the new law is fully inforce by January of 2018.
So how can you tell if the product you have today is in the best interest of you and your employees?
There is a basic scientific axiom that says in order to improve or manage something, you must be able to measure it. It is a fiduciary best practice to have your plan benchmarked against plans similar to yours on a regular basis by a third party. This benchmark also gives you the ability to gauge the health of your plan and identify any shortfalls that need to be shored up. An independent benchmark analysis should include at a minimum: a comparison of all of the fees you are paying, an analysis of the investment lineup, and a review of your plan features and plan design. More advanced benchmark analyses will include an evaluation of how your employees are utilizing the plan, including participation and deferral rates and average investment allocations based on age.
So will the new regulation affect me?
You might be asking how, when, or if this new law will specifically affect your plan since it really is directly talking about the advisors and not the plans themselves. The retirement plan industry has changed fairly significantly over the past several years. For example, because of another DOL ruling a few years back, fees are now more transparent than they once were and fees on new plans have been dropping as a result. We expect over time with this new ruling we will see more fee compression and even more transparency – we see this as a very positive step for the industry, plan sponsors and participants.
For plan sponsors, possibly one of the most powerful effects of this new regulation is simply an increased awareness that they are ultimately responsible, under the highest standard of care, to make sure their plan is in the best interested of their employees. Moreover, simply relying on their current service providers may not be enough to ensure that.
Additional resources on Investopedia:
Suitability vs. Fiduciary: http://www.investopedia.com/articles/professionaleducation/11/suitability-fiduciary-standards.asp