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Broker-Dealers and Other Non-Fiduciaries as Fiduciaries? (Part 2)

There's a solution for registered representatives.

W. Scott Simon, 11/05/2009

In September, I cited the white paper issued by the Obama Department of Treasury titled "Financial Regulatory Reform, a New Foundation: Rebuilding Financial Supervision and Regulation." It seeks, in part, to (1) subject broker-dealers providing investment advice to their clients to a fiduciary standard and (2) "harmonize" the regulation of broker-dealers and registered investment advisors by replacing the suitability standard that now governs broker-dealers with the fiduciary standard that now governs registered investment advisors. In short, the two-pronged goal is to turn broker-dealers into fiduciaries and then subject them to the same fiduciary standard that governs registered investment advisors when ongoing advice is given.

(Caveat: Even though the white paper isn't concerned with participants in qualified retirement plans (such as 401(k) plans) governed by the Employee Retirement Income Security Act of 1974, if Treasury's proposal is adopted it's likely that it will govern the conduct of broker-dealers in their relations with participants in these plans.)

I've contended a number of times over the years that B-Ds do not want to have anything to do with being fiduciaries. But what do the registered representatives of B-Ds think about this? No doubt many registered representatives wish to do right by their clients and, in fact, many of them believe that they already are fiduciaries to their clients (whether or not that's true legally).

The ultimate outcome of the great wrestling match among the executive and legislative branches of the federal government, and various powerful financial services interest groups as to whether broker-dealers will be turned into fiduciaries and, if so, what kind of fiduciary standard they will have to live up to is not yet known, of course. Given that, many of the registered representatives who believe that they already are fiduciaries to their clients cannot be blamed for perhaps feeling as though they're in a state of suspended animation. There are other registered representatives, of course, who wish to do right by their clients but don't believe that they're fiduciaries to them (they would be legally correct in most cases).

There is a way, however, for all registered representatives including (1) those who believe that they already are fiduciaries to their clients and those who have no such belief and (2) those who are already in--or are thinking of getting in--the qualified retirement plan market of 401(k) plans to not only increase their income but also incur no fiduciary risk. The key to this business model is not to focus at the plan level per se but on the many participants in a retirement plan.

The way to accomplish this is for a registered representative (through its B-D) to associate with a provider that offers a multiple employer plan (MEP). As discussed in this column in August, a MEP is the "platinum standard" of delegation for the sponsor of a qualified retirement plan because it allows the sponsor to offload all day-to-day fiduciary responsibility (and therefore all fiduciary liability) including that for the operations of the plan (i.e., administration) and the plan's assets (i.e., plan investment options) to an existing platform designed for the specific purpose of alleviating the burdens of fiduciary responsibility.

In considering the MEP scenario, a plan sponsor need make only one decision: whether to join the MEP or not to join it. If the sponsor decides to join the MEP, it then morphs, so to speak, into what could be termed a "participating employer" in the MEP. Once the plan sponsor joins the MEP, it has absolutely no duties, not even on-going duties to monitor vendors or investments. All duties would instead be borne by the provider that set up the MEP and by other fiduciaries appointed by the provider that are necessary in prudently managing the plan.

Where do registered representatives fit into all this? Well, B-Ds have a strong presence in the small retirement plan market. This market, which currently totals nearly $300 billion in assets, is comprised of plans with assets of between $1 and $10 million. Registered representatives who have significant experience in the small retirement plan market as well as those that have little experience but are eager to enter this market will find a MEP with a complete fiduciary governance platform to be the ideal vehicle.

Registered representatives that can bring plans to a MEP garner a number of benefits. They can earn a fee based on the assets in a plan, which becomes recurring and relatively more stable "annuitized" income. Such registered representatives, of course, will first do the math: If I bring in, say, $10 million in plan assets but am paid relatively small incremental revenue, does that justify the extra work required? Such registered representatives will naturally seek to create more revenue with as little additional work as possible, so the provider of any MEP that wishes to attract them will need to clearly define all roles and expectations in addition to how the registered representatives are to be paid. Registered representatives no doubt would find that the cleanest, simplest and most attractive way for them to be paid is by debiting participant accounts. 

At the same time, registered representatives can cross-sell non-plan products to plan participants such as life insurance, long term care insurance and health insurance. These kinds of sales have always been more lucrative than asset-based fees and are one big reason why many registered representatives in the retirement plan market get into it in the first place. The revenue earned on the sales of such policies is estimated to be five to seven times more than plan asset-based feesPAGEBREAK.

In the kind of MEP that I'm describing, any ERISA prohibitions against cross-selling such policies wouldn't apply to a registered representative since neither it nor its B-D is a fiduciary to the plan or its participants. registered representatives don't give advice (a fiduciary act), they provide only education (a non-fiduciary act) so they're not fiduciaries and since they're not fiduciaries they face no fiduciary risk. Remember, it's the MEP provider that assumes all fiduciary duties once a plan sponsor has delegated them to the provider.

The weakness of the economy and its impact on business, the cost and time involved in meeting current and future compliance requirements, any ERISA prohibitions against cross-selling, smaller profit margins and a whole host of other negatives would all seem to make it plain that there's not enough revenue in the small retirement plan market to justify the risk involved including that of being an ERISA fiduciary.

All this would be true for registered representatives that are in (or want to go into) the small plan market and that provide stand-alone plans only. But these negatives would not be present for those registered representatives that are associated with the kind of MEP provider that I've suggested. Commentators that advise registered representatives and B-Ds to avoid the small plan market give two primary reasons for doing so: there's too much risk in being an ERISA fiduciary and too little revenue in that arena unless cross-selling can be employed--which, of course, incurs the catch-22 of ERISA.

The kind of MEP provider that I've suggested registered representatives associate with allows them to reverse this equation by increasing revenue (primarily through sales of such products as life insurance, long-term care insurance and health insurance which provides revenue more lucrative than asset-based fees earned from retirement plans) while at the same time eliminating risk.

In turn, this allows small-sized retirement plans to enjoy the protections and other advantages of a MEP managed by an ERISA section 3(21) named fiduciary and an ERISA section 3(38) fiduciary as well as other professional fiduciaries on the team. That way, the smallest retirement plans can take advantage of the pricing and risk aversion that some of the very largest retirement plans now (or should) enjoy.

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