Blog Posts

Consequences of Unrestricted MEPs

With the lifting of restrictions on Multiple Employer Plans “MEP” two major shifts are likely to occur in the retirement plan market. First is that all small plans will gravitate to local MEPs that do not include their direct competitors. The second is a massive increase in demand for local MEPs.

The MEP requirement that participating employers must be in the same industry has stunted any chance of growth. Small businesses for whom MEPs would offer great benefits would have to join forces with the very companies they face every day on the competitive battlefield. This problem is made even more acute by the fact that most small businesses serve a local area so the baker would have to join forces with the baker in the same town. To provide economies of scale, the small businesses must be geographically close together.

The unrestricted MEP would permit multiple MEPs in one locality, each serving a diverse set of non-competing businesses. With the removal of the requirement to collaborate with competitors, it is reasonable to assume that small businesses would find the better, cheaper and less risky plan to be irresistible.

The second shift is anticipated to be for new MEPs. This market would be unattractive for large service providers with centralized operations. Locally situated advisors could fill the need but often lack the technical expertise to administer an MEP. The most likely sector are third party administrators (TPAs) who possess the knowledge and skill and already serve these local customers.

The TPA need only become familiar with how to mitigate the fiduciary risk and could almost immediately establish an MEP.

The MEP also opens a new market that consists of small businesses that do not currently offer plans to employees. There is the potential to double the size of the small plan market within two years.

Read More

This Mistake Cost Merrill $9 Million: Mitigating Conflicts of Interest (Part 3)

The SEC’s proposed Regulation Best Interest seeks to impose a duty on brokers to mitigate certain conflicts of interest. This series of articles will explore the various ways firms can effectively mitigate or eliminate conflicts of interest.

Part 1 – Introduction

Part 2 – Level fee

Mitigating Conflicts of Interest – Part 3: Controlling Conflict-Inciting Information 

On August 20th the SEC imposed sanctions on Merrill Lynch related to its handling of a conflict of interest, which cost the firm nearly $9M. Apparently it could have cost much more because this was an offer submitted by Merrill, which was accepted by the SEC.  I thought this might be a good opportunity to step out of the abstract discussion of conflicts and look at a real world scenario that played out over 5 years ago.  In a somewhat overly simplistic summary, it went a little something like this.

Merrill had a Due Diligence Committee responsible for recommending to the Governance Committee what managers and products would be part of a particular set of platforms. The Committee recommended terminating a manager on the platform who was a Merrill subsidiary (“Subsidiary”) and who also had a strong business relationship with BoA.  Subsidiary learned of the upcoming termination prematurely and a “plan of action” was put in place involving members of both Subsidiary and Merrill. This led to a string of events, with the crescendo being an email by an Officer of Subsidiary to a Merrill employee responsible for writing up the Governance Committee meeting agenda which read:

“It was recently communicated to us that the proposal to terminate will not be part of tomorrow’s Governance Committee agenda and [the U.S. Subsidiary] will be afforded an extension of time to further and fully demonstrate our commitment and capabilities in the SMA space…. As it stands now, this news is so new that it may be filtering through your organization, down to the key players in Due Diligence [and other areas, including the product group] but I wanted to inform you directly.”

The Subsidiary’s termination decision was put on hold and Subsidiary ultimately remained on the platform. 

This scenario is not hard to imagine and none of the actors behaved in a way that shocks the conscious (although the email was a little shady). In conversations with Merrill, Subsidiary executives expressed their appreciation for the due diligence team’s autonomy and presented legitimate concerns about the fairness of the termination. For example the due diligence committee often conducted on-site due diligence reviews before terminating a manager, but did not do so in this instance.  The main thrust of Subsidiary’s plea to have the termination put on hold was the fact that such an on-site review was not conducted. And while hindsight is 20/20, it’s interesting to note that the Subsidiary’s new management team did in fact perform well over the relevant period, in fact better than the would-be replacement. As innocent as these actions may have seemed, if not for the outside influence that was exerted on the Due Diligence and Governance Committee, the manager would have been terminated. The Committee did not prove to have the autonomy that was described in Merrill’s ADV and on which investors relied.

The SEC sanctioned Merrill for violating the anti-fraud provision of the Advisor’s Act as well as failing to implement policies and procedures reasonably designed to prevent violations of the Act. But where did Merrill go wrong, what policies and procedures did it fail to implement and what can we learn from this?  To answer this question we need to identify the point in time within these events where policies and procedures could have made the most difference. I would suggest that the only time that a policy could prevent this conflict with reasonable certainty is at the very beginning, BEFORE Subsidiary had any reason to adopt a “plan of action.”

Our cognitive biases as humans can make ethical decision-making very difficult because we identify and analyze facts in a self-serving manner to rationalize why a particular action is allowed or justified. In a competitive corporate environment, these physiological factors make it extremely difficult for a firm’s policies and procedures to stop these human behaviors. In this case, once the horse was out of the barn, reeling her back in was next to impossible. The only way to keep the horse in the barn was by preventing the horse from knowing it should leave the barn. Subsidiary should never have known it was on the chopping block.

In this case, the horse was let out of the barn when an operational employee from Merrill contacted the soon-to-be terminated Subsidiary to get started on all the legwork that would have to be performed to actually remove Subsidiary from the platform.  Usually, a Merrill employee would notify the third party manager after the termination decision had been made by the Governance Committee. However, as the SEC keenly pointed out, no written policy or procedure governed this process.

Had the operational employee at Merrill either not possessed the information about Subsidiary’s termination or had he been trained on a policy to keep such information strictly confidential, Subsidiary would have had no reason to act in a conflicting manner until it was too late to do anything about the termination. The Committee would have acted with the autonomy that it represented to its investors in its ADV and that was required to avoid a conflict of interest. I’d be willing to bet that Merrill at this very moment has extensive policies and procedures governing the confidentiality of Due Diligence Committee recommendations, particularly with respect to the managers who have been recommended for termination.

When designing your policies and procedures, first think about the types of information that could trigger interested parties to act in a manner that conflicts with client interests. Seek to limit the number of people who have access to such information to only those who need to know. Once you have effectively limited the number of people with such information, policies and procedures must put a gag order on such information (both internally and externally) until the passing of a certain event. Had this firewall of information been in place, Merrill would be $9 million richer and I would be writing this article about something else.

                                                                                             ###         

                Cory Clark is a Director at DALBAR, Inc., the nation’s leading independent expert for evaluating, auditing and rating business practices, where he has worked since 2006. Cory holds his Juris Doctor from New England Law |Boston where he graduated Cum Laude and holds a Bachelor of Arts degree in Economics from the University of Massachusetts, Amherst. Cory resides near Boston, Massachusetts with his wife and 3 children.

These articles are provided for general information only, and does not constitute legal advice, and cannot be used or substituted for legal advice.

Read More

Mitigating Conflicts of Interest - Part 2

In Part 1 of this series on mitigating conflicts of interest, I discussed the SEC’s proposed Regulation Best Interest and the potential significance of the mitigation requirements for financial incentives.  The mitigation requirement would appear to be one area where broker/dealers and their reps could be responsible for some significant changes.

When tackling conflicts of interest, it’s helpful to look to a place where disclosure has never been a sufficient remedy; employer-sponsored retirement plans. ERISA is perhaps the strictest regulatory regime related to financial services and under ERISA, an advisor’s conflict of interest is always a prohibited transaction (subject numerous potential exemptions).  Even those not familiar with ERISA parlance can surmise that a prohibited transaction is bad news. However, there are two well established methods of avoiding prohibited transactions in ERISA that serve as a good starting point to neutralizing conflicts of interest in the broker community. Those two methods are (1) fee leveling and (2) the use of a computer model. Fee leveling is the subject of this Part 2 article. Subsequent parts to this series will discuss the use of computer models and other financial technology as a means for elimination and mitigation of conflicts.  

Fee leveling is not the same as fee-only and does not require a shift to a wholly new business model; it simply implies an offsetting arrangement to avoid variable compensation. The distinction between fee leveling and fee-only is an important one.  First, shifting to a model where fees are deducted directly from the client’s account could be disruptive to some client relationships.  Second, shifting to a truly fee based compensation structure and no longer relying on commissions, markups, and markdowns would constitute “special compensation,” in which case the broker may magically morph into an investment adviser with respect to that client.

Regulators have been consistent that when compensation cannot be increased by the advisor, there is no conflict of interest. The Department of Labor stated in a landmark advisory opinion known as the Frost Letter that when fees are passed through to the investor, the advisor is not being benefited. Congress would later codify the concept of level fee in the Pension Protection Act when it created a new level fee exemption for advisors under ERISA §408(g). The SEC specifically mentioned the option of an offsetting arrangement in its Regulation Best Interest proposal.

Fee leveling does more than mitigate conflicts of interest, it eliminates them. Firms should explore the possibility of eliminating some conflicts altogether because in some cases it may be the only appropriate action. The SEC noted that the nature of the conflict, its inherent lack of transparency involved, and the level of sophistication of a particular investor are all factors which may lead to a determination that disclosure and mitigation are insufficient. In these cases, elimination will be the firm’s only viable option. Nonetheless, fee leveling will often be over and above what is required to mitigate a financial incentive, but serves as a preemptive strike against the continuous cost of procedures designed to police lingering incentives. It may pay long term to simply cut the head off the snake and eliminate financial incentive completely through fee leveling or other methods.

###

     Cory Clark is a Director at DALBAR, Inc., the nation’s leading independent expert for evaluating, auditing and rating business practices, where he has worked since 2006. Cory holds a law degree from New England Law |Boston where he graduated Cum Laude and earned his Bachelor of Arts degree in Economics from the University of Massachusetts, Amherst. Cory resides near Boston, Massachusetts with his wife and 3 children.

These articles are provided for general information only, and does not constitute legal advice, and cannot be used or substituted for legal advice.

Read More

Mitigating Conflicts of Interest – Part 1

In the wake of the Fiduciary Rule’s slow and painful extinction, a new regulatory initiative has emerged front and center, albeit with much less angst and trepidation attached. The SEC's proposed Regulation Best Interest; what one might consider the Commission’s bite at the “fiduciary rule” apple, was released for public comment last spring. The initial reaction to Regulation Best Interest for many was “nothing to see here.” It was difficult to discern how this regulation materially differed from existing regulations and it certainly had far less bite than its Department of Labor predecessor. What Regulation Best Interest does do is mark an apparent shift on the part of the SEC from a scheme of disclosure to a scheme of mitigation and this philosophical change should not be taken lightly.

Regulation Best Interest carves out a distinction between conflicts of interest generally and those arising from financial incentives (it’s safe to say that we care most about the financial incentives). It then imposes a duty on the broker/dealer to identify, disclose, and mitigate the financial incentives. This represents a significant change for brokers who previously relied on disclosure to properly receive compensation that amounts to financial incentives. Adopting policies and procedures to mitigate financial incentives will certainly prove to be more vexing, involve many more moving parts, and cost much more money than putting words on a page. The good news is that at the very same time, changes in the industry are giving B/D firms and their reps more viable options for mitigating conflicts.

 These series of articles will explore various questions emanating from the proposed Regulation Best Interest with a focus on the policies and procedures that are available to properly mitigate financial incentives. The next two articles will look at two prominent methods for conflict mitigation used today: fee levelizing and computer models.

Read More

The Case for Plan Sponsors to Support Participants' Financial Health

Is an employer’s decision to provide assistance with an employee’s 401k a sound investment?  The answer is almost certainly yes, with this kind of benefit having significant impacts to productivity and quality of work.

Historically, 401k providers have long been offering tools and resources to help plan sponsors drive saving for retirement to the top of participants' priority list. For many years however, providers and employers were failing to see the much, much bigger picture.

How can one expect employees to focus on their financial future when they do not have control over their current financial situation?

Fortunately, employers and plan providers have come to understand the impact employees' current financial health has on those employees’ overall well-being.

Employers now realize that financial stress affects employees' health, therefore their use of health benefits, as well as their rate of absenteeism.

The key question for employers to consider is this: If employees spend an average of thirteen hours/month preoccupied about their financial situation, what are they not doing during that period? (Mercer: 2017 Inside Employee's Minds Survey)

Employers have acknowledged how financial woes affect productivity and quality of work.

If employees cannot afford to pay for reliable and quality child care, their utility bill, their rent, their student loan debt, transportation, health care; are these really the employer's concern? Without question they are and employers realize the direct impact that these employee stressors have on their bottom line, so focusing solely on increasing plan participation and contribution rates is simply not an option. The employee's entire financial picture must be addressed as it impacts just about everything.

DALBAR analysts recently reviewed how plan sponsor websites address financial wellness and saw that a substantial number do, in fact, address financial wellness; and among those that address financial wellness online, the majority present full and comprehensive programs. Others offer support for more specific stressors such as student loan or credit card debt.

Below are examples of innovative approaches to financial wellness implemented by several plan provider firms.

T. Rowe Price offers a highly customized three-part wellness program focusing on:

1. Assessing employees' current financial health - The firm utilizes its Confidence Number, a personal retirement readiness score, and resources such as planning calculators, videos and account aggregation capabilities to complete the first phase of the wellness program.

2. Setting meaningful financial goals - Two programs are offered to assist with this phase of the wellness program, one being its Retire with Confidence educational program and the firm's SmartDollar program that attempts to drive behaviors such as accumulating an emergency cushion, paying down mortgages or funding college.


3. Make reaching goals automatic - The third phase utilizes T. Rowe Price's DoubleNet Pay cash flow management tool to establish automatic payments to reduce debt, build an emergency fund, pay bills and meet long term goals.






SunTrust's mobile optimized onUp portal seeks to change participants' mindset from stress to confidence and encourages them to become a part of the onUp "movement".

This highly engaging portal is packed with self-paced training modules, coaching, a MyMoney Desktop - a one-stop financial management shop, financial tools, games and so much more.

Participants are encouraged to accept the onUp Challenge and travel through the 7 Lands of Confidence.










Bank of America Merrill Lynch utilizes it 2017 Workplace Benefits Report findings to drive home to employers the need to implement their 6 Step Financial Wellness program.

The vulnerability of Millenials is focused on with respect to their lack of financial education.

BoA Merrill Lynch points out the hit that productivity takes due to employees' preoccupation with their finances.



Fidelity reveals to sponsors how the findings from its research drove the firm to:

  • Define financial wellness
  • Develop its Financial Wellness Score
  • Establish a method for gauging the financial wellness of a workforce.
  • The firm goes on to provide a sample "Workforce Analysis" result.




Among other key facts, Fidelity also points out the impact that financial stress has on employees' work performance.








Acting on its Workplace Survey findings that 79% of employees with student debt are hampered in their ability to save for retirement, Fidelity tackles this issue head on with a suite of resources to help sponsors promote the use of its Student Debt tool.