This is not your Dad’s 401(k) plan space. The market has changed much in 20 years. The war stories that big advisory firms in the 401(k) space tell about getting into the business are not going to be the same ones advisors tell today. Much of this business used to be drummed up by advisors from clients they already had relationships with on other business (and perhaps with whom they played golf, too). Today, it’s a complex RFP carefully written to meet the specs of human resources pros in the corporate world. And with the increasing pressure by regulators to push fees down, it’s not surprising that, according to different sources, only a small fraction of advisors in the independent RIA channel are focused on DC plans.
“There are not a lot of RIAs that are specializing in 401(k) [plans],” says Brent Brodeski, CEO of Savant Capital in Rockford, Ill., which advises on $500 million in the space. “A few dabble and do a few plans. But this is generally a disservice to plan sponsors. The only thing in common between 401(k) plans and wealth management clients is both have investments. Everything else is different.”
For that reason, Savant has started to offer its 401(k) platform to other advisors and community banks who want to provide a solution but do not want to invest in platforms of their own.
But there are lots of reasons to get involved in the business. Simply put, defined contribution plans represent the single largest asset accumulation vehicle for most Americans. In 2015, the Investment Company Institute estimated DC plans hold $6.6 trillion in assets, with about $4.7 trillion residing in 401(k) plans alone.
Another attraction is that 401(k) plans are predictable revenue sources for advisors. Americans are constantly replenishing these retirement accounts from their paychecks every couple of weeks. That’s a regular, growing income stream for retirement plan advisors, at a time when many of their baby boomer clients are about to retire and enter the decumulation phase. Moreover, the money advisors receive from wealth management clients is lumpy by comparison, often coming from big payday events (like divorces, inheritances, job transfers or business liquidations).
And 401(k) advisors can snag other kinds of business from this specialty, things like the rollover IRAs of plan participants or the wealth management business of executives in the plans.
But the big plan advisors got into this space when it was a vastly different business. Smaller advisors who want in are likely to be doing it with third-party firms helping them bundle services, and those who specialize and don’t specialize will have to fight for the scraps.
So those prizes in the piñata are too good to ignore. In fact, Skip Schweiss, president of TD Ameritrade Trust Services, says that more advisors have become interested in the space since 2012, when the Department of Labor came out with new disclosure regulations requiring plans to fully disclose their compensation and plan sponsors to disclose costs. TD Ameritrade recently reported that of its 5,500 advisor clients, 10% of those are now using its retirement plan development tools. That’s almost doubled from 2014, he says.
“Even though [in a 401(k) plan] you can’t charge 100 basis points like you can your individual clients—you can charge 25 to 50, which is the range we see a lot—the attraction is … you have new money coming in every two weeks or every pay cycle for every plan you advise, and your individual clients simply are not adding money every two weeks like the plans are,” Schweiss explains. “So you get sort of a baked in AUM increase that way that you don’t get with your individual business.”
Pitfalls
Yet advisors are also wary, and for good reason. Plan sponsors are bright targets not only for regulators but for class action lawyers on the hunt for what they consider to be abnormally high fees. Class action lawyers have found a new gravy train, and anything that sticks out like a sore thumb will give them an excuse to drag plan sponsors into court. Just ask many of the mutual fund complexes that have proved to be particularly juicy targets for the plaintiffs’ bar.
A case in point is a recent lawsuit against a subsidiary of computer equipment company Fujitsu. Class action lawyers alleged that the company’s pension, at $1.3 billion in 2013, failed to keep its costs under control, was among the top five most expensive plans among 650 others of similar size, and that its 2014 fees added up to 90 basis points when typical firms charged around 30 or so.
The suit bemoaned that employers have no incentive to keep from having high-cost, low-performing investments and referred to a study by public policy group Demos saying that “the average working household with a defined contribution plan will lose $154,794 to fees and lost returns over a 40-year career.”
What’s scarier is that this time, lawyers snagged an RIA firm into the suit as well: Boston firm Shepherd Kaplan had designed a target-date strategy for the fund, and not only were the fees allegedly higher, but the strategy reportedly used unconventional, speculative asset classes “such as natural resources, micro cap stocks, emerging market stocks, emerging market bonds, and real estate limited partnerships.”
It was too novel for the participants and their lawyers. (Shepherd Kaplan did not return calls for comment.)
The fear is that advisors in this hostile environment will continue to see downward pressure on their fees and Monday-morning quarterbacking when an asset class disappoints. Margins in the business already are slim. Throw in litigation risk and the appeal fades for many advisors. Finally, defined contribution plans also require a lot of administration expertise. So the conventional wisdom is that advisors who merely dabble in the space, the so called “two-plan Tonys,” will be flushed out.
But Schweiss says that’s not what he’s seeing. The rewards are too great, and fiduciary advisors are in the right place at the right time. He does say, though, that the fee squeeze has changed the business. Advisors on TD’s platform have 36% of clients’ 401(k)s in Vanguard funds and another 15% with Dimensional Fund Advisors. Among active managers, low-cost fund groups American Funds and T. Rowe Price lead the field.
“What we’ve seen since 2012,” says Schweiss, “when the Department of Labor disclosure regulations came out …. we started to see more advisors get more interested in the marketplace. It was about that time we saw more assets moving from higher cost plans and higher cost investment offerings to lower cost. We’ve seen quite a surge from more active managers to more passive managers.”
Schweiss believes it’s a great opportunity for RIAs, and he hasn’t heard many voice concerns about potential liabilities. TD Ameritrade’s platform pitch is that it can provide a turnkey offering and brand name to help these advisors compete, especially with smaller plans.
DC Nostalgia
The business has changed so much since the 1990s, that those in the business a long time might feel downright nostalgic. Back then, retirement plan business was something you got from your relationship with company CEOs—something they brought to advisors when they needed plans for the companies they ran. According to veterans, the business 20 years ago was focused almost only on investments.
That’s all changed in the age of fee scrutiny, regulation and litigation. Today, there must be processes, a rationale for the investments chosen, a close relationship with HR departments. Relationships are still important for small RIAs working with small plans, but at the high end of the spectrum, big advisory specialists will have to start going to casting calls and auditioning. Those who don’t focus just on 401(k) plans are going to have a harder time, say the big players.
Susan Conrad, the director of retirement plan advisors at St. Louis RIA Plancorp, has been in the industry 28 years, first at a boutique record-keeper where she started with plan design. She joined Plancorp six years ago after the firm had taken on about 10 plans. Regulations had become so cumbersome by 2011, she says, that her firm realized it needed someone like her on board full time. She came in and built a team that’s 100% focused on the retirement space.
It was the new fee disclosure requirements in 2011-2012 that changed the landscape, she says. “You had to know that your disclosures were compliant and that they were delivered at appropriate times. And interfacing with record-keepers along this line became more important.”
The challenge today, she says, is that strong advisors in the retirement space must know that they are basically an extension of the companies’ HR departments, she says.
That requires more of a time commitment. Because there’s a race to the bottom in fees, even record-keepers are pushing some duties back onto the companies, Conrad says. “HR departments are already overloaded with all their duties. So an experienced advisor will help them identify a record-keeper that’s best equipped to provide the level of service they need.”
The founders of Chicago’s DiMeo Schneider & Associates, Bob DiMeo and Bill Schneider, started working with 401(k) plans when they were still at Kidd er, Peabody & Co. in the mid-1990s, says the firm’s director of institutional consulting, Doug Balsam. The firm now has roughly $30 billion in assets under advisement for DC plans and has more than 150 retirement plan clients.
Balsam agrees that there wasn’t a lot of scrutiny of fees back in the early days. Back then, he says, you picked bundled packages that wrapped in an investment selection with record-keepers like Fidelity, Scudder or Kemper, and the selections were proprietary.
“For many years, there was no way you were going to get a Vanguard fund on a Fidelity platform or vice versa. There were a lot of closed walls between the investment firms and record-keepers.” Those walls came tumbling down not because of regulators but because of the revolt of other market players: Asset managers wanted a taste of the plans, plan consultants wanted more flexibility, plan sponsors wanted better-performing funds, and employees wanted more fund choices. “You had the investment-only providers … who were knocking on doors and saying ‘We’re managing your DB plan and you see us doing well. Why don’t you let us manage your 401(k)?” The fiduciary movement meant there could no longer be closed walls, Balsam says.
But when RIAs got into the space, he continues, they realized that they would have to extend their expertise beyond their regular services. That’s led to a new breed of third-party service providers popping up like mushrooms after the rain. RIAs “are starting to realize now, ‘I’ve got to balance what I’m doing for my individual clients and go out to speak to 50 people in a manufacturing plant three times for a couple of days.’ I think it really forced the hand of advisors to say ‘I’m going to be in this space and I’m going to hire people who can get a staff together that can provide education, help with the print material, get up to speed on taxing and administrative issues.’”
CapTrust, a Raleigh, N.C., firm, has $200 billion in assets under advisement, most of it in retirement plan advisory client relationships around the country (it also has a huge wealth management business). It was founded as a wealth manager in 1997 after being spun off from broker-dealer Interstate/Johnson Lane and is now overseen by CEO Fielding Miller. Miller had a lot of 401(k) clients since the early 1990s.
“There weren’t a lot of retirement plan advisors in the early ’90s or late ’80s because the world was not really set up for that,” says John Curry, CapTrust’s senior director of marketing. He also says that companies used proprietary arrangements, often with group annuity products or bank products, and these were trustee directed, not participant-directed.
By the early 2000s after the tech bubble burst, Curry says, the new status quo was full of confused plan sponsors who didn’t know where to turn looking for guidance. “All of that is a perfect setup for an independent and objective retirement plan advisor like CapTrust to inform and put some perspective around the choices to be made and to help plan sponsors negotiate their partners, pick their fund lineups and educate or provide advice to their employees.”
Buddy List
Curry also says that new business used to be based on relationships, but that’s changing at the high end of the market. Marty Bicknell, the CEO of Mariner Wealth Advisors in Leawood, Kan., agrees with that assessment.
“In the past,” says Bicknell, “it was definitely that you could be managing money for the CEO of a company and get the opportunity [to advise its 401(k) plan] because you were doing a good job for them personally. Those days are gone.”
In fact, he says, if you have a relationship with the plan, it might be used against you. “The buddy list is behind us,” Bicknell says.
Curry says that CapTrust has done 1,300 or 1,400 RFPs in its corporate history, and that this trend has really taken root in the last six years.
Still, according to Schweiss, it would be premature to write the obituary of the “two plan Tonys,” especially in the smaller client space, where TD now has an offering that bundles record-keeping and plan design and administration. The RIA has only to bring the TD Ameritrade product to the plan sponsor. (Vanguard and others have also bundled record-keeping into a plan sponsor offering.)
“We have many, many hundreds of two-plan Tonys,” he says. “We keep hearing predictions that that person is going to get shaken out. … [But] the advisor who is really going to put together a business plan for proactively going after plans, really understanding what the opportunities are, is going to have a leg up on somebody doing it on a reactive basis.”
Legal Environment
But it’s not enough to know how to deal with HR departments. These days, you are going to have to understand the legal landscape if you want to play in this space says ERISA lawyer Marcia Wagner, whose firm the Wagner Law Group has represented dozens of RIAs, often on the defense side, and says, “We’re up to our eyeballs in this in every conceivable way.
“You can’t be an RIA firm and not have a really strong knowledge and understanding of ERISA,” Wagner says, “and the best practices and the evolving best practices. If RIAs are going to do well and mitigate risk, I often say they need to be mini-ERISA lawyers.”
She says many class action suits against 401(k) plans are about fees being excessive. “This is a standard type of argument.” It was started by one law firm and then it snowballed and many others got in the game.
Advisors also need to realize that the standard for being an ERISA fiduciary is higher than that for an SEC fiduciary. “Under the SEC rules, in general, if a fiduciary has a conflict of interest, full and complete disclosure satisfies the legal issues,” Wagner says. “Under ERISA, if a fiduciary merely discloses prohibited conflicts, that disclosure provides people with a road map of how to sue the fiduciary, unless the fiduciary complies with a prohibited transaction exemption, such as the best interest contract exemption.”
The standard defense for plans that have higher fees is that they must provide better services and provide a better mousetrap.
“ERISA doesn’t require the lowest cost option being provided with respect to fees,” Wagner stresses, “but that the fees for services are commensurate.” Firms get in trouble, she says, with things that are egregious. “If your gut tells you something isn’t right, guess what, it probably isn’t right.”
For instance, lawyers might pounce if there hasn’t been an RFP done for a number of years, if the fees are excessive, if the returns of the funds have underperformed basic industry benchmarks, if plan participants have been complaining, if the plan has had bad audits that haven’t ended well with the IRS or DOL, or if the plan sponsor isn’t making timely distributions when people leave the company and seek to cash out. “These are all red flags,” Wagner says.
But the new fiduciary rules are going to change the game. “RIAs are going to have to up their game to be in compliance with these new rules,” Wagner says. “There’s going to be a lot more compliance costs; more paperwork; a lot more outreach to the clients to explain what all this is; and a change in processes, protocols and procedures.”
She says her clients are working around the clock to get themselves into compliance by April 10. “We’ll make it,” she says. “Fingers crossed, knock wood, spit to the wind, salt over the shoulder.”
But with all these headaches, she says she doesn’t see advisors shying away from the business. Like Schweiss, she sees people seizing opportunity: People who want to practice advice will feel compelled to do it, as they would any passion. “No matter how litigious medicine has gotten, every year you see more people going into it,” she says. “I think becoming a financial advisor is going to become more and more difficult, but people who truly have the calling, this isn’t going to hamper that. If anything, they’ll up their game.”