“They can maintain their compensation structures and at the same time control what it is their advisors are doing in the field,” he says, noting broker-dealers spend vast sums on arbitration costs because clients sue a firm based on what their advisor told them to do. “With the computer model that goes away,” Harvey says.
Broker-dealers have long resisted regulatory efforts to impose a fiduciary standard on their financial advisor reps. ERISA 408(g) allows broker-dealers to attain fiduciary certification while enabling broker-dealer reps to engage in sales and service activities. “Our computer model is a fiduciary,” Harvey says the firms can say. “But our guys are not there to provide investment advice; they deliver the investment advice that comes out of the [computer program].”
Such a program would be designed by finance experts in strict accord with generally accepted investment theory, Harvey says. That means that clients don’t end up with portfolios built on oil and gas MLPs or commercial REITs that blow up. “I don’t know any generally accepted investment theories that support REITs as your only investments. [The computer program] adds discipline from a consumer perspective,” he says.
While the broker-dealer expands its business and reduces arbitration costs, and the consumer wins out with more and better advice, a computer model has powerful advantages for retirement advisors.
“You’re taking work off the advisor’s plate and giving him a solution that has the imprimatur of the firm,” Harvey says.
But the biggest opportunity for advisors and broker-dealers waiting to be tapped in the ERISA provision is on the IRA side of the market rather than in 401(k)s.
That is because, as things are currently structured under the Labor Department’s SunAmerica ruling, a firm — say, Merrill Lynch — escapes fiduciary liability if it hires a firm like Morningstar or Financial Engines to provide independent third-party advice to 401(k) plan participants.
But only with 408(g) does the financial industry have an exemption that works for IRAs.
“The idea here is that the Labor Department frowns on advisors who recommend that people roll over the assets out of their 401(k) into an IRA [in order to increase their] compensation,” Harvey explains. “But if you have a computer model, it’s the computer model that is the fiduciary. The Labor Department has been explicit that there are no restrictions on the non-fiduciary. The rep can be uninhibited in his pursuit of rollovers.”
In other words, advisors can capture the flow of funds occurring every day when people take distributions out of their 401(k) plans as they retire — if that is consistent with the certified and annually audited computer model’s unbiased investment recommendations.