Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - big news in this week's edition is that the Department of Labor has released the latest update to its proposed fiduciary rule, which would expand the scope of ERISA fiduciary rules to IRA rollovers and require advisors (including brokers acting as such) to act in the best interests of their clients, but does not necessarily limit the nature of the compensation those advisors can receive and permits commissions to continue as long as they are paid pursuant to implementing best-interest advice. Perhaps not surprisingly, fiduciary advocates are saying the new rules may be too weak, while the brokerage industry is already objecting the new rules would be too stringent.
From there, we have a number of technical planning articles this week, including a look at the latest rules for income-based repayment (IBR) and public service loan forgiveness (PSLF) options for those with significant (Federally-based) student loan debt, a look at the new once-per-year IRA rollover rules that took effect at the beginning of January, a review of the Windfall Elimination Provision (WEP) rules that can reduce Social Security benefits for those who receive a pension based on "non-covered" earnings (i.e., wages not taxed under the Social Security FICA system), and some of the compliance and practical issues that advisors must consider as clients age and potentially face cognitive decline and diminished (financial and other) mental capacity.
We also have a couple of technology-related articles, including a look at Orion Advisor Services and some of its recent initiatives, a discussion of the latest research on cybersecurity risks in financial services and how safe client assets really are, and a broader overview of the major trends currently underway in technology providers for financial advisors (from M&A activity to an explosion of robo-advisor-for-advisors solutions).
We wrap up with three interesting articles: the first looks at some recent market research on how advisors advertise their services, suggesting that the "traditional" views like lighthouses and walks on the beach may feel nice and comforting to consumers, but are failing to differentiate advisors or generate much interest for consumers to explore further; the second is a somewhat amusing look at the "bubble in bubbles" as the "bubble" label is increasingly applied to everything from actual potential bubbles (which are rare) to anything that might just be overvalued or is even just a short-term fad; and the last is a look at how regardless of the ongoing potential for regulatory reform about the standards to which advisors are held, that perhaps the primary elephant in the room to address is simply the confusing ways that (genuine) advisors, insurance agents, and registered representatives all hold out to consumers as "advisors" instead of requiring them to use more accurate titles and labels to describe what they actually do.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including major new updates to the Grendel CRM the announcement by Schwab that its "robo-advisor" platform Schwab Intelligent Portfolios already has $500M of AUM, highlights of a recent review of Orion Advisor Services, and the LinkedIn acquisition of popular app Refresh.
Enjoy the reading!
Weekend reading for April 18th/19th:
Tougher Rules But Flexible Comp Under New Fiduciary Proposal (Andrew Welsch & Suleman Din, Financial Planning) - This week, the Department of Labor unveiled the latest version of its new rules that would extend the fiduciary standard to IRA rollovers, thereby also extending the rule to a wide range of brokers previously subject only to FINRA's suitability standard. The key aspect of the new rule is that anyone providing investment advice to (but not just an order-taker for) a retirement plan sponsor, plan participant, or IRA owner, would be required to establish a contract with the advice recipient that commits to putting the clients' interests first and avoid misleading statements about fees and conflicts of interest, as well as publishing a webpage disclosing compensation arrangements. Notably, though, the nature of the compensation itself is not regulated under the rule; in fact, brokers would still be able to earn commissions, as long as the sale itself met the "best interest" advice requirement. The new proposal would also require that best interests contracts allow for a class action lawsuit in court, potentially limiting the ability of brokerage firms to exclusively resolve all disputes in (non-public) arbitration. Now that the rule has been published, both supporters and opponents will have 75 days to weigh in with public comments, after a yet-to-be-scheduled public hearing about the rule, and after the comment period has closed the Obama administration (which, notably, has been a supporter of the rule) will decide what to implement. So far, though, both sides have had some criticism, with opponents like FSI objecting to both the rules and the fact that the Office of Management and Budget (OMB) took "only" 50 days to review the rule (on average DOL rules are reviewed by OMB for 117 days), and fiduciary advocates like Ron Rhoades suggesting that the details of the best interests standard from the DOL proposal still represents a somewhat watered down fiduciary standard due to the compensation-based conflicts of interest it still permits.
Analysis: Watering Down the Fiduciary Standard? (Ron Rhoades, Financial Planning) - Following on the announcement of the DOL's latest proposed rule, Ron Rhoades provides a good dissection of proposal itself and the potential impact. Key points include: the DOL's "best interests" rule would apply broadly to anyone who is compensated for providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner, which actually expands the scope of fiduciary beyond the DOL's existing exemption for product sales (though strict order-taking would still be permitted); the rule does not ban commissions, and actually permits a wide range of "reasonable" commissions, 12(b)-1 fees, and other forms of revenue sharing, as well as the use of proprietary products, as long as the brokerage firm still meets the best interests advice standard and puts in place procedures to at least mitigate conflicts of interest and provide clear disclosures (though notably, the rule does not require levelized compensation, and varying compensation across different types of products/solutions is still permitted, notwithstanding the conflicts of interest that presents); because much of the management of conflicts of interest and the delivery of disclosures relies upon firms to execute, the effectiveness of the rule may depend heavily upon how the DOL enforces it, which is not yet clear; and while the DOL is broadly applying a fiduciary standard for any advice that is delivered, the rule does not otherwise address the way advisors use titles and hold themselves out to the public.
Income-Based Repayment and Loan Forgiveness: Implications on Student Loan Debt (Jarrod Johnston and Ivan Roten, Journal of Financial Planning) - The majority of undergraduate students (68%!) in the U.S. have received some type of student loan, and the average balance of those loans in 2012 was a whopping $25,900, with those pursuing professional degrees (e.g., doctors and lawyers) maintaining an average balance of $102,460! Given these high levels of debt, borrowers with Federal student loans (e.g., Stafford, PLUS, and consolidation loans made under the certain Federal programs) have been allowed since 2009 to arrange an "Income-Based" Repayment (IBR) plan, which adjusts the required debt payment amounts based on income and family size (e.g., capping payments at 15% of the borrower's discretionary income for 25 years, with loan forgiveness of any remaining balance at that point), as opposed to just the standard formula to amortize principal and interest. For these rules, "discretionary income" is defined as the excess of the person's AGI over 150% of the Federal poverty line (for married couples, the income calculations will include joint income, unless they are married filing separately), though even if discretionary income is "zero" (which means no payments will be due) the borrower is still treated as making "payments" to satisfy the forgiveness period. In addition, Public Service Loan Forgiveness (PSLF) programs permit loans to be forgiven after as little as 10 years, for those who work full-time for certain organizations (including Federal, state, and local government, and certain non-profits). Notably, loan forgiveness under IBR is still taxable income, though, while loan forgiveness under PSLF is tax-free. Current, IBR plans are only available to those who borrowed directly from the Federal government where the loan was granted after September 30, 2007, although the Department of Education is exploring the possibility of expanding the program to prior loans as well.
IRA Rollover Limit May Lead to Tax Penalties for Clients (Seymour Goldberg, Financial Planning) - Starting January 1st of 2015, new rules took effect regarding the once-per-year rollover limitation on IRAs, a result of updated IRS guidance (Announcements 2014-15 and 2014-32) that were issued after a new Tax Court ruling in the case of Bobrow v. Commissioner. Under the "old" rules, the once-per-year limitation only constrained subsequent rollovers from the particular IRAs involved (e.g., if you did a rollover from IRA #1 to IRA #2, no further rollovers could occur from those accounts for a year, but you could still do a new rollover from IRA #3); however, under the new rules, you can only make one rollover from an IRA to another in any 12-month period regardless of how many IRAs you own (i.e., the rule applies once in the aggregate for all IRA accounts). Notably, these rules apply not only for traditional IRAs, but also a SEP or SIMPLE IRA, and a Roth-IRA-to-Roth-IRA rollover as well, though it does not apply to rollovers coming out of a qualified plan, nor to any direct trustee-to-trustee transfers. Yet while the primary limitation of the new rules may simply be to limit those trying to 'abuse' the rollover rules by engaging in multiple separate or sequential rollovers (no longer feasible under the new rules), Goldberg notes that the restrictions may create many accidental errors as well. For instance, a spousal IRA rollover from a decedent could also fall within the once-per-year rollover rules (if not completed via a direct trustee-to-trustee transfer), which means a spousal rollover could limit any other rollovers for that spouse for 12 months, or alternatively if the spouse previously did an IRA rollover of his/her own it may not be possible to roll over an inherited IRA as well (necessitating a direct trustee-to-trustee transfer). While such situations can be navigated by always doing trustee-to-trustee transfers, the limitations do highlight the problems that can quickly arise if an IRA owner fails do transfer IRAs in this manner going forward.
Retirement Planning for Workers Impacted by the Windfall Elimination Provision (Laura Coogan and Shari Lawrence, Journal of Financial Planning) - The Windfall Elimination Provision, or "WEP" for short, is a special rule enacted in 1983 that applies to Social Security recipients who have both their own retirement benefits and also will receive a pension from a job where the employer did not pay into the Social Security system. The situation occurs most commonly where a state or local government system opts out of Social Security, and as a result the employee may have significant "non-covered" earnings. The purpose of the WEP rules are to reduce the Social Security benefits for an individual who has both covered earnings and a pension from non-covered earnings, in recognition of the fact that Social Security provides a larger relative benefit for "low income" workers but was not intended for workers whose average income is lower solely because a portion of their lifetime earnings were from a non-covered job (which is providing its own pension amount). The WEP adjustment is made by reducing the replacement rate applied to the first Social Security bend point from 90% to as low as 40%; given a maximum amount of indexed monthly earnings of $826/month up to the first bend point, this would effectively reduce the retiree's benefits by $413 per month (though the reduction is also capped at 50% of the worker's pension from non-covered earnings, if lower). Additional rules apply to determine how the WEP will be applied in situations where the retiree elects a lump sum payout of a non-covered pension.
Client Diminished Capacity From The Compliance Perspective (Sandra Adams, Practical Compliance & Risk Management) - Increases in longevity and the rising number of seniors is creating more and more situations where financial advisors have to deal with clients facing some form of diminished mental capacity, including both cognitive decline, and also Alzheimer's and other dementias; in fact, a whopping 22% of adults over age 71 have some neurocognitive disorder (mostly minor issues but some major), and it's estimated that by 2030 there will be 7.7 million seniors with Alzheimer's. And notably, when cognitive decline occurs, a person's financial mental capacity in particular is often one of the first abilities to decline; by one study, a full 50% of those with even just mild Alzheimer's disease were fully incapable of making effective financial judgements, and the uptick in impairment of financial mental capacity amongst seniors is likely related to the rising trend of financial exploitation of seniors. For financial advisors, perhaps the greatest challenge is simply to recognize the early warning signs of diminished capacity; accordingly, advisors should learn to watch for warning signs (including a rise in confusion about instructions, missed office appointments or showing up without an appointment, increased difficulty in following directions or recalling past decisions, etc.), and also train staff to watch for such red flags as well. Ideally, advisors working with seniors should also address with the client in advance how the situation should be handled if the advisor observes warning signs of cognitive decline, including getting clients to sign an authorization document to permit the advisor to contact family members to raise the issue if necessary.
What Makes Orion So Special? (Joel Bruckenstein, Financial Advisor) - At this year's T3 Advisor Technology conference, the "hot topics" included M&A activity amongst financial software companies, and the rise of tools for advisors to battle the "robo-advisors", two trends that are both embodied in portfolio accounting software solution Orion Advisor Services, which was recently acquired by a private equity firm in part to help fund reinvestment into offering a growing array of tools to support the advisors who use their software. Accordingly, in addition to its core functionality of providing portfolio accounting, and a "report builder" tool for advisors to customize their performance reporting, new features include the ability to create "trading sleeves" (where a single account is divided into multiple virtual accounts, which makes it feasible to apply different model portfolios or different fee schedules to a subset of assets in a single account) and a growing array of integrations with providers like AdvisoryWorld (which can provide deeper portfolio analytics to support investment accounts in Orion), MoneyGuidePro (which receives automatic updates of account values from Orion), and Riskalyze (where portfolios are monitored daily and the advisor is notified if the portfolio ever deviates from the client's risk score). Another new Orion-related initiative was the launch of AutoPilot with its sister company CLS Investments, which is essentially a turn-key robo-advisor platform (including a self-directed risk tolerance via Riskalyze, and an online account opening process) that advisors can privately brand as their own and embed into their own sites at a cost of just 25bps.
How Safe Are Your Clients' Assets? (Jeff Schlegel, Financial Advisor) - Cybersecurity is an increasing concern in today's environment, not only for us as advisors, but for our clients as well, especially with an ongoing stream of high-profile data thefts including Target, Home Depot, and more. And a recent report from the SEC found that 88% of broker-dealers and 74% of RIAs have experienced some kind of cyber attack, either directly or through their vendors, primarily in the form of malware, or fraudulent emails requesting wire transfers. The good news, at least, is that financial services firms that store client assets have been increasingly vigilant about their defenses against the rising threat, and have developed good response plans to handle an incident promptly if it does arise; a growing number of firms are participating in intelligence-sharing initiatives to further come up with collective strategies to protect consumers. And notably, the reality is that often cybersecurity breaches occur not because the technology itself was compromised, but because undertrained employees made mistakes or took inappropriate steps that resulted in a breach, which means good cybersecurity protections are about people and training as much as the technology itself. Similarly, advisors should be cognizant to both train staff about not sending sensitive information via email, and training clients not to do so either; implementing a procedure to confirm and verify distribution requests, even seemingly urgent ones, is also crucial. Notwithstanding all of these protections, when breaches do occur, the entity responsible for maintaining the security of the system is likely the most liable - which means a custodian would likely be liable for its own breach, but an advisor could be liable for allowing his/her own systems to be compromised. A growing number of advisory firms and broker-dealers are now purchasing cyberinsurance coverage to help manage their potential liability exposure, though the details of coverage can vary materially from one policy to the next.
4 Big Changes In Advisor Technology (Joel Bruckenstein, Financial Planning) - The world of technology providers for financial advisors is heating up, and Bruckenstein highlights here the four broad trends that are currently underway. The first is the sheer volume of M&A activity, with both the big Fidelity acquisition of eMoneyAdvisor, the SS&C Technology acquisition of Advent software for $2.3B, and the purchase of Orion Advisor Services by private equity firm TA Associates, which suggests that notwithstanding the robo-advisor threat, the "smart money" sees value in technology companies serving financial advisors. Another notable trend is that the rise of robo-advisors has spawned an array of new technology solutions to help advisors to compete, from existing tech providers offering new services, to new firms developing "robo" technologies for advisors to use. And more generally, the pressure on technology firms to step up seems to be driving an accelerating pace of innovation and new features across the board; for instance, Bruckenstein notes that at the recent T3 Advisor Technology conference, MoneyGuidePro announced its next major release (entitled "G4"), Advicent (makers of NaviPlan and Financial Profiles) announced their Narrator tool (which allows advisors to easily create customized client portals), FinancialLogix released a major version update, and eMoney Advisor demoed its new emX platform including the coming separate release of emX Select, a standalone version of its popular account aggregation and client portal solution.
Consumer Research: People Say, “Get Real” (Gail Graham, Financial Advisor) - Last summer, Graham's firm conducted an extensive marketing study to evaluate perceptions of financial advisors and the services we provide, and test some of the "typical" advertising concepts we use. For instance, one ad focused on helping clients with their "Inner Dialogue" fears (e.g., "I'm worried about retiring comfortably"), while another looked at engage clients in a conversation (e.g., "What Are Your Dreams?"), and the third actually took a "truth in investing" approach by mocking the financial services industry about getting real. The results revealed that while traditional ads seem nicer and more reassuring, they're viewed as less innovative, less confidence, and less intelligent than edgier alternatives (as Graham notes, sometimes it's better to be interesting than to be nice!). More generally, the implications of the research are that consumers may be bored with traditional industry marketing (and/or don't believe it altogether) and would rather hear the truth even when it's not pretty, and being a little disruptive can actually help to make people interested enough to learn more. Overall, this implies that advisors relying on the more traditional marketing messages and visuals - lighthouses, walks on the beach, etc. - may want to re-evaluate their approach, as while these traditional images may be 'reassuring' and pleasant, they're no longer differentiating or "interesting" in today's environment.
Fighting the Bubble in Bubbles (Justin Fox, Bloomberg View) - It's one thing to believe that equity or bond markets may be "overvalued", but in recent years it's become popular to call anything/everything that is believed to be overvalued a "bubble", to the point where Fox suggests that now there may be a bubble in bubbles! In the case of tech stocks at the turn of the millenium, this label was probably reasonable, as the Nasdaq index experienced a stunning climb from 1,500 to 5,000 in barely 18 months, followed by a crash from 5,000 back to 1,500 again in the subsequent 18 months. In that case, the key characteristics were the fact that asset prices rose very quickly, they become unmoored from their fundamental underpinnings (the average P/E ratio of the Nasdaq exploded from 20 to over 170 from early 1998 to March of 2000), there was an element of psychological contagion (many of those were dubious about tech stock valuations bought anyway, in part because everyone else seemed to be doing it successfully), there were feedback loops that fed the process further (e.g., new funding into money-losing startups was spent on other tech companies which artificially boosted their earnings, too), and when prices did start falling they fell very quickly. Viewed from this context, a lot of today's alleged "bubbles" are probably not; for instance, the rapid rise in popularity of cupcakes, which now appears to be on the wane, may have been a passing fad but was not a full blown "bubble" with asset price implications. Similarly, higher education doesn't really appear to be a true "bubble" either; even experts who are predicted a "crash" in the cost of education attribute it not to a post-bubble price decline but to competition from online learning opportunities, which is more the "normal" process of technological disruption of an established "industry" but not a bubble. And even the bond market, while arguably overvalued by many measures, isn't necessarily a "bubble" either. Though Fox does not that by at least some views, the concerns about the private-market tech bubble (think Uber and Snapchat) may be more valid and bubble-like, though again it's still hard to draw the line between mere 'normal' exuberance and a true bubble.
So, Who Are You Calling An ‘Advisor’? (Richard Wagner, Financial Advisor) - The word "advisor" is being used to characterize an increasingly broad array of people, and Wagner notes that major financial services firms are now conducting national advertising campaigns holding out what are legally their (insurance) agents and (registered) representatives as "advisors", which makes it virtually impossible for consumers to distinguish between the genuine advisors and the financial services product salespeople. The point is not that there isn't a role for both - there is - but that the misuse of the "advisor" label leads to significant consumer confusion about who really does what, how they are compensated, and what their duties and commitments to clients really are. And from the advisor's perspective, Wagner claims the fact that true advisors have no means to distinguish themselves from salespeople is a form of unfair competition. Ultimately, ongoing regulatory reforms - e.g., the recent DOL fiduciary proposal - may attempt to exert higher standards on all advisors (including brokers and insurance agents who deliver advice), but Wagner makes the case that first we must address the "language" issue head on, and at least clarify and resolve the now-blurred lines of distinction between advisors, insurance agents, and registered representatives.
I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!
In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!
I suspect the info on IBR/ PSLG may be dated for new graduate students. According to the white house budget, Deparment of Education regulations are changing as of July 1, 2015. Loan forgiveness will be capped at $57,500.. IBR is out, and only PAYE is available. The married filing separately option is out; marrieds must file jointly to determine payments. Interest rates will be Ten Year treasury + 3.6%