Roboadvisors and the DoL rule: No more guessing

When the DoL fiduciary rule passed, many feared that small retirement accounts will be orphaned because the changing fee structure will make them unattractive to advisors.

In response, others claimed that automated advice, or roboadvisors, should be able to swiftly, cheaply and compliantly sweep those accounts up. However, many top level officials, executives and legal experts have debated whether software-based, automated advice can truly client’s personal situation into account when issuing advice and conducting proper due diligence.  Such solutions lend themselves to a one-size fits many model, experts say, and might not qualify as having the clients best interest.

The DoL just issued its first FAQ, clarifying its position on the subject. The bottom line: roboadvisors that can act as level fee fiduciaries are OK.

“There is a clear and substantial conflict of interest when an adviser recommends that a participant roll retirement savings out of a plan into a fee-based account that will generate ongoing fees for the adviser that it would not otherwise receive, even if the fees going-forward do not vary with the assets recommended or invested,” the DoL wrote in its FAQ. “The streamlined level fee provisions of the BIC Exemption cover roboadvice providers engaging in these discrete transactions.”

The rationale for this exception is that charging a level fee eliminates any conflict of interest that arises from the traditional commission-based compensation structure.

Level fee fiduciaries must still comply with the impartial conduct standards, which require fiduciaries to act in the best interest of their clients, charge no more than reasonable compensation, and make no misleading statements.

This puts some robos in hot water, particularly those that are, in effect, distribution channels for proprietary products.

The classic, plain vanilla, roboadvisors, like Betterment and Wealthfront, should feel pretty comfortable under the level fee exception. Incumbent-run digital portfolio managers, which tend to overemphasize their own financial products, might have a hard time complying with the impartial conduct standards.

For example, though Schwab Intelligent Portfolio charges investors a level fee of $0, it does charge investors different fees for different products offered by automated advice.  Under this scenario, there is a clear incentive to offer certain products and not others. This is exactly the type of conflict of interest the DoL sought to eliminate.

Are robots the answer to DoL rule challenges? Maybe, maybe not.

automation technologies

The U.S. retirement income industry is a complex beast with income derived from many sources, like Social Security, traditional pensions, 401(k)s, and Individual Retirement Accounts.

Managing an IRA can be a hard task for individuals, as they involve many possible products. This leads people to seek professional advice. With commission-based compensation and complex fees, conflicts of interest are commonplace.

A report by the The Council of Economic Advisers estimated that the annual cost of conflicted advice is about $17 billion each year, with $1.7 trillion of IRA assets invested in products with conflicts of interest.

It is on this backdrop that the DoL released a new set of rules requiring anyone providing investment advice to retirement plans to do so under fiduciary requirements to be prudent and avoid conflict of interest. The industry is now scrambling to change products, workflows and fee structures to comply with the new rules before the effective date of April 10, 2017.

With compliance costs high, many advisors are exiting the business. Other are restructuring their compensation structure. Cambridge Investment Research, an independent broker dealer, estimates that it will spend $15 million to $17 million on technology upgrades and other operational changes in anticipation of the rule.

With higher compliance costs, some are looking to cheaper options, like roboadvisors, to offer scalable solutions.

“Since roboadvisors charge a flat fee, many believe that they will comply with the DOL fiduciary rule without the need to justify fees or show that there is no conflict of interest under the Best Interest Contract Exemption,” wrote Bates Research Groups. Technology firm, CGI suggested roboadvisors will be used to service accounts that otherwise would be deemed not profitable enough and might be orphaned.

However, the question whether roboadvisors themselves can themselves be considered fiduciary is debatable.

Earlier this year the Massachusetts Securities Division issued a policy statement that examined roboadvisor compliance with their fiduciary responsibility. The policy statement questioned software’s ability to take a client’s personal situation into account when issuing advice and conducting proper due diligence.

“The commoditization of advice and streamlining of solutions, based on few broad initial survey questions, lends itself to ‘one-size-fits-many’ portfolios that may not be suitable for each client,” commented Min Zhang, CEO of Totum Wealth, a provider of technology solutions to advisors. The way roboadvisors are structured, she added, lures clients into a potential false sense of confidence that something truly unique is being created for them.

Blaine Aikin, executive chairman at fi360, which offers fiduciary education, certifications, software and practice management offerings, echoed Zhang’s sentiment. Roboadvisors do a good job for people with simple and well-defined goals, he said. Problems arise when cases become more complex, though. Roboadvisors currently do not really personalize their offerings, which might be a breach of due care responsibility.

In addition, algorithms might have systemic biases, which might prevent them from offering advice that is truly in the best interest of their clients.

Both Zhang and Aikin agree technology and roboadvisors will play an increasing role in the future of wealth management, but envision more of a hybrid model, where robos support humans to make better decisions, but the humans have their hands on the wheel.

There is no overarching regulation regarding roboadvisors. FINRA, the SEC and the DoL are dealing with aspects of automated investments advice. It is mostly up to advisors to figure out how to comply with the ever-changing regulatory landscape.

Retirement advisors turn to secret web analytics to poach corporate clients

retirement plan administrators getting competitive

As the industry mulls over what to make of the DoL fiduciary ruling, one thing is certain: it’s going to get more complicated to acquire rollover clients. That’s because the new rules extend advisor responsibilities beyond just finding suitable investments for their clients. Under the new rules, if it doesn’t pay to rollover an existing plan 401(k), then the advisor just shouldn’t do it.

And they should. This year, $432 billion of assets are expected to exit sponsored plans and enter IRA brokerage accounts, according to Cerulli Associates. That’s around 5% of total IRA assets. Retirement rollovers are a major source of new asset flows into the industry and one that incumbents would be pained to lose.

The rules are still being debated but that hasn’t stopped the brokerage industry from scrambling for solutions. Indeed, 51% of advisors now think that their business will improve in the face of the DoL rule.

Whatever happens, retirement plan admins can get more aggressive about their marketing to large corporations. SimilarWeb, a web analytics company, recently released a report that details how retirement plan adminstrators can use competitive intelligence to identify the clients of their competitors.

One way firms can do this is by analyzing referral traffic to an administrator’s website. Plan sponsors make it easy for their employees to check on their 401(k)s by supplying them links to their administrator. By analyzing traffic to a provider, a competitor can get a feel for that firm’s client base. Firms will need to use a premium tool like SimilarWeb to get access to this type of web traffic data.

U S401k Retirement Plan Companies’ Marketing Strategies
from SimilarWeb

There are other marketing strategies retirement plan adminstrators can implement to poach new clients. One technique SimilarWeb recommends is looking at the architecture of a competitor’s website for clues about customers. The analytics company has a tool called Leading Folders which analyzes highly-trafficked sections of adminstrator websites. By doing so, you can uncover links that may hint at possible clients. Clicking on these links frequently yields confirmation that the company does indeed do business with a particular corporate client.

competitive intelligence for retirement sponsors
from SimilarWeb

Lastly, SimilarWeb encourages retirement providers to analyze search data that’s driving web traffic to their competitors’ websites. Occasionally, administrators receive significant amounts of traffic from search engines using keyword terms that include their clients’ names. Dive deep into this data and an administrator can further breakdown their competitors’ lists of clients.

Beyond the impact of the DoL ruling, the retirement plan business is seeing a push towards more transparency, broader product selection, and fee compression. Employees of M.I.T., N.Y.U., and Yale recently filed suit against their universities for allowing excessive fees to be charged to plan participants. With new business up for grabs, retirement plan administrators can use competitive intelligence to yield fruit in the future.

Photo credit: Nicholas Eckhart via Visual Hunt / CC BY