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October 14, 2019 12:00 AM

Broker-dealers see automation as key to gain business edge

Margarida Correia
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    Jason Grantz
    Gary J. Barragan
    Jason Grantz said RIAs don’t need to do much with the automated systems.

    More broker-dealer firms are looking to win over retirement plan advisers with automated 3(38) fiduciary platforms that they believe will give advisers an edge in gaining plan sponsor clients.

    Cetera Financial Group in June, for example, launched a 3(38) platform for its more than 5,000 investment adviser representatives using Mesirow Financial as its technology provider, while Merrill Lynch introduced a similar platform using its own technology for some 4,100 advisers specializing in retirement plans in March. Other 3(38) platforms were rolled out by Commonwealth Financial Network late last year and Raymond James Financial Inc. last summer.

    The firms are following the lead of early providers LPL Financial LLC, which introduced a 3(38) fiduciary platform for advisers serving small retirement plans in late 2016, and Morgan Stanley, which launched its service in March 2017.

    The platforms — offered through the firms' RIAs — allow advisers to relieve plan sponsor clients of having to select and monitor plan investment as is required of them if they decide not to outsource to a 3(38) fiduciary. Advisers have typically taken on a lesser 3(21) fiducia- ry role in which they provide sponsors with investment recommendations for plan lineups but stop short of executing those recommendations as they do not have the discretion to do so.

    The automated platforms simplify the task of fiduciary investment oversight for advisers, while giving them an additional service that they can provide to plan sponsor clients seeking to relinquish their 3(38) responsibilities. Sponsors of small retirement plans — those served by the advisers the broker-dealers are trying to reach — often don't have the time, training or knowledge to select and monitor plan investments, said Mathew Powers, manager of Commonwealth's retirement consulting investment services in Waltham, Mass.

    "It can be a struggle for plan sponsors to approach their investment oversight duties," he said.

    Sponsors that do outsource their 3(38) fiduciary role, however, still need to monitor their 3(38) managers as they would any other service provider or face the risk of being sued for breach of fiduciary duty, said Linda Haynes, a Chicago-based partner in law firm Seyfarth Shaw LLP.

    "You're still responsible for not only the decision to hire that 3(38) but also too you're responsible for the ongoing decision to continue to use that 3(38)," Ms. Haynes said. "You need to periodically get reports from them about the performance of the (investment) options and periodically benchmark their fees."

    In essence, the platforms develop investment lineups for plan sponsors, changing investments with the sponsors' record keepers.


    Monitor funds

    The platforms not only determine the asset classes and select the funds but also monitor the funds and replace them as needed, a process that's done automatically, said Jason Grantz, the Highland Park, N.J.-based director of institutional retirement consulting for Unified Trust Co., a provider of discretionary trustee, record keeping and other services to small- and midsize plans.

    "The adviser does not actually have to do a heck of a lot of work or research or behind-the-scenes spend time on investments because it's being done for them by the broker-dealer's chosen tool or chosen service provider," Mr. Grantz said.

    Keeping the adviser's work to a minimum not only frees up the adviser to pursue more business but also gives broker-dealers greater peace of mind knowing their advisers now have a smaller margin of error, according to industry experts.

    "Being a 3(38) adviser is not something that should be taken lightly," said Michael Annin, the Chicago-based senior managing director of investment strategies at Mesirow, explaining that the role carries enormous fiduciary risk.

    "They're an ERISA fiduciary, so they're subject to all of ERISA's fiduciary duties and responsibilities," Ms. Haynes said of 3(38) advisers.

    Indeed, liability concerns have prompted many broker-dealers to launch 3(38) platforms, a trend that accelerated in the wake of the now-defunct Department of Labor fiduciary rule, industry observers said.

    "I think the DOL rule prompted broker-dealers to look for ways to control the fiduciary and the investment fiduciary process so that it became more standardized within the broker-dealer," Mr. Grantz said.


    2 fiduciary roles

    As part of the 3(38) platforms, either the broker-dealer's affiliated RIA or its corporate RIA — and not the broker-dealer itself — assumes both the role of 3(38) fiduciary as well as the associated fiduciary liability risk, according to lawyers and industry experts. The advisers in these types of arrangements do not technically assume the 3(38) role. In most investment management agreements between financial institutions and plan sponsors, the institutions are technically the 3(38) and therefore assume the liability, Ms. Haynes said.

    "By definition, a 3(38) manager has to be a bank, a registered investment adviser or an insurance company," she said, noting that broker-dealers that are not also RIAs cannot be 3(38) managers.

    The new platforms are stirring up competition for record keepers, which have long been adding "embedded 3(38) platforms" into their service offerings for advisers serving small plans.

    John Hancock Retirement, Principal Financial Group, Empower Retirement, Transamerica Corp. and Fidelity Investments all have 3(38) offerings, according to industry observers.

    John Steiger, president and founder of Wealth Planning Resources LLC, Waltham, Mass., a retirement plan and wealth management firm that uses Commonwealth as its broker-dealer, serves some 80 small retirement plans with $260 million in assets. He offered Commonwealth's 3(38) platform services to his clients but so far most have demurred, citing high fees.

    While Mr. Steiger says he appreciates having Commonwealth's automated 3(38) service, he opted not to use it and went instead with an option available to advisers with more than 40 plans. He and four other Commonwealth advisers banded together to create their own investment menu under Commonwealth's RIA, allowing them to exercise more control over the 3(38) investment oversight process.

    Mr. Steiger wanted to pick the funds rather than a provider make all investment choices, he said.

    He and the other advisers worked with Empower to build a menu of 15 investments, which included target-date and socially responsible funds.

    "We're giving him a little bit more flexibility to have a voice in what the investment menus would look like," Mr. Powers said of Mr. Steiger.

    The menu was part of a program the advisers created for plan sponsors that married the 3(38) services with 3(16) administrative services provided by retirement services provider Pentegra, which small plan sponsors would likely find desirable given all the administrative work they do, Mr. Steiger said.

    In addition to gaining more control over investment oversight, Mr. Steiger and his colleagues were looking to reduce costs. The four other advisers, who each operate their own separate practices, collectively serve 155 plans with $1.1 billion in assets, Mr. Steiger said.

    "The goal was to aggregate assets to reduce overall administrative and investment fees," Mr. Steiger said, adding that the group was able to reduce the 3(38) service fee to 4 basis points for plans under $10 million, less than half the 9 to 12 basis points charged by Commonwealth's platform.


    Not typical

    Mr. Steiger is not the typical adviser for which the automated 3(38) platforms are designed. Most platforms are intended to help advisers whose focus is on wealth management and not retirement plans, according to industry experts. Mesirow's Mr. Annin, for example, says Mesirow caters to non-specialist retirement advisers, serving tens of thousands of small plans with average assets of $1 million.

    Advisers with 100 or more retirement plans have the ability to be the 3(38) fiduciary because they've internalized the process and don't need the "push-button" or outsourced version of a 3(38) service, Mr. Grantz said.

    Those with only a handful of retirement plans, in contrast, would find the process of investment selection, monitoring and replacement time-consuming and laborious, he said.

    What's more, the universe of specialist retirement advisers is small with less than 10% of advisers focusing on the 401(k) plan business, according to Jon Anderson, head of retirement plan solutions at Cetera in San Diego.

    "If you want to serve more retirement plans and have more small businesses covered by retirement plans, you have to create services that help non-specialist advisers be able to provide high levels of service, which includes training and platforms like this," Mr. Anderson said.

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