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Guest Commentary

New Retirement Plans Business Models: Adapt & Grow Or Die (Revised 7/13/04)

By Phil Chiricotti, Founder and President of the Center for Due Diligence. The Center for Due Diligence (CFDD) is an independent consulting/research organization specializing exclusively in full service 401k program competitive analysis for the trade. The CFDD is widely recognized as the premier provider of unbiased, detailed, bottom-up competitive analysis and also assists providers with product development, marketing and strategy. You may contact Phil at


Increased investment regulation, burdensome compliance costs, a contracting industry, shifting market share, "joint distribution" and converting to the fee-based model could be the primary trends in the retirement plans industry in the years ahead.

Commissions and fund expenses will remain under pressure, all forms of revenue sharing will be challenged, billable costs will increase and more RIAs focusing on the retirement plans market will give up their registered rep status.

Sponsors will increasingly seek out co-fiduciary partners to help them select and monitor investments and working in conjunction with ERISA attorneys will become central to success.

Alternative investment vehicles could also gain market share and different service providers will probably dominate the advisor-sold retirement plans market in the years ahead.

Traditional broker-dealers will no doubt convert to the flat-fee model, but as generalists drop out of the market, b-ds will probably lose retirement plans market share. New service and marketing affiliations will also emerge and this could have a meaningful impact on distribution.

Sadly, the soap opera media coverage will remain biased, the investment witch hunt will continue and litigation will probably increase.


The retirement plans market and the financial services industry are evolving, but the industry has been slow to react to major changes. As a result, many of the business models used by the trade today are no longer valid.

The regulators will no doubt force the industry to evolve in a direction it would normally not pursue and this will spearhead further contraction. The contraction and changes will also cause significant market share to change hands and new service providers will emerge.

Consolidation has been going on for a number of years, but the regulatory witch hunt will intensify consolidation at the investment manager, provider, broker-dealer and most notably, the advisor level.

Investment managers will continue to change hands, non-mutual fund investment vehicles will increase market share and many investment type providers will drop their retirement programs and pursue "joint distribution." Broker-dealers will also merge and many advisors will leave the business.

On the corporate front, mid and large plan formations have already peaked, but small plan formations will be tied to the economy. The equity markets could remain challenging and while informed sources may not agree, an erosion of confidence and the increasing availability of other savings vehicles could cause contributions to corporate sponsored plans to slow.

Contributions aside, assets leaving corporate plans will increase significantly and the disparity between government and private sector plans could become an issue.

Litigation and regulation have always been a deterrent to providing employee benefits, but in the past, the tax and personnel benefits have out weighed the negative. The regulatory burden is, however, shifting back to plan sponsors, and some will no doubt conclude that corporate sponsored plans aren't worth the effort and terminate their plans.

It is, however, important to note that most of the new regulation is geared towards investment managers, but the increased costs of compliance will no doubt be borne by plan participants and advisors.

The regulators efforts to reduce mutual fund expenses will also cause the cost of retirement plans recordkeeping and other services to increase significantly.

The industry is headed for rough and uncharted waters, but the retirement plans market remains enormous. The changing environment will also present major opportunities for specialists with the right business model and the vendors that support them. TPAs will also have to develop more expertise to work with successful advisors, but the generalist is already in the history books.

The trade must participate in consolidation to grow their business and many advisors and vendors will try to adapt to the changing conditions, but like any new business, many will not succeed. Contrastingly, those that adapt will find the changing business environment a path to growth.


The CFDD has discussed the fee-based model at length in recent months, but make no mistake, "joint distribution" will be the other major trend working through the retirement plans industry in the years ahead.

The industry is evolving rapidly and regulatory changes, a shift to fee-based business and the growing perception that traditional products are not as prudent as custom products are permeating the market.

Fund companies with a few outstanding funds are no longer able to capture business solely on the merits of their proprietary fund lineup, alternative investments are moving to the forefront and DB/DC plan investment menus may now be mirrored.

Most single source providers are no longer in a premier position and all providers would be wise to adjust their business models and focus on capturing pieces of business in more plans rather than trying to conquer each new plan opportunity.

Providers that do not embrace specialty practices and leverage their competitor's strengths via joint marketing or servicing could find themselves at a competitive disadvantage in the years ahead.

In short, "coopetition" (cooperating with the competition) will become a growth vehicle for the well managed and it could result in more market share over a broader range of plans along with increased profitability.


Given the regulatory environment, the traditional approach to retirement plans is fraught with problems. The commission model is also tired and most broker-dealers never really did a good job supporting retirement specialists.

Mutual fund pricing, revenue sharing - including pay-to-play & shelf space costs - and compensation structures are a nightmare of inconsistent complexities. The traditional approach to retirement plans, i.e., limited menus, proprietary fund requirements, unequalized commissions, skewed stable value fund discontinuance, high fees, CDSCs and less than full disclosure may also be at odds with ERISA.

The trade doesn't realize it yet and they certainly don't want it, but open architecture, equalized compensation, full revenue rebates, full disclosure, unbiased investment advice and a shared co-fiduciary role for the investment process are the only real solutions to the challenges facing the retirement plans industry today.

Fees and commissions will remain under pressure and while it may not be the Age of Aquarius, the Age of Disclosure and the unbundling of investments, advice, service, pricing, transparency and negotiated compensation have arrived.

As account balances increase, older participants with the highest balances may, however, challenge the asset-based fee approach. As a result, sponsors may allow older participants with high balances to have their portfolios customized and managed directly by professionals.

The RIA/fee-based model certainly has its own challenges, particularly when the advisor is registered, and it is generally not suited for small plans. The fee-based model is also harder to communicate and pricing may fluctuate as assets shift. Some sponsors are also uncomfortable with RIA contracts, don't like fees on participant statements and prefer "all-in" pricing.

The fee-based model will, however, be the "mid-market" model of the future and it's important for advisors marketing this approach to focus on "total costs" and service rather than billable costs. Fee-based advisors should also help sponsors document the approach and communicate it to their legal counsel and participants.

Advisors may not be used to interfacing with legal counsel and they generally don't understand the advisor's role, but working in conjunction with ERISA attorneys will be central to success in the years ahead.

In addition to being prudent, the fee-based model could lower total plan costs, increase investment flexibility, demonstrate the worth of retirement advisory services and help justify fees.

It's also important to note that sponsors are increasingly willing to pay for "unbiased" investment advice and a co-fiduciary partner. The co-fiduciary role is still somewhat unique, but in the end, most sponsors will engage a co-fiduciary partner to help them select and monitor plan investments.


Many RIAs depend on the revenue stream of cross-sold products, but this may not be applicable to retirement specialists. Indeed, to avoid the unguided freight train of regulation, a biased media and guilt by association, some RIA types will drop their registered rep status and seek new marketing and service affiliations.

We are not experts in this area, but unlike the RIA designation, requires a Series 65 Securities license, "unaffiliated" RIAs do not appear to need a broker-dealer affiliation.

An unaffiliated RIA may not be able to assist clients with the purchase or sale of securities, but they could render investment advice for a fee. If the advice was given to a retirement plan client, they would, however, probably be assuming some fiduciary liability.

Some don't agree, but the unaffiliated RIA does not appear to be under NASD governance and they are unencumbered by many of the restrictions and regulations pertaining to b-ds and their employees. RIAs appear to be generally supervised directly by the SEC, although smaller RIAS may be supervised by the states.

RIAs operating in this fashion often accept written designation as a co-fiduciary and maintain E&O coverage for the function.

Some large plan fee-based advisors in our network note that registered reps are generally precluded from acting in a fiduciary capacity due to the manner in which the prohibited transaction rules work and ERISA attorneys generally refer clients to unaffiliated RIAs rather than registered reps.

Contrastingly, broker-dealers in our network that truly support the retirement plans effort note that b-ds with deep pockets and in full compliance with all NASD mandates are more marketable. They further note that they are not precluded from acting as fiduciaries and often embrace their fiduciary responsibilities in writing. These same b-ds also point out that they are advisors to dozens of law firms, many with skilled ERISA attorneys, and often receive referrals from them.

B-ds are not going to rollover and watch their retirement plans business go out the door and those that eat raw meat for breakfast are adamant that there is no case law supporting the much publicized contention that unequalized compensation for advice to plan participants is a prohibited transaction. These same b-ds cling to the notion that the retirement business is a relationship/trust earning business and they don't believe the RIA model is the model for the future.

The change in status for retirement specialists would also provide more co-fiduciary flexibility, allow them to sidestep and leverage marketplace turmoil, position for consolidation on an independent basis and work in conjunction with ERISA attorneys.

RIAs don't have to operate with a hard dollar approach, but those focusing on the large plan market generally operate without a broker-dealer. The hard dollar approach also precludes the need for wrap fees and expands the universe of providers, but it also puts advisors in the collection business.

The world of healthcare is becoming more DC like and some advisors are starting to join forces to provide a total benefits advisory solution (retirement plans, HR consulting and health & welfare), leverage distribution and develop deeper corporate relationships. The well managed consortiums may also offer established advisor groups a piece of the equity.

Broker-dealers are under intense pressure and we don't know what the future b-d model will look like, but they will no doubt gravitate towards the flat-fee model which could easily be adapted by recordkeeping systems.

Less than full disclosure and unequalized commissions never made sense and some of today's problems have been in the pipeline for a long time. Today's b-d model for retirement specialists is dated and they must build product and services at the advisor level and push them up in a way that serves the client rather than pushing them down at a 50% cost to the advisor.

Some advisors will never leave their comfort zone, but as noted, advisors specializing in retirement plans could move to specialty shops if the broker-dealer community fails to adapt to changing conditions.


In an effort to support full disclosure, the proliferation of institutional retirement share classes will continue, but some are wondering if the baggage, pricing and revenue rebates associated with mutual funds are worth the hassle.

The use of non-mutual fund investment vehicles within retirement plans, particularly separately managed accounts, will no doubt grow, but opinions are strongly mixed on the extent of their growth.

SMAs are not without their own problems and they lack transparency. The rating services are also just starting to evaluate SMAs and "trade sequencing" could end up being their own mutual funds scandal.

The expenses associated with SMAs could also be an issue and they can be difficult to mange for small accounts which could create some fiduciary issues.

Daily valuation is also a big challenge for SMAs. Some trust companies can unitize them, but the service is not cheap and they would still lack the automated trading and pricing available to NSCC traded funds.

Commingled trust accounts once dominated the market and to satisfy SEC issues, some expect them to reemerge as retirement plans investment vehicles. Vendors that target the mid-market with collective trust flexibility don't disagree, but they have not yet experienced the increased interest in collective trusts.


Revenue sharing means different things to different people. The subject is also complicated and as a result, the CFDD will issue a separate release on revenue sharing in the months ahead.

Payments for shareholder services are not, however, viewed as revenue sharing by some and reasonable fees for quality services no will doubt continue. Better disclosure and more consistent rules will also no doubt surface in the period ahead.


There are only a few retirement vendors that fully support fee-based advisors today, but the service providers that will end up as leaders in this area will not be determined for several more years.

DAC, BISYS, Ceridian, Invesmart, Schwab and a few trust companies are already supporting open architecture and the fee-based model. Some of these firms also appear to be close to launching new initiatives to support fee-based business.

DAC, BISYS and Ceridian don't sell direct and are much improved, but they are not viewed as larger plan vendors. Invesmart and Schwab sell direct and neither, particularly Invesmart, can compete with Fidelity and Vanguard in terms of scale, efficiency or brand.

Assets remain the prize and it will be difficult for management to allow their retirement groups to market open architecture. Fund companies are managed with a retail mindset, but fund companies like MFS or a trust company like ABN-AMRO could have an advantage if they are allowed to market open architecture.

Other than the proprietary stable value fund, ABN-AMRO is already offering true open architecture and "if" any of their proprietary funds were elected - and all fund companies have a few good funds - they could offer pricing (proprietary fund subsidies) and service advantages over non-investment manager providers with open architecture.

The distributor-sold fund companies that pursue open architecture and fee-based business will also have to increasingly support advisors that dropped their registered rep status and this will require them to walk a fine line.

Distributor-sold fund companies will also be challenged by advisors that want to convert their commission book to a fee-based book, but the right management could figure out how to accommodate broker-dealers, registered reps and non-registered RIAs.

Those same fund companies must also be prepared to support the growth in non-mutual fund investment vehicles in retirement plans.

The fund companies damaged by the mutual funds scandal will also have to change operating procedures and improve disclosure. Changing management and paying fines won't be enough to re-brand with advisors.

Every major civilization, government, military power, industry, vendor and distributor that failed to adapt to changing conditions ended up on the garbage heap of history. In short, we all have a choice, we can adapt and grow or die.

As you might guess, the CFDD prefers growth and we will be launching a new web-based service for RIAs that specialize in retirement plans in the months ahead. Most retirement advisors don't now much about the fee-based business, but it's important to note that most RIAs don't know anything about retirement plans.

Copyright 1999-2004 Center for Due Diligence. All rights reserved. This information has been taken from sources believed reliable, but accuracy and completeness cannot be guaranteed.

### is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of

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