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Are Those Fees ‘Reasonable’?

5986083_s It is hard for me to believe that our oldest daughter, Maeve, is finishing up her freshman year of high school in just a few months. It feels like yesterday that we put her on the school bus for her first day of school. In recent years, Maeve has earned the nickname “The Wizard” because, as a 15-year-old, she thinks she knows just about everything. In the eyes of a teenager, we, as parents, are stupid; we just don’t know we’re stupid, right?
 
The Wizard is often used as our family’s guinea pig, or our test case, for our household rules. One of those rules pertains to her curfew, which Maeve argues is too early. Since she made the varsity softball team, Maeve has been spending time with girls that are two and three years older than she is, whose parents are “so much more chill” than Jill and I are.
 
In our last discussion with Maeve about this issue, we told her what we always tell her, to be home by 9 PM. She responded with a surly look and said, “Dad, be reasonable.”
 
Hmm. Reasonable.
 
You know, reasonableness is just about one of the hardest things to define. What is reasonable? How do you measure “reasonableness”? How can you apply a concept so subjective to something as quantifiable as time?
 
Discussing what’s reasonable with my 15-year-old daughter made me think about the even more difficult conversation many brokers are going to need to have with FINRA, other regulating authorities, and their clients after the new Department of Labor rulings that we discussed a few weeks ago go into effect next April.
 
If you missed that article (http://old.cutterfinancialgroup.com/nothing-to-lose-and-everything-to-gain), the DOL issued its final “fiduciary” rule, which provides that all intermediaries, including brokers, giving investment advice involving qualified retirement accounts (Traditional IRAs, Roth IRAs, SEP IRAs and Simple IRAs, among others), must adhere to a “fiduciary” standard, just as plan managers of employer-sponsored retirement plans have been required to do so under the federal ERISA law. It is hard to believe that up until now, brokers have been able to operate under a less-stringent “suitability” standard, even when dealing with qualified retirement accounts.
 
You see, advisors held to a fiduciary standard are required to act in their clients’ best interest, and in doing so, must and should receive “reasonable” compensation for their services.
 
So, what is “reasonable” compensation?
 
For those of us who are licensed Registered Investment Advisors, or Investment Advisor Representatives, we have already asked this question, since we are always held to a fiduciary standard, no matter whether we are dealing with qualified (retirement) accounts or nonqualified accounts. However, for brokers who have not previously been held to a fiduciary standard, who will now be required to operate with fiduciary responsibilities, courtesy of the DOL’s new rule, it may not be an easy question to answer. But they had better figure it out quickly, because the answer to this question will have a big influence on the way they are able to do business with qualified retirement accounts going forward.
 
So, I ask again, what is “reasonable” compensation?
 
The answer? Well, it depends.
 
Actually, there is no set rule for the amount of fees that is considered reasonable. The new law does not define reasonable compensation, just as ERISA does not define reasonable compensation for fees associated with employer-sponsored retirement plans.
 
In fact, we have seen this issue come to a head with recent 401(k) lawsuits in which plan participants are suing the fiduciaries responsible for managing those accounts based on management and record-keeping fees that they allege are “unreasonable.” These sticking points arise because of the vagueness of the rules.
 
In my opinion, an advisor needs to be able to rationalize the fees charged with the amount of meetings he or she will have with you, his or her experience and expertise, the scope of work involved, whether or not they are a retirement specialist, and of course, the proposed strategy.
 
Folks, strategy is important here and, as I have said before, you must understand how the proposed strategy behaves over a market cycle, which is usually five to seven years. This is often accomplished by back-testing the proposed strategy especially through down years, such as 2008. Back-testing will also help to identify whether the proposed strategy is an asset allocation, hope and a prayer model, or an asset rotation model that focuses on downside risk management.
 
Finally, another factor in determining reasonableness is something that my daughter also deems her curfew should be based on: industry benchmarks. Maeve’s a good negotiator and makes the argument that her friends get to stay out until 10:30, so she should be able to also! Although this argument does not have much influence on Jill and me, it is likely the most powerful point an advisor can make in justifying the reasonableness of his or her fees. Industry standards are the easiest way to set the bar.
 
Folks, changes are beginning to take place in the financial services industry. And as I always tell all of my kids, change creates opportunity, if you know the questions to ask. Now you do.
 
Be vigilant and stay alert, because you deserve more.