fi360 Blog

The fiduciary role of investment advisors

As the overall manager of the investment process, investment stewards have a responsibility to delegate to professionals roles they are not equipped to handle themselves. The regulated investment professionals to whom they turn for assistance in the management of a plan or portfolio are what we call investment advisors. We define investment advisors as "professionals who are responsible for providing comprehensive and continuous investment advice, including wealth managers, financial advisors, trust officers, financial consultants, financial planners and fiduciary advisers."

"Comprehensive and continuous" is the operative term here. There are many service providers, sales people, etc., who make their living servicing investment portfolios in some fashion, but not all of them operate as fiduciaries. Those who are giving ongoing advice to the stewards on the management of the plan are deemed to be fiduciaries. In that case, they will be held to standards of conduct as defined by the appropriate rules. (Note: The purpose of this post is not to go over in detail the standards of conduct for advisors, as that is what we do in this blog on a day-to-day basis. Rather, it is to put into context the overall role of the advisor in the investment process and fits into our "Fiduciary Basics" category. For more information on the rules for fiduciaries, start with our post on Practice 1.1)

Basically, an advisor can be engaged to fulfill any role that defaults to the investment steward. Whether that means engaging in a limited scope capacity, advising over the entire process while leaving discretionary decisions to the steward, or even being engaged to take discretion of all the steward's duties, it is critical that the scope of services is agreed upon in writing at the outset of the engagement, specifically addressing the assumption of fiduciary responsibility.

Unforunately for the investing public, it is not always evident who does or does not assume a fiduciary role. Investment advisors operate under a wide range of job titles and are governed by a fragmented and outdated regulatory structure. Non-fiduciary service providers often operate under job titles that include the words "advisor" or "consultant" and can even give "incidental" advice without assuming any fiduciary responsibility. An influential and controversial report by the RAND Corporation highlighted these issues when it found that even when explained to them, most investors still could not differentiate between fiduciary and non-fiduciary advisors. Also, because of the disjointed regulatory structure and lack of uniform advanced education requirements, even the advisors who are fiduciaries often have a limited understanding of the fiduciary code of conduct.

Clearing up this confusion and enhancing consumer protections are among the goals of financial regulatory reform that is currently being debated by Congress. It remains to be seen, however, just how effective new legislation will be. You can keep up to date with the progress of regulatory reform, which will have major implications on how advisors operate and how investors identify them, by following the "regulatory update" posts on our blog.

For more information on basic fiduciary responsibilities for investment advisors, check out the following resources:

• fi360's Self-Assessment of Fiduciary Excellence for Investment Advisors: http://safe.actifi.com
• fi360's Prudent Practices for Investment Advisors handbook: http://www.fi360.com/main/practices_sa.jsp
• The RAND Report on Investor and Industry Perspectives on Investment Advisers and Broker-Dealers: http://www.rand.org/pubs/technical_reports/TR556/
• Scott Simon, AIFA® describes the different flavors of investment advisors for Morningstar Advisor: http://advisor.morningstar.com/articles/article.asp?docId=17902&pgId=rss
• The definitions section of ERISA: http://frwebgate3.access.gpo.gov/cgi-bin/TEXTgate.cgi?WAISdocID=09927814470+0+1+0&WAISaction=retrieve
• The Investment Advisers Act of 1940: http://www.sec.gov/rules/extra/ia1940.htm
• The Department of Labor's Employee Benefits Security Administration: http://www.dol.gov/ebsa/
• Reish article on the hazards of investment advice to both advisors and participants: http://reish.com/publications/article_detail.cfm?ARTICLEID=457

Fiduciary Links: Who counts as a fiduciary under ERISA to expand

A short week last week leads to a short fiduciary links post. The most interesting news being the Department of Labor adding to its agenda the publishing of new regulations expanding the definition of "fiduciary" under ERISA to include consultants.

Matt Hutcheson summarizes the intent of the new regulations as, "Everybody who works with retirement plans should presume that they will owe a fiduciary duty or they will owe a duty for loyalty to those who they service."

The rest of the best links from the past week:

In the news/commentary:

• fi360's Kristina Fausti on KDKA's Sunday Business Page talking regulation and the impact on investors.
• Fee data still insufficient
• Bob Veres imagines the conversations that lead lawmakers to compromise investors' best interests
• New York Times looks at the banks that bundled bad debt and short sold them.

From the organizations/associations/government/academia:

• The top ranking Democrat and Republican on the Senate Banking Committee agreed to work together in continuing to craft their reform bill.
• The Government Accountability Office released a report on additional changes needed to the Form 5500

From the blogs:

• In response to the above New York Times article, a Seeking Alpha post points out that investor demand drives product creation and that pension fund managers share the blame for not fulfilling their fiduciary duties
• Fiduciary News asks you to vote on what were the biggest fiduciary stories of 2009?

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Practice 1.2: Roles must be documented and acknowledged

It is not uncommon for some investment fiduciaries to be unaware of their status and liability when working with investment portfolios, or for gaps to exist where certain essential functions are not being performed for the portfolio. This is particularly true among investment stewards, who will ultimately be held responsible for ensuring all duties are being fulfilled. Ignorance, however, is not a viable excuse when it results in a fiduciary breach. For this reason, the second Practice in a prudent investment process is to identify every party involved, fiduciary and non-fiduciary alike, document their respective roles and have those who are acting in a fiduciary capacity acknowledge so in writing.

Let's take a look at the Practice and associated Criteria:

As we touched on in Practice 1.1, the investment policy statement (IPS) is the de facto business plan for an investment portfolio and must contain the details for the management of the investment plan. As such, it is here that you should define the roles and responsibilities of everyone involved in the investment process. Some of the specific roles that should be spelled out in the IPS are those of the investment committee, the investment advisor, the custodian, and money managers. Those are the primary involved parties, but may not be exhaustive of all the roles involved in a particular portfolio. Also, roles may be identified by title in the IPS, rather than name, for the sake of continuity when turnover occurs. Names can be attached to titles in service provider agreements and fiduciary acknowledgment letters.

Fiduciary Links: Hat switching rule limits the potential of House reform bill

In her regulatory update last week, Kristina looked at the amendment to the House reform bill that would permit advisors to take off their "fiduciary hat" after completing the provision of investment advice. This is just the latest development in the battle over the fiduciary standard in regulatory reform, with the Financial Planning Coalition quickly responding with their displeasure.

As opined in a Market Watch column, the danger is that the provision basically negates the benefits of extending the fiduciary standard to all investment advice if the advisor doesn't have to live up to it at the point of transaction or in an ongoing capacity. If one of the goals of reform is to help clear up investor confusion over who is or is not a fiduciary, then the provision surely provides a set back.

Now on to the rest of the links, beginning with our Tweet of the week, which also was on the subject of the hat-switching provision:

@BeManaged: 'Hat-Changing' Fiduciary Proposal May Confuse Investors - WSJ - There is no "may" about it. It will. http://ow.ly/MTEe  #401k #fiduciary

In the news/commentary:

• IN calls House reform bill an early Christmas present despite the lump of coal
• A local paper story says to contact your representative to voice support of fiduciary standard
• Cincy and Indy papers help explain the differences in standards
• Reform progress was made in '09, uncertainty looms for '10 with Senate elections
• Mercer Bullard, AIF, named to the InvestmentNews top 20 influencers list
• A look at the efforts to improve the 401(k)
• Some thoughts on dealing with 12(b)-1 fees
• The unintended consequence of auto enrollment may be lower company matches
  

From the organizations/associations/government/academia:

• Retirement Research Council releases 403(b) compliance white paper
• In order for target-date funds to be QDIA eligible, new bill would require managers to take on fiduciary responsibility
• Junk bonds in target date funds make them riskier than investors believe
• Reish looks to ERISA to wade through the brokers as fiduciary issue
• SEC approves surprise audit rules
  

From the blogs:

• The Float recounts a first hand experience of dealing with an independent fiduciary
• What the SEC gains from the House reform bill
• A look at the multiple layers of fees that can add up in a 401(k) rollover
• Slow and steady wins the investment race
  

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Fiduciary provision takes a hit in the House

The passage of the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173) by the House last week brought with it small victories for the advisor industry in the form of the removal of a provision that would have allowed FINRA to gain oversight of firms dually registered as investment advisors and broker-dealers, and the inclusion of provisions extending the fiduciary standard to broker-dealers who provide personalized investment advice.  However, a closer look at the final House provision regarding broker-dealers' fiduciary duties reveals quite a few shortcomings that have all been the result of legislative compromises and may chip away at core fiduciary principles. 

As reported this week, a manager's amendment introduced by Barney Frank last week added a limitation to the extension of the fiduciary duty. In particular, the provision that would require the SEC to adopt rules applying a fiduciary standard of care to broker-dealers now states: "Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities." 

While the new language seems to have taken the advisor industry by surprise, it is actually the result of a compromise in the making since late October.  Similar language was introduced by Rep. Jeb Hensarling (R-TX) in October during the House Financial Services Committee markup of the Investor Protection Act, a bill that was rolled into the comprehensive legislation approved last week.  At the time, Hensarling voiced concern about certain business models, such as discount brokerage, that don't involve the provision of advice.  The Hensarling amendment was withdrawn at the committee level, but only with the understanding that Hensarling's concerns would be addressed by the time the legislation made it to the House floor.  Hence, the new limiting language in the final House bill.

Several other limiters have also been inserted into the House bill over time, such as the addition of language addressing commissions and proprietary products. Despite Congress' apparent desire to delegate the fiduciary issue to the SEC as the expert agency, such limitations in any final bill will likely tie the commission's hands in how far its rule making can go. Moreover, such qualifying language appears to be a roadblock to true harmonization of the standard of care and rules that apply to all professionals who provide investment advice. 

So where does financial, and in particular fiduciary, regulatory reform go from here?  It's becoming clearer that on the Senate side even more compromise will be required for reform to pass, and even once it does, a conference committee will be required to resolve any differences that emerge between the Senate and House bills, an activity that will require even more cooperation.  While there are other provisions in the comprehensive financial legislation that will require more compromise than others, the longer that reform takes, the greater the likelihood that fiduciary provisions may change more, for better or worse as was seen this past week. 

When is accepting a gift a problem?

With the holidays upon us, we've reached the time of year when most gift giving takes place. Fiduciaries are often the recipients of gifts and we were recently asked whether they are permitted to accept them?  If so, what kind and how large?  Although not an attorney, as fi360's CCO I have some suggestions.

When considering whether or not to accept a gift, a fiduciary should always ask his or herself whether they believe it will impair their ability to carry out their duties objectively.  DOL's Employee Benefits Security Administration (EBSA) provides guidance to investigators or auditors (See No. 12) evaluating if a fiduciary violation has occurred, stating that the investigator should determine if "the receipt of gifts, gratuities, or other consideration were for the fiduciary's personal account and received in connection with a transaction or transactions involving the assets of the plan."  They go on to say that the "Investigator/Auditor should also determine whether the fiduciary of the plan maintained a reasonable written policy or plan provision governing the receipt of items or services from parties dealing with the plan and whether the fiduciary adhered to that policy." 

EBSA's guidance is instructive for all fiduciaries, not just plan sponsors.  The first step is to have a gift policy that provides guidance regarding their acceptance.  A typical policy would set parameters under which gifts can be accepted and may include:

• the maximum monetary value allowed ($200-$300 seems reasonable)
• prohibition from certain types of gifts, such as high profile sports events (Super Bowl, World Series, etc.)
• a requirement to keep a record of all gifts received (this would not normally include things like an occasional lunch)

Of course, the policy could be that no gifts of any type or amount can be accepted at all, but this would most likely be excessive. Most policies would allow gifts of a nature that could not reasonably be interpreted as influencing decisions as a result. So, in general, think fruit baskets, rather than Final Four tickets.  

A comprehensive overview of accepting gifts and setting policies can also be found from the Vedder Price law firm. Always consult legal counsel when drafting policies on gifts to ensure they are in compliance with ERISA and all relevant laws.

So enjoy the holidays, graciously accept gifts that conform to your gift policy, and continue doing what all fiduciaries are called to do, look out for the best interests of your clients, participants and beneficiaries.

Fiduciary Links: House reform bill reaction

The big news from last week was that the House passed their regulatory reform bill, the Wall Street Reform and Consumer Protection Act. You can view the entire bill and other documents explaining the legislation on the House website. One provision of the bill that did not make it into the final version passed was FINRA oversight of broker-affiliated advisors, which the Financial Planning Coalition had spoken out against early in the week.

Earlier in the week, Republicans apparently outlined an alternative bill. I haven't found text of their bill, but the Democratic response seems to indicate that it did not include any directive for a fiduciary standard. (UPDATE: Here is a side-by-side comparison of the Democratic and Republican bills released by the Republican Press Office)

The Senate still needs to finish and vote on their version of regulatory reform being drafted by Christopher Dodd's (D-Conn.) Banking, Housing and Urban Affairs Committee. At that point a committee would be formed from members of both the House and Senate to form a unified bill.

Here is a sampling of the responses that have come out since the bill passed:

• The Republican response calls it the permanent enactment of bailout policies and the "government takeover of financial services"
• Obama addresses the passing of the bill.
• Paul Krugman of the New York Times says that Republicans voting against the bill refuse to learn lessons from the financial crisis.
• An InvestmentNews editorial suggests the bill may not do much to grow the economy.
• IN looks at the influence of Rep. Paul Kanjorski (D-PA) on the Act.
• Today heads of the 12 largest banks in the U.S., who aren't necessarily on board with the entirety of the bill, will meet with Obama
• Regulatory reform means a hot job market for compliance officers.

That's just a sampling of the more prominent responses. You can also find many Representatives who released statements either in support or opposition to the bill. The vote went according to party lines, and the statements are all mirrors of each other with Democrats hailing this as the reining in of a corrupt Wall Street and Republicans deriding it for over regulating and over spending. We'll just say for now that we're glad the fiduciary issue is at least addressed and that the SRO option for oversight seems to have gone away. We still anxiously await to see what the fiduciary standard will look like and who will make that determination. We won't know exactly what the bill that eventually gets passed into law will look like until after the Senate votes on their version anyways.

This will be an interesting debate that will continue into 2010, so stay tuned for what will be a front burner issue for months to come.

Now on to the rest of the links, and there were a lot of them this week:

In the news/commentary:

• Blaine's latest Fiduciary Corner column looks at the four stages of the annual review
• Danny Sarch doesn't seem to think a fiduciary standard makes sense for investors
• NAPFA wrote a great argument for holding all investment advice to the standard of the Investment Adviser Act
• Designee Scott Simon writes about the various types of fiduciaries as defined by ERISA.
• The economy's turmoil has fueled demand for advice.
• Members of the Committee for the Fiduciary Standard describe how the authentic fiduciary standard benefits investors.
• Here's a great Q&A explaining to the consumer audience how the regulatory and legislative reform would affect 401(k) plans.
• A column from Australia, which is facing similar regulatory reform issues as the U.S., says the fiduciary standard could mean a higher price for advice, which would also mean more direct investment in mutual funds.

From the organizations/associations/government/academia:

• Mary Schapiro gave a speech at the Consumer Federation of America conference calling for "a strong fiduciary standard," as well as touching on 12(b)-1 fees, compensation, products and more
• Then the various adviser groups questioned if she was committed to the Adviser Act standard.
• Gerson Lehrman Group says plan sponsors should be prepared for more stringent requirements in providing advice for participants.
• The Department of Labor released a new page for information and interaction on their latest regulatory agenda.
• DOL's Employee Benefit Security Administration examining the ERISA fiduciary standard for loopholes

From the blogs:

• Fiduciary News looks at how recent comments by Schapiro regarding 12(b)-1 fees could mean increased fiduciary liability.
• Roger Wohlner lists the best Twitterers for advisors
  

Have a link we missed? Leave them in the comments section or email us at blog@fi360.com. For more of the best links during the week, make sure you follow us on Twitter.

Top issues to include in your year-end review

The annual performance review is an essential part of the monitoring phase of the investment process. In order to ensure that the investor's objectives are being met, each year the advisor must gather and analyze relevant facts regarding that state of the portfolio, create an action plan based on the analysis, report this all to the investor and then document what decisions were made. 

The following web presentation, Top issues to include in your year-end review, goes through a top-down approach to the process that first looks at how the investment landscape and investor objectives may have changed, then an asset class and portfolio composition review, and finally recommendations on manager retention and/or replacement. You may view the webinar by pressing the "play" button on the player below. 

Below are the links referred to in the presentation to the signup pages for daily email alerts from various sites that we find most helpful for monitoring the latest developments of note for investment professionals:

• InvestmentNews Daily
• Mondaq
• Seeking Alphan (daily email signup appears at bottom of page)
• Financial-Planning
• CFA Institute Financial NewsBrief
• Advisors4Advisors (site requires paid subscription)

In addition, the following links provide more detailed information on some of the specific topics mentioned during the webinar:

• Information on UPMIFA
• Latest on estate tax legislation
• PIMCO (global market commentary, search for Bill Gross's The New Normal)
• fi360's online SAFE
• Free trial to the fi360 Toolkit that was used to generate the reports used in the presentation

If you have any thoughts or questions related to the webinar that you want to share, let us know in the comments below. We'll attempt to answer as many questions as possible in the comments section or in future blog posts.

Check back again to the webinars page of fi360.com for other recordings, slide downloads and announcements of future webinars. You can also send us questions or suggestions for future webinars by emailing us at blog@fi360.com.

House set to debate financial reform

Last week, the House Financial Services Committee completed its work on proposed financial regulatory reforms and released The Wall Street Reform and Consumer Protection Act (H.R. 4173), a comprehensive bill that incorporates nine major pieces of legislation, including the Investor Protection Act, which would extend the fiduciary standard to broker-dealers providing investment advice. The full House will begin to debate the comprehensive reform bill today. House Financial Services Committee Chair Barney Frank expects debate to continue over the next three days with a vote on the bill taking place on Friday.  Frank and others have been working behind the scenes to resolve any outstanding issues and opposition to the bill, but still expect several amendments to be introduced on the House floor.  For now, it appears that provisions related to fiduciary issues will survive, but oversight of investment advisers remains an area of concern, including a current provision that would give the SEC the authority to delegate to FINRA examination authority over firms dually registered as investment advisers and broker-dealers. 

Despite the progress on the House side, the pace of financial reform has slowed down substantially in the Senate as a result of sharp criticism from Republicans and Democrats alike aimed at a proposal issued last month by Senate Banking Committee Chair Christopher Dodd.  As a result of opposition to his bill, Dodd announced a new plan for addressing the legislation to his Committee right before the Thanksgiving break in hopes of reaching workable compromises and gaining bi-partisan suport.  While the new approach will hopefully aid the eventual success of financial reforms, it has also created a delay that will prevent the Senate from considering a complete financial reform bill until the new year.  

With financial regulatory reform looming in 2010, regulators appear to be gearing up for the large amount of work that will be required to implement legislative changes.  In a speech delivered earlier this week, SEC Chairman Schapiro outlined her agency's efforts to improve investor protection and restated her belief that "all securities professionals [who provide advice] should be subject to the same fiduciary duty" as well as an "effective oversight regime."   Meanwhile, NASAA President Denise Crawford, voiced support for a legislative approach that  preserves the "authentic fiduciary standard" and also announced the signing of a Memorandum of Understanding that will allow states to work with each other to regulate additional investment adviser firms if the threshold for federal registration is raised to $100 million assets under management.  Such statements seem to confirm that regulators are laying the groundwork and will be ready to act quickly once Congress enacts the much anticipated financial reforms.

An interview with Fiduciary Benchmarks' Tom Kmak

The Department of Labor has informed ERISA requirements on fee expenses by stating, "In choosing among potential service providers, as well as in monitoring and deciding whether to retain a service provider, the trustees must objectively assess the qualifications of the service provider, the quality of the work product, and the reasonableness of the fees charged in light of the services provided."

The difficulty of this fundamental fiduciary requirement has always been availability of information and a fiduciary's ability to disseminate information provided. This is where Fiduciary Benchmarks comes in. Fiduciary Benchmarks considers fees, services, support and success measures compiled from real plan data to assess a plan's fees reasonableness in comparison to comparable benchmark groups.

Fiduciary Benchmarks' CEO and co-founder Tom Kmak was kind enough to answer some questions for us regarding his company's approach and the state of fee disclosure and evaluation in general.

Fi360: Thank you for taking the time to answer our questions, Tom
Tom Kmak: Thank you for having me.  We respect and admire fi360 and the fiduciary and investment standards they are bringing to the marketplace.

Fi360: What kind of difference can fiduciaries make for the plans they manage by taking advantage of benchmarked data?
Tom Kmak: Well, there are really three benefits of our service.  The first is compliance with the law as you outline at the beginning of this interview.  Given the recent Caterpillar settlement for $16 million dollars, I cannot imagine any plan sponsor not having in place an annual process for reviewing their fees and services.  Secondly, it can save the plan money by making sure that the fees for all service providers are no more than reasonable.  Thirdly, benchmarking the fees AND services for a plan will make sure employees are getting the best plan possible thereby helping them achieve the best retirement outcomes possible.  Too often people associate benchmarking with just fees, but the value side of the equation is mathematically even more important.

Fi360: How or why has an environment existed for so long that made meaningful benchmarks so difficult to obtain?
Tom Kmak: It comes back to the fact that any proper benchmarking exercise considers both fees and value.  So, the reason benchmarking was difficult basically boils down to two reasons:

1. The fee schedules were so incredibly inconsistent from service provider to service provider.
2. There was no consensus on service standards.

This is why it took Fiduciary Benchmarks 9 months to finalize our first report. We had to make sure we could handle and normalize any fee schedule. Then, we had to define 8 critical value standards that could be compared against those fees to make sure the benchmarking exercise was comprehensive and informative.

Fi360: How cooperative have the service providers and record keepers been in providing data for your benchmarking?
Tom Kmak: At this time we have working protocols with 36 recordkeepers.  Some of them like Mass Mutual have been “very helpful.”  They are responsive to the requests of their advisors and they react quickly to make sure they enter the data we need via the FBi portal for our benchmarking reports. 

Then, there are firms like Fidelity that are “helpful.”  These firms may require a sponsor signature but they are happy to provide the documents to us or their clients.  We then enter that data into the FBi portal. 

Thirdly, we have service providers that are simply not offering any support whatsoever.  At this time, there are only 3 firms in this category and I would rather not name any names since I think they truly want to do the right thing for their clients.  And, while they all have a variety of reasons for not helping a client use our service, I do believe their stance will be short lived once the 408(b)(2) regulations are released.  Having said that, advisors are refusing to accept their reasons for not participating and we are working with these advisors to find the proper documents that have the data we need so their clients can get the benefits of our service.

Fi360: What challenges have you faced in developing meaningful benchmark peer groups for plan comparison?
Tom Kmak: At this time, we can benchmark any plan under $100 million dollars.  Our benchmark groups typically include 25-30 companies from approximately 10 different service providers.  Above $100 million dollars, it is taking us a little longer to get companies to participate for a variety of reasons.  We do have, however, a number of initiatives that are designed to solve this problem and we are confident we will issue reports in this segment in no more than 90 days.

Fi360: What practical issues have you encountered in sorting through the innumerable fee and expense names?
Tom Kmak: Well, the first thing we had to do was make sure we got the investment fees right since they account for 90% of the fees in our industry.  We had to be able to handle annuities, mutual funds, commingled funds, separate accounts and all of the revenue sharing mechanisms that may exist in those investments – things like 12b-1 fees, shareholder servicing fees and sub-transfer agency fees.  But, as we all know, there are also fees for services like participant recordkeeping or loans.  So, we looked at all of the major services a plan could be billed for and we provided a mechanism for those fees to be submitted to us as well.

Fi360: How would you define a successful plan? High participation? Low fees? Adequate choices?