401(k) plan fees: Three fundamental questions every advisor should be prepared to answer

If you advise 401(k) plans, you’ve probably heard the following fee questions from the plan sponsor or investment committee at some point in time. Before 408(b)(2) regulations went into effect in 2012, much of this expense information was hard for the plan sponsor to even find. While more readily available today, that doesn’t mean your plan clients necessarily understand it.    

Here are three typical 401(k) plan fee questions you may encounter and some thoughts on how you might want to answer them:

Q. Why should I keep my plan with you when another firm is offering a “no-cost” solution?

Let’s start by examining two basic ways to pay for services in a 401(k) plan:

The plan can pay via check/invoice on a periodic basis based on a set price stated in the plan agreement. The price can be a flat dollar amount, a per-participant amount or a percentage of net assets (typically quoted in basis points).

The plan can pay via the investments the participants hold, which is called revenue sharing. When using mutual funds, the total expense ratio paid to the mutual fund company can be used to compensate not only the fund manager, but also the investment advisor/broker/consultant and the service provider/TPA. Two components of the total expense ratio–the 12b-1 fee and the sub-transfer agency (sub-TA) fee–are typically passed from the mutual fund to a third party.

It’s easy to see that when the services are paid via revenue sharing, an unknowing plan sponsor could consider the plan setup as “no-cost.”  Obviously, that’s not the case. To find out the real cost of services, always refer to the 408(b)(2) disclosure.

(Note: There is also an alternative method that many plans use, which we will address in Question #3.)

Q. Where do revenue share expenses go?

As mentioned above, a mutual fund can pay revenue sharing via the 12b-1 fee and the sub-TA fee. First, let’s look at the 12b-1 fee.

The maximum value for the 12b-1 fee is stated in the fund’s prospectus and can differ by fund share class. What most plan sponsors don’t realize is that there can be two components of this fee:

Sales fee: The most common use of the 12b-1 fee. It is used to compensate the selling agent, such as a financial advisor or broker. You could think of it as similar to a front or deferred load. Loads are typically much larger, but they are only assessed once. The 12b-1 fee is assessed annually.
Service fee: Helps to reduce other costs of the plan, such as recordkeeping, custody, participant accounting, etc.

The sub-TA fee is used to compensate a third party such as a TPA for participant accounting.  This third party executes, clears and settles buy or sell orders for mutual fund shares, and maintains shareholder records of ownership.

Q. What is a “level-compensation” or “revenue neutral” fee structure?

When paying the plan fees through revenue sharing, plan fees can vary and increase drastically over time as the assets grow.  The increase in plan assets doesn’t necessarily correspond one-to-one with the required level of service needed to support the plan.  Hence, fees should not always rise proportionately with assets.  Revenue sharing can also be problematic in that it may incentivize an advisor providing advice to participants to recommend options where they receive greater compensation.

To help with these issues and to encourage complete fee transparency, many plans use a combination of flat/contract stated fees and revenue sharing.  Here’s how it works:

The plan’s investments pay revenue sharing to the third parties (advisor, broker, TPA, etc.) as described above.

The third parties aggregate this money and rebate it back to the plan.

The rebated money is then used to pay the plan expenses. If the amount of rebated money is less than the total stated fees in the plan agreement, the plan will cut a check to the respective parties for the difference. Otherwise, the plan will maintain a positive balance in what is typically referred to as an “ERISA budget account.” This money can be used in the future to pay plan expenses, or, if it grows too large, it can be given back to the participants. If it does grow too large, the plan agreement should likely be revised to utilize lower cost investment options with less revenue sharing.

One item to note with this structure is when the investments in the plan lineup don’t all have the same revenue sharing levels.  In this situation, some participants could be paying more (or less) of the plan’s fees if they choose funds with higher (or lower) revenue sharing.

* * * * *
Editor's note: The original version of this blog post was first published in 2010 and is one of the most popular and positively reviewed posts we've published. We're revisiting and updating it to reflect that the 408(b)(2) disclosure regulations from the DOL that went into effect in 2012 have made this fee information more accessible. This post is not only helpful to our primary audience of advisors, but to help explain plan fees to your plan sponsor clients. A companion post regarding two other common ratios, the Prospectus Gross Expense Ratio and Audited Net Expense Ratio, and how they compare and contrast to the Prospectus Net Expense Ratio, is forthcoming. Another good resource for plan's to better understand their 401(k) plans is the DOL website. To help you customize and communicate the fees and expenses for your clients, the fi360 Toolkit includes a section for client (plan) level fees, revenue sharing components, and transaction fees specific to the client. This section is included in our Fee & Expense report, the 408(b)(2) Fee Disclosure report, and 404(a)(5) Fee Disclosure report.

Your Primer on the DOL's Fiduciary Rule Proposal

The Department of Labor’s anticipated rule on conflicts of interest (aka, the Fiduciary Rule), is now available. For your convenience, we’ve prepared an executive summary covering the basics of the rule. We’ll have much more information about the rule in the coming days and throughout the comment period. But, for now, here’s your quick guide to the just released rule proposal.

What is it?

Yesterday’s release is a new rule proposal under ERISA from the Department of Labor. It seeks to expand what constitutes retirement advice and therefore subject to a fiduciary standard of care and under the purview of Department of Labor enforcement. There are still a number of procedural steps that must be completed before it can become an official rule.

What’s notable about the new rule?

A few things really stand out about this version of the rule, which is markedly different than the abandoned attempt at a new rule in 2010.

• It’s a best interests, principles-based standard – The proposal calls for those offering advice on retirement investment decisions to act in the best interests of their clients, without defining exactly what that means. In concept, this simplifies compliance by being less prescriptive about specific business practices, and instead puts the onus on the adviser to be able to demonstrate the prudence of their investment recommendations. In practice, this likely would shift a considerable portion of the enforcement burden to the court system when breach of fiduciary duty lawsuits begin to percolate up under this rule.  
• It includes IRAs – The new rule covers any advice “for consideration in making a retirement investment decision.” This includes advice on IRAs or to rollover into an IRA. That’s the most significant change in terms of expanding the breadth of covered advice. A major segment of the investment advice industry would suddenly find itself being subject to new fiduciary regulations pertaining to IRAs.
• It doesn’t require fee leveling – Compensation has been at the forefront of this debate and a major part of the White House and DOL’s recent PR push behind this rule. While supporters of the proposed rule might have been happier with a ban on certain compensation practices or a requirement for fee-leveling, the new rule allows firms to choose their preferred compensation model (with certain restrictions), as long as they can demonstrate it is in the best interests of their client. Again, this shows a preference by the DOL for a principles-based solution.
• It segments sales and education from advice – Opponents of the rule have been most concerned with preserving entrenched business practices and keeping low-cost options available to middle-market clients. This proposal explicitly carves out certain sales practices, such as selling to large and/or sophisticated clients and fulfilling sales orders when no advice is given. In addition, general participant education is defined and exempted from fiduciary status.

What happens now?

With the release of the rule, we are now in a 75 day public comment period. Any person or organization can submit their comments to the DOL on how the rule helps investors or misses the mark. Then there will be a public hearing on the rule, an additional public comment period, and potential revisions to the rule based on the comments and hearing. At that point, the rule would theoretically be ready to be implemented.

Download our executive summary.

Tibble v. Edison: Why investment monitoring is as important as investment selection

Editor's note: The following post was written by Roger L. Levy, who is Managing Director of Cambridge Fiduciary Services, LLC. Mr. Levy is also an AIFA designee and CEFEX Analyst. In December 2014, Mr. Levy and Cambridge Fiduciary Services, LLC filed an amicus brief with the Supreme Court in support of the plaintiffs in the Tibble v. Edison case, a 401(k) fiduciary breach lawsuit regarding fees and the fiduciary duty to monitor investments. The brief includes substantial references to fi360's Prudent Practices handbooks, as well as CEFEX's assessment process. Mr. Levy, along with attorney Troy Doles and fi360 Policy Analyst Duane Thompson, will be appearing at INSIGHTS 2015 to discuss this case and other developments in fee litigation under ERISA.)

Introduction

On February 24, the US Supreme Court heard oral arguments in Tibble v. Edison, a 401(k) fiduciary breach lawsuit that had garnered a lot of attention even before the hearing.  The issue that the court has to decide is whether a claim may proceed for a breach of the fiduciary duty to monitor investments when a claim based on the initial imprudent selection of the investments is barred based on statutory limitation grounds because the initial selection occurred more than six years earlier.

In this case, the alleged imprudence is that the plan sponsor investment committee selected retail class shares for the chosen funds rather than institutional class shares that were available and would have reduced participants’ investment expenses.  Because the claim based on the initial selection was barred by the statute of limitations, the participants argued that a subsequent breach occurred when the plan fiduciaries failed to monitor the investments and switch share class shares as a result of further investigation that they should have conducted.

Edison argued that permitting a claim based on a failure to monitor would allow participants to attack conduct that occurred outside the limitation period, namely the initial selection.  However, Edison conceded that ERISA imposes a duty to monitor investments but sought to excuse Edison’s conduct by relying on the finding of the Court of Appeals for the Ninth Circuit that a claim for a breach of the duty to monitor must be supported by evidence of “changed circumstances,” and by arguing that less stringent due diligence is required when monitoring investments than when making an initial selection.  Further, Edison argued that changing investments causes disruption that participants don’t like.

Although Supreme Court watchers will tell you that you can’t predict an outcome based on a reading of the oral arguments, commentators tend to agree that the questioning by the Justices indicated a favorable leaning towards the participants.  However, the Justices questioned when the duty to monitor arises and what it involves.

Before the oral arguments, some commentators argued that this case is really about a duty of plan sponsors to select the cheapest funds available.  That, of course, is wrong:  the case is about the need to investigate the availability of the cheapest share class for a particular fund.  Still, with oral arguments over, commentators are now predicting dire consequences for plan sponsors if the Supreme Court comes down in favor of participants, suggesting that it will be difficult to define the monitoring duty and that managing a 401(k) plan will become more burdensome and costly.  Having been one of those who contributed to the amicus brief filed in this case by Cambridge Fiduciary Services, LLC, I disagree, and AIF® and AIFA® designees will readily understand why.

Discussion

At the end of the day, the Supreme Court should have little difficulty in resolving the issue before it. Both sides agree that there is a fiduciary duty to monitor investments once selected, but they disagree upon what triggers monitoring and what is the extent of investigation that monitoring calls for. The answer is pretty simple.  When monitoring investments, the same level of prudence is required as when making the initial selection: that is the level of prudence mandated by ERISA's prudent expert standard. Such a finding would be consistent with the Supreme Court decision in Fifth Third Bancorp. V. Dudenhoeffer 134 S. Ct. 2459 (2014) that effectively found that there were no different levels of prudence under ERISA.  Prudence is judged on the facts and circumstances and requires fiduciaries to perform that level of monitoring that is prudent based on the facts and circumstances with which they are faced at the time. The Supreme Court probably does not need to go further, but the Justices might indicate that monitoring requires investigation of performance, costs, manager tenure, and circumstances that might distract the manager, such as regulatory action, litigation, or corporate transactions, such acquisitions and divestitures.  This would, of course, be consistent with the fi360 Prudent Practices handbooks.

In our amicus brief before the Supreme Court, we argued that most diligent fiduciaries already perform prudent monitoring so that there is no huge burden or additional cost to requiring ongoing monitoring as a fiduciary responsibility. As mentioned earlier, Edison's counsel argued that plan sponsors are wary of the disruption caused when funds are changed but, as one of the Justices asked, what kind of disruption is it worth when a significant difference in fees is on the line?

Prudent Practices and CEFEX Assessment

We filed our amicus brief as a firm engaged in advising plan sponsors and investment advisors on fiduciary best practices and in performing assessments of fiduciary conformity.  In so doing, we drew attention to the particular Practices and Criteria in the fi360 Prudent Practices handbooks that inform the process employed by diligent fiduciaries.  It is worth mentioning here broader material from the Handbooks in order to demonstrate that advisors and their plan sponsor clients who follow the Practices will have little difficulty in meeting their monitoring obligations, once the Tibble decision is handed down.

The Handbooks explain with respect to monitoring:

No one should be lulled into thinking that the ‘heavy lifting’ was done in the previous three steps (Organizing, Formalizing and Implementing)  and the client portfolio is now on ‘auto pilot,’ marked only by periodic re-balancing, quarterly performance reports, and routine client meetings.

For the investment fiduciary, the starting point of monitoring is working backwards through the four-step Fiduciary Quality Management System. The logic is simple: activities involved in monitoring are dependent upon what was done in the first three Steps. As you work your way back through the process, you will typically analyze what you did in the first three steps.

The Handbooks continue:

Step 4 is where many fiduciary breaches occur, and the cause may be inadequate preparation and execution in the earlier parts of the investment process, resulting in errors of omission, which are more common than acts of commission. For example, a poorly written investment policy statement undermines effective monitoring. Another common form of an omission is failure to follow through on established policies and procedures.

Thus, it can be seen that the duty to monitor and perform due diligence does not simply arise when there is a need to respond to changed circumstances as found by the Ninth Circuit.

The specific Practices and their Criteria which are relevant to the monitoring issue in this case are as follows:

Practice 4.1 - “Periodic reports compare investment performance to appropriate index, peer group, and investment policy statement objectives.”

Practice 4.4 - “Periodic reviews are conducted to ensure that investment-related fees, compensation, and expenses are fair and reasonable for the services provided.”

Criterion 4.4.1 - “A summary of all parties compensated from the portfolio or from plan or trust assets and the amount of compensation has been documented.”

Criterion 4.4.2 - “Fees, compensation, and expenses paid from the portfolio or from plan or trust assets are periodically reviewed to ensure consistency will all applicable laws, regulations, and service agreements.”

Criterion 4.4.3 - “Fees, compensation, and expenses paid from plan or trust assets are periodically reviewed to ensure such costs are fair and reasonable based upon the services rendered and the size and complexity of the portfolio or plan.”

Practice 4.5 - “There is a process in place to periodically review the Steward’s (or Advisor’s) effectiveness in meeting its fiduciary responsibilities.”

Criterion 4.5.1 – “Fiduciary assessments are conducted at planned intervals to determine whether a) appropriate policies and procedures are in place to address fiduciary obligations, b) such policies and procedures are effectively implemented and maintained, and c) the investment policy statement is reviewed at least annually.

The referenced Criterion brings in the role of CEFEX as a fiduciary certification body and it should be noted that entities undergoing CEFEX certification assessments would likely be cited with a deficiency or shortfall if they did not examine available fund share classes.  In the case of an assessment of an investment advisor, the assessment questionnaire known as the “CAFE” (CEFEX Assessment of Fiduciary Excellence) asks:

If applicable, does the Advisor select share classes in accordance with the purchasing power of the client?

The note to the CEFEX analyst included in the CAFE states:

Advisors should make recommendations based on the share classes available and must educate plan sponsors about available share classes, including their costs.

Importantly from the perspective of the Tibble case, the referenced assessment question is tested annually in a CEFEX assessment not just in the year in which the initial fund and share class selection is made.  Accordingly, a failure to monitor share class selection will come to light.

Conclusion

When looking at the Practices and the CEFEX assessment process, a number of conclusions can be drawn:

The duty to prudently select plan investments and the duty to prudently monitor plan investments are separate fiduciary responsibilities, but there is no difference in the standard of prudence required in each case;

Most plan fiduciaries are already performing the type of monitoring that is prescribed by the Practices, thus protecting themselves and existing participants, as well as newly appointed plan fiduciaries and new participants, from risks associated with prior imprudent decisions;
Such monitoring, if performed in this case, would have uncovered the imprudent selection of retail-class mutual fund shares in time to avoid or at least mitigate the loss to participants and/or risk of participant legal claims;

A CEFEX assessment performed with respect to the Edison plan would have uncovered a failure to investigate and evaluate the appropriate share class when selecting mutual funds and the subsequent selection of retail class shares.

In conclusion, the Supreme Court should have little difficulty in supporting ERISA’s fiduciary standard of care by explaining the duty to monitor, and advisors and their retirement clients who conform to the Practices should be well prepared to deal with the Tibble outcome.  To the extent that advisors and plan sponsors want independent evidence that they are meeting their monitoring and other fiduciary obligations, CEFEX offers the appropriate solution.

How Long Should An IPS Be?

There is no one right way to write an IPS.  There is no prescribed set of topics that need to be included.  The length of an IPS can be whatever is right for the advisor and the client.

For that reason, the appropriate length of an IPS rests with what needs to be said and how detailed the discussion of the selected topics need to be.

THE "FOR DUMMIES” version OR just the facts?

For example, if you want to include "Risk Tolerance" as a topic in your IPS, your entire discussion of that might just say "Moderate." That of course assumes that you as the advisor and your client understand what Risk Tolerance is, what its implications are for the investment policies, and that there is a shared and clear understanding of what "moderate" means in the context of an IPS.  It also means that you have no concern that if there should ever be litigation, that the court would also understand the meaning of "moderate" in the same way.

I've seen excellent IPSs for pretty large institutional clients that were only one page long.  The investment committee wanted a record of their direction given to the investment consultant, but felt that there was enough information in the bullet points, given all the discussion that had taken place, that single words or short sentences were generally sufficient.

I've also seen very good and quite appropriate IPSs that were 20 or 30 pages long, and in a couple of cases, nearly 40 pages.  These included lots of background, definitions of key words, discussion about the implications of each particular topic, and paragraphs (rather than single words) on important decisions that are to be implemented.  Each reflects the style of the advisor and the particular needs of the client.

START WITH YOUR OUTLINE AND FILL OUT as much as NECESSARY

Since it is likely you are an advisor and want to write your IPSs in a way that reflect your style and your clients' needs, you'll need to make your own decisions about the depth of discussion you want to include on each of the topics that you'll need to address in a thorough IPS:

Key factual and client background data
Investment objectives– The client’s goals
The client's time horizon / risk tolerance
Asset constraints and restrictions
Asset allocation / variance limits
Investment selection criteria
Assignment of Responsibilities – Who does what
Performance Review and Evaluation
Signatures

The IPS can be so much more than just a technical document that outlines your investment strategy and process. It can be the central document informing your client interactions. If you want to learn more about how you can make the most out of your IPSs, check out the webinar we did on the subject with IPS AdvisorPro co-founder, Linda Lubitz-Boone.

White House Stirs Up Fiduciary Debate

The White House came out strong today in support of raising the standard of care for anyone providing advice on retirement accounts. Speaking at AARP, President Obama aimed his comments to investors, explaining how small differences in fees can have a big effect on account balances and making the case for a “best interests” standard for advisors. This came in coordination with the release of a report by the White House Council of Economic Advisers on the economic effects of conflicts of interests by advisors, as well as new PR efforts on the White House website. As we wait on our first glimpse of the DOL’s new fiduciary rule proposal, today’s announcement leaves little doubt that the DOL is sticking to its guns and that it has the backing of the White House in what will be a heated debate within the industry.

What’s it all about?

By now, the DOL has either already or soon will submit its “Conflicts of Interest” rule to the Office of Management and Budget, the first step towards its public release and comment period. Until the OMB has completed its review, we can only speculate on exactly what the rule will entail. However, we already have a good sense of what the two most significant developments will be:

Broadening the definition of who is a fiduciary under ERISA – The current definition of an ERISA fiduciary requires that advice be both regular and the primary factor in decision-making. These requirements often scope out a broad segment of retirement service providers who have successfully maintained that their services are limited to a single act and do not constitute the primary factor for plans making investment decisions. By eliminating these criteria, the number of providers considered fiduciaries under ERISA would greatly expand.

Advice to IRA-holders will be covered – Currently, DOL does not generally have enforcement over IRAs. So when participants roll over their 401(k) accounts into IRAs, they are losing some of their protections under ERISA and their advisors aren’t subject to DOL regulations. It is expected the DOL will look to change this dynamic and make advice to rollover retirement accounts into an IRA a fiduciary function under ERISA. This, too, would greatly expand the number of advisors who are considered fiduciaries under ERISA and cause advisors to take a close look at how they make recommendations to existing and potential clients.

What's it mean for advisors?

Advisors who are currently pursuing IRA rollovers or otherwise offering plan services, but do not currently consider themselves ERISA fiduciaries should be following this news closely. Depending on what happens over the coming months of debate and procedure until (or if) a rule becomes official, you may find yourself subject to a whole new enforcement regime, or have to seriously revamp your service offerings and processes.

Santomenno court case a window into debate over DOL fiduciary rulemaking

As the industry waits for the DOL to re-propose its fiduciary rule, a case at the appellate level last year provides an interesting preview of the upcoming debate. Last September, the U.S. Court of Appeals for the Third Circuit decided that a retirement plan provider was not a functional fiduciary by virtue of its role selecting and monitoring a “Big Menu” of funds for its clients to select from. This was not a surprising result, as it merely reinforced settled law from previous court decisions.

What makes this case so interesting is how the plaintiffs, defendants, and the DOL itself, via its amicus brief in support of the plaintiffs, addressed the past, present, and future of the DOL’s fiduciary rule.  On the one hand, the plaintiffs asked the courts to ignore DOL’s current definition of fiduciary on the basis that it wasn’t aligned with Congress’s intent when it first passed ERISA. On the other, while the DOL attempted to dissuade the court from dismissing the plaintiffs’ case, it wasn’t willing to go so far as to stand behind their updated rule as it was first proposed in 2010. All of this leads to fi360 Senior Policy Analyst Duane Thompson to speculate on what it means for the anticipated 2015 version of an updated DOL fiduciary rule.

Just how far will the existing, five-part test of fiduciary status be streamlined to cover more service providers?

What will the DOL do to prevent providers from disclosing away fiduciary responsibility?
How will a seller’s exemption be incorporated?

Will DOL be able to provide a sufficient argument on the economic benefits of the rule, a point of emphasis in recent challenges to new regulation?

Duane’s thoughts on these questions and more are available in a new briefing paper presented by fi360:  https://www.fi360.com/uploads/media/WP_Santomenno_021315.pdf

Survey Finds Fiduciary Decision-Making Key To Building Trust With Clients And Helping Raise Assets

Learning about fiduciary best practices can be instrumental in helping financial advisors hone their craft, build client trust, and raise assets, according to a recent survey conducted by fi360, an organization that provides training programs and software to help clients gather, grow, and protect assets through better investment and business decision-making.

Seven qualitative factors for evaluating investments

Due diligence is the heart and soul of investment selection. A good due diligence process objectively whittles down the universe of available funds to just those that meet your high standards for inclusion in an investment portfolio. Investment due diligence typically begins on the quantitative side by evaluating funds against set benchmarks and in relation to peers.  The fi360 Fiduciary Score®, for example, is calculated using nine quantitative factors that we consider to be the minimum due diligence criteria that you should use when evaluating an investment.  But in addition to quantitative analysis, fiduciaries should consider applying qualitative factors, which can help detect organizational instability. Organizational instability, over time, usually leads to underperformance.

Here are seven qualitative factors that a fiduciary should consider implementing into their due diligence process:

Manager quality – Does the portfolio manager have the necessary experience to manage the type and size of portfolio you are investigating?  In addition to credentials, take a look at prior experience. This is especially important if the manager is new to the firm.

Staff turnover –Along with the portfolio manager, you should also look at the professional staff of the investment company. Has there been significant turnover?  If significant turnover is found, you should dig deeper to find out why.

Organizational structure – You should also investigate any structural changes to the investment company.  It’s important to examine the firm’s mergers or acquisitions to see if the organization is more focused on “castle building” than managing money. If they are building the firm, how will it benefit your client?

Level of service provided - Does the investment company provide a better level of service than other firms in the marketplace for a comparable fee? Does the money manager provide other share classes for a fund or separately managed accounts? Depending on your client’s situation, you may be able to invest with the same portfolio manager, but at a lower cost.

The quality and timeliness of the money manager’s reports – Registered investment companies are required to report information to the SEC, but do they do so in a timely manner? In addition, does the manager provide an adequate amount of information to make an informed decision? If they do not, what is the cause of delay or omission?

Response to requests for information – Like every other service company, the investment company has customers, primarily advisors and investors.  Do they treat their customers with care? If you request information from the investment company, do they provide it in a timely manner with a relevant response?

Investment education - Does the portfolio manager provide an adequate explanation of the investment decisions made and the factors considered in making decisions?  Is the portfolio manager able to easily articulate the portfolio mandate, the plan to follow the mandate, and any problems seen in achieving the mandate?

This is by no means a comprehensive list. Instead, it’s a demonstration of the type of probing analysis an advisor can use in their selection and monitoring process.

How often should I update my client's IPS?

An investment policy statement (IPS) is a reflection of the initial and on-going agreements between the client (what I want and don’t want, who I am, how much risk I’m willing to take, what decisions I expect to be involved in, etc.) and the advisor (discretion or no, the intended allocation and how much it can be strayed from and the process for rebalancing, the general investment process to be followed, the kinds of investments/securities to be used, etc.).  It should outline each party’s responsibilities to each other and identify how and when things will be reviewed and updated.

In other words, how often the IPS should be updated should be part of the IPS, part of the agreement.

WHY THE IPS NEEDS UPDATING

In broad, general terms, an update is needed when something about the original agreement has or needs to change.  While we have full discretion with our advisory firm clients’ assets, we also have an agreement with our clients that if we would like to change anything that is documented in the IPS, then we need to check with them first, before making that change. That makes the IPS a meaningful document, to our clients and to us, and it gives an important degree of control to clients about their important issues as they are asking us to manage their investments on their behalf.

In the IPSs we have, the most frequent change is a change in the asset allocation.  Rather than update the whole IPS, we simply send our client a single sheet that acts as an amendment to the IPS, reviews their current target allocation, highlights what changes we want to make, and it provides a simple explanation regarding why we want to make the change (in all cases, we’ve talked to the client beforehand to explain our reasoning and get their input).  Their signature is evidence of their approval and amends the IPS so that it is kept up to date.

EVENT-BASED UPDATES

Because an important element of the IPS is documenting who the client is, what their mindset was when they approved the investment process, and what their goals and tolerance for risk were, we believe it is important to renew the IPS periodically.  It helps to have the IPS as part of the discussion every time you talk with the client, reinforcing that it is a living and vital document that you take seriously.  That said, the IPS needs to be updated when and if the following events occur:

You want to change something about your investment procedures or policies that is different from what is in the IPS.

You want to further clarify a procedure or policy that is less than clear in your IPS.

You want to change how you are managing this particular client’s investments (e.g., change in asset allocation or change in types of securities or asset classes to be utilized).

When there are meaningful changes to the client’s circumstances.

SET A REGULAR UPDATE SCHEDULE

Beyond updating the IPS when circumstances require it, we also recommend keeping a regular schedule of review and update. Individual clauses can be reviewed and updated on a schedule that corresponds with normal portfolio monitoring procedures.

In addition, we think the IPS should be reviewed in full on an annual basis to review for any outdated information. Once the IPS is sufficiently old, you and the client (or the courts!) might consider it stale and no longer valid. Just on principle, we believe every IPS ought to be rewritten every 3-5 years, just to remind the client this is an active and important document and because it needs to accurately reflect the client’s current thinking and circumstances (which often evolves over time without anyone realizing it).  The IPS needs to be updated so that your understanding and the information documented in the IPS is always current, consistent and accurate.  Unless you formally ask every once in a while, you can’t be sure that your thinking and the client’s thinking are the same.

* * * *

Norman Boone, MBA, CFP® is one of the creators of IPS AdvisorPro and an expert on investment policy statements. He is also the founder and principal of Mosaic Financial Partners, Inc. in San Francisco. He will be appearing at INSIGHTS 2015, fi360's professional development conference, in March. 

- See more at: http://www.fi360.com/blog/post/how-often-should-i-update-my-clients-ips#sthash.X4QRCH5O.dpuf

Identifying the fiduciaries

Fiduciary duty is determined by facts and circumstances and it is not uncommon for fiduciaries to be unaware of their status. One of the first issues that will arise in breach of fiduciary duty litigation is determination of whether the defendent, in fact, owed a fiduciary duty. For the protection of the fiduciaries and investors alike, it is better to address this issue up front, by properly identifying the fiduciaries, documenting their status and role in the investment policy statement, and requiring the fiduciaries to acknowledge their status in writing. Not only will this help prevent misunderstandings, it ensures every step in the investment process is accounted for and that the fiduciaries are taking the proper steps to fulfill their role.

Fiduciary momentum from the industry, FINRA outstrip SEC's pace

Fiduciary momentum from the industry, FINRA outstrip SEC's pace

Posted by Bennett Aikin on January 07, 2015

"Irrespective of whether a firm must meet a suitability or fiduciary standard, FINRA believes that firms best serve their customers—and reduce their regulatory risk—by putting customers’ interests first. This requires the firm to align its interests with those of its customers."

This statement was part of FINRA’s annual Regulatory and Examination Priorities letter that came out yesterday. It’s a notable position to take for the self-regulator that is thus far under no obligation to expect anything more of its members than the traditional suitability standard. But if you’ve been paying close attention, it’s just one more signal of the industry-wide trend towards placing the best interests of investors ahead of all other interests.

In his most recent Fiduciary Corner column for InvestmentNews, fi360 CEO Blaine Aikin looks at some of these trends that are working in investors’ favor, even as the wait for SEC action on a fiduciary rule drags on through its fifth year.

To read the entire blog, please visit www.fi360.com.

A fiduciary approach to fund due diligence and what to do with Pimco funds

A fiduciary approach to fund due diligence and what to do with Pimco funds

Posted by Bennett Aikin on December 10, 2014 in Fiduciary Basics

As redemptions from Pimco reach $100 billion in the wake of departures by both Bill Gross and Mohamed El-Erian, investors and advisors still holding Pimco funds are left to figure out if they too should be making changes to their portfolios. Fiduciaries, however, need to be deliberate in their decision-making. Context is everything and it would be a mistake to act rashly and without a clear rationale for how a particular decision is ultimately the best decision for the portfolio.


To read the entire blog, please visit www.fi360.com.