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.
Wednesday, March 4, 2015
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.
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.
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
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.
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.
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