Time to update ERISA fiduciary rule--OPINION

Currently, some advice, however conflicted, is seldom actionable

Pensions & Investments
By Phyllis C. Borzi
April 18, 2011, 12:01 AM ET

Image via WikipediaPension plans and participants routinely depend on experts for guidance in making important investment decisions. They turn to these investment professionals for reliable advice on how best to manage and safeguard retirement assets. Most would assume that these experts give their advice as fiduciaries, obligated to act with prudence and undivided loyalty to the plans' financial interests, rather than in their own interests — and that's exactly what the Employee Retirement Income Security Act of 1974 provides. However, a regulation issued in 1975 by the Department of Labor substantially narrowed the statutory fiduciary definition, making it far too easy for today's advisers to avoid fiduciary responsibility. We are now working to update this rule.

John Dean
Phyllis C. Borzi is assistant secretary of labor for the Employee Benefits Security Administration, Washington

So much has changed over the last three decades and the concepts and interpretations developed long ago often need to evolve or they risk becoming irrelevant. … The department's plan to update its 36-year old fiduciary regulation is necessary to ensure its relevance in today's environment of participant-directed investments.

… ERISA provides that a retirement plan fiduciary must act with prudence and undivided loyalty to the participants in that plan. Among other things, the law says that anyone providing investment advice for a fee, either direct or indirect, is a fiduciary. The department's 1975 rule restricted this definition by creating a five-part test for the definition to be met. At the time, … 401(k) plans didn't exist and individual retirement accounts were just starting up. Now the majority of retirement plan assets are in 401(k) plans where participants shoulder most of the investment responsibility, regardless of their financial sophistication. Additionally, IRA assets now exceed those in 401(k) plans. As a result, good investment advice is in greater demand, both by participants and by the plan sponsors who select plan investments.

Among the key elements of the five-part test was the requirement that the advice had to be given on a regular basis and that it had to be given pursuant to a mutual understanding that the advice would be the primary basis for the investment decision. This means that advice given infrequently, however flawed or conflicted, is seldom actionable by the department. … Moreover, unless both the plan official and the adviser understand that the advice serves as a primary basis for the investment decision, advisers who base their advice on their own financial interests rather than the plan's can't be held accountable under ERISA for the resulting losses.
Consequently, plan sponsors and participants are often left holding the bag for damages caused by conflicted advice, even in cases where the adviser might have represented that the advice was covered under ERISA. Plan officials who relied on that advice, as a result, are often the sole targets of legal actions that may follow.

… Plan sponsors hire their advisers with the expectation that the advice will be free of conflicts of interest and that these advisers will be held to the same legal standard of care that any fiduciary would.
To fix this problem, we have proposed a new rule that more closely reflects Congress' decision in 1974 as to when investment advisers are “fiduciaries” to the plans they serve. The new rule would remove the “regular basis” and “primary basis” requirements to give added protection to both employees who participate in retirement plans and to the businesses that offer them. ...

Image via WikipediaIn developing this rule, we are working collaboratively with the Securities and Exchange Commission and the Commodities Futures Trade Commission to harmonize our respective regulatory activities. We want to ensure that compliance with one regulatory regime does not create violations of the other. … We also have broad authority to issue exemptions from ERISA's prohibited transaction rules, so we can make sure that beneficial advice practices are permitted, even if they would otherwise be technical violations of the statute. While we recognize that most advisers act in good faith, the new rule would permit us better to protect plans from abusive practices and to address them when they occur. We will, however, continue to evaluate the scope, terms, conditions and exceptions in the proposed rule to ensure that the final regulation is as clear and effective as possible, and to make sure that we avoid any unintended consequences.

Our actions will benefit America's businesses and their employees nationwide. The proposed rule would hold financial professionals who present themselves as expert purveyors of investment advice more accountable for that advice, allowing plan sponsors to be secure in the knowledge that outside advisers are giving them the best possible guidance. Shouldn't advisers who provide such crucial advice be held to the same standard of care as those who are paying them for it?

Phyllis C. Borzi is assistant secretary of labor for the Employee Benefits Security Administration, Washington.

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SIFMA Asks DoL to Reconsider Fiduciary Definition Change

February 3, 2011 (PLANSPONSOR.com) - The Securities Industry and Financial Markets Association (SIFMA) has asked the Department of Labor (DoL) to reconsider its proposed rule that would redefine the term “fiduciary” under the Employee Retirement Income Security Act (ERISA).

Image via WikipediaIn its letter to the DoL, SIFMA noted that the proposal could critically impact the ability of individuals to reach a successful retirement, because the financial institutions most able to efficiently deliver investment assistance will no longer be able to do so without added cost to the plan participant or IRA account holder. If the agency will not reconsider its proposed rule, SIFMA requested that it carve out IRAs at this time to determine whether the unique costs and structure of IRAs would support a different fiduciary standard. …

Image via Wikipedia“In the midst of other regulatory initiatives in this area, we ask the Department to reconsider this proposal and work with other regulators to ensure regulatory consistency,” said Tim Ryan, president and CEO of SIFMA, in the letter.

SIFMA contended that the DoL has not fully considered the costs of this proposal on small plans and IRAs and the manner in which their investment choices will be curtailed, or the costs on large plans that may be unable to engage in swaps, prime broker their assets, invest in alternatives, obtain futures execution and otherwise have their investment choices limited by the proposal. …
A copy of the letter can be found at http://www.sifma.org/issues/item.aspx?id=23239.
Rebecca Moore
editors@plansponsor.com

PLANSPONSOR.com - SIFMA Asks DoL to Reconsider Fiduciary Definition Change

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DoL Broadens Fiduciary Net

Image via WikipediaOctober 21, 2010 (PLANSPONSOR.com) – For the first time in a generation, the Labor Department has taken another crack at the definition of a fiduciary under the Employee Retirement Income Security Act (ERISA).

The proposed rule was unveiled today by the Department of Labor (DoL), which noted that its adoption “would protect beneficiaries of pension plans and individual retirement accounts by more broadly defining the circumstances under which a person is considered to be a ‘fiduciary’ by reason of giving investment advice to an employee benefit plan or a plan’s participants.”
The proposed rule is designed to “take account of significant changes” in both the financial industry and what was described as “the expectations of plan officials and participants who receive investment advice,” as well as to protect participants from “conflicts of interest and self-dealing.”

Testing, Tested

Image via WikipediaIn explaining the proposal, the Labor Department noted that while Section 3(21)(A) of ERISA provided a “simple two-part test for determining fiduciary status,” a subsequent (1975) regulation served to “significantly narrow” the “plain language” of the legislation; effectively replacing the two-part test that would impose fiduciary status when a person renders investment advice with respect to any moneys or other property of a plan, or has any authority or responsibility to do so and receives payment (direct or indirect) for that advice, with a 5-part test that included conditions that: the advice regarding plan investments be rendered “on a regular basis,” that the advice would serve as a primary basis for investment decisions with respect to plan assets, that the recommendations are individualized for the plan, that the party making the recommendations receives a fee for such advice, and that it be pursuant to a mutual understanding of the parties. Moreover, the Labor Department noted that it further limited the definition of “investment advice” in a 1976 advisory opinion, when it concluded that the valuation of closely-held employer securities in an employee stock ownership plan (ESOP) relied on in purchasing those securities would not constitute investment advice.

…[The] Labor Department noted that the financial marketplace and the types and complexity of services have expanded dramatically. The proposal notes that although professionals such as consultants, advisers, and appraisers “…significantly influence the decisions of plan fiduciaries, and have a considerable impact on plan investments,” if they are not deemed fiduciaries under ERISA “…they may operate with conflicts of interest that they need not disclose to the plan fiduciaries who expect impartiality and often must rely on their expertise, and have limited liability under ERISA for the advice they provide.”
In essence, the Labor Department now says that ERISA does not compel it to apply its own five-part test, and that new facts and circumstances mean it is now time to update the investment advice definition. Specifically cited is that the proposal no longer requires that the advice be provided on a “regular” basis, not does it require that there be a mutual understanding that the advice will serve as a primary basis for plan investment decisions. [emphasis added']
Advice Description
As for what constitutes advice, the proposal now includes the provision of appraisals and fairness opinions as a type of advice [emphasis added], noting that the incorrect valuation of employer securities was a “common problem” identified in the DoL’s recent national enforcement project, including cases where plan fiduciaries have “reasonably relied on faulty valuations prepared by professional appraisers.” The proposal also makes specific reference to advice and recommendations as to the management of securities and other property, including such things as voting proxies or recommendations regarding the selection of persons to manage plan investments.
Finally, in what was described as reflecting “the Department’s longstanding interpretation of the current regulation,” the proposal makes clear that fiduciary status “may result from the provision of advice or recommendations not only to a plan fiduciary, but also to a plan participant or beneficiary.” [emphasis added]

Distribution Advice
The proposal notes that while the DoL has previously taken the position that a recommendation to a plan participant to take a permissible plan distribution would not constitute investment advice, even when combined with a recommendation as to how the distribution should be invested, “[c]oncerns have been expressed that, as a result of this position, plan participants may not be adequately protected from advisers who provide distribution recommendations that subordinate participants’ interests to the advisers’ own interests.” As a result, the Labor Department is now seeking comment “on whether and to what extent the final regulation should define the provision of investment advice to encompass recommendations related to taking a plan distribution.” [emphasis added] The proposal notes that the agency is specifically interested in:

• information on other laws that apply to the provision of these types of recommendations,
• whether and how those laws safeguard the interests of plan participants,
• the costs and benefits associated with extending the regulation to these types of recommendations.

The proposal says that the definition of advice does not include “the preparation of a general report or statement that merely reflects the value of an investment of a plan or a participant or beneficiary, provided for purposes of compliance with the reporting and disclosure requirements,…unless such report involves assets for which there is not a generally recognized market and serves as a basis on which a plan may make distributions to plan participants and beneficiaries.” [emphasis added]
Other Points
The proposal says that the DoL believes that explicitly claiming ERISA fiduciary status, orally or in writing, is sufficient to result in fiduciary status, if provided for a fee (in that it “enhances the adviser’s influence, and gives the advice recipient a reasonable expectation that the advice will be impartial and prudent”).
Consistent with existing regulations, the proposal acknowledges that the provision of investment education materials (plan information, general financial and investment information, asset allocation models, and interactive materials) would not be deemed advice.
The proposal notes that the “marketing or making available” investments or an investment menu (e.g., through a platform or similar mechanism) “without regard to the individualized needs of the plan, its participants, or beneficiaries…will not, by itself, be treated as the rendering of investment advice within the meaning of section 3(21)(A)(ii) of ERISA”—if the person making those investments available “discloses in writing to the plan fiduciary that the person is not undertaking to provide impartial investment advice.” Additionally, the provision of information and data to assist a plan fiduciary’s selection or monitoring of investments isn’t deemed to be rendering advice “if the person providing such information or data discloses in writing to the plan fiduciary that the person is not undertaking to provide impartial investment advice.”
The proposal does set aside some limitations, exempting from the fiduciary umbrella persons that can demonstrate that the advice recipient “knows or, under the circumstances, reasonably should know, that the person is providing the advice or making the recommendation in its capacity as a purchaser or seller of a security or other property, or as an agent of, or appraiser for, such a purchaser or seller, whose interests are adverse to the interests of the plan or its participants or beneficiaries, and that the person is not undertaking to provide impartial investment advice.” [emphasis added]
Finally, noting that a necessary element of fiduciary status is that the advice be rendered for a fee or other compensation, the proposal states that that includes, but is not limited to, “brokerage, mutual fund sales, and insurance sales commissions,” [emphasis added] and that it includes fees and commissions based on multiple transactions involving different parties.
Effective Dates
The proposal is set to take effect 180 days after publication in the Federal Register tomorrow, but the Labor Department is first seeking comments on the proposal. The comment period for the proposed regulations will end 90 days after publication of the proposed rule in the Federal Register. That means that the comment period will end January 20, 2011. Comments can be submitted electronically by e-mail to e-ORI@dol.gov (enter into subject line: Definition of Fiduciary Proposed Rule) or by using the Federal eRulemaking portal at http://www.regulations.gov/.

The DoL notes that persons submitting comments electronically are encouraged not to submit paper copies. More information on paper submissions is available (along with the proposal itself) at http://www.ofr.gov/OFRUpload/OFRData/2010-26236_PI.pdf

Judy Ward
editors@plansponsor.com

Just Out of Reish - Too Safe Is Too Bad

PLANSPONSOR.com

Safe investments may not be safe…for fiduciaries
…For fiduciaries, safe means that they are protected from lawsuits either because they complied with the law or because they have a legal safe harbor. Safe—for most participants—means an investment that has very little, if any, volatility. In the investment world, volatility measures how much the value of an investment fluctuates. For example, stable value or money market accounts are intended to have a fixed principal that does not fluctuate in value.
Another important definition is time frame. When the market is highly volatile, …people tend to measure their investment results in weeks or months. However, that is inconsistent with ERISA’s approach, which would measure investment results over years, or decades, or working careers.
With that in mind, how can safe be risky for 401(k) fiduciaries, and vice versa, particularly for default investments?
Risky can be safe for 401(k) fiduciaries when selecting qualified default investment alternatives, or QDIAs. …QDIAs are the investments that can be used for participants who …fail to direct their investments, as a fiduciary safe harbor under ERISA section 404(c)(5). While there are three categories of QDIAs, this column discusses only target-date funds, or TDFs.
By legal definition—and common application—QDIAs, and therefore target-date funds that qualify as QDIAs, must have a material allocation to publicly traded stocks and, therefore, are volatile when compared with, for example, stable value investments.
The first step of our analysis is that risky or volatile investments in equities are safe for fiduciaries when used in QDIAs even though they seem less safe—or more volatile—to participants.

Image via WikipediaHowever, what about the use of safe investments, such as stable value and money markets, as default investments? In that case, what feels safe for participants is risky for fiduciaries. …Succinctly stated, the DoL viewed the riskiness of inadequate benefits at the end of a working career as being more important than the riskiness of stock and bond market volatility in the short term.

If you accept the DoL’s view on this issue, or if you want the fiduciary safe harbor protections for QDIAs, the prudent course of action is to invest default money for the long term. Based on conventional investment thinking, that means that fiduciaries should place defaulting participants in diversified portfolios consisting of, at the least, stocks, bonds, and cash.

Image via WikipediaYet, what if an employer wants to avoid possible employee criticism for investment losses? Isn’t that permissible?

It may be permissible based on the demographics of a particular work force, but only after the fiduciary has engaged in a prudent process and reached an informed and reasoned decision that a long-term investment in stable value or money market vehicles is likely to produce equivalent or superior retirement benefits. However, in that case, the fiduciaries have lost the safe harbor and, as a practical matter, the burden will be on the fiduciaries to prove their case—that is, to overcome the common belief that is expressed in the DoL language.
Even there, is it possible that there could be a lawsuit where participants have small gains, but no losses?
Yes, it is. In 1986, the DoL filed a lawsuit against a union pension trust and subsequently entered into a settlement of that lawsuit. In the press release regarding the settlement, the DoL stated, “The department has charged that the trustees caused the plan to sustain financial losses by investing virtually all of its assets in ordinary savings accounts during the period of time covered in the suit.” To help you understand the quote, ERISA considers insufficient gains to be losses. So, there you are. Risky is safe and safe is risky.

---

Fred Reish is Managing Director and Partner of the Los Angeles-based law firm of Reish & Reicher. A nationally recognized expert in employee benefits law, he has written four books and many articles on ERISA, IRS and DoL audits, and pension plan disputes. Fred has been awarded the Institutional Investor Lifetime Achievement Award and the PLANSPONSOR Lifetime Achievement Award. He is also one of the 15 individuals named by PLANSPONSOR magazine as “Legends of the Retirement Industry.”
PLANSPONSOR staff

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Protection from the Storm

PLANSPONSOR.com

Thinking about investment-management outsourcing? Here are seven of the biggest myths and realities
“If it is raining, you are looking for the best umbrella,” says Joshua Dietch, Managing Director at Waltham, Massachusetts-based Chatham Partners, a market research and consulting company. Some employers—who sponsor underfunded defined benefit (DB) plans that need better risk management or defined contribution (DC) plans that need less-costly, more-customized investment options, for example—have looked to the expertise of investment-management outsourcers as that protection from the current storm.

However, this complex field is ripe for confusion among employers considering it. Sources talked about several of the most common investment-outsourcing myths:

1. It is just for mid-size sponsors. “The real sweet spot for outsourcing is mid-size companies,” says Seth Masters, CIO of AllianceBernstein Blend Strategies and Defined Contribution, and most of the first wave of deals did, in fact, happen with these plans. These employers often do not have the in-house resources to do all the work effectively, but have enough in assets to make deals scalable for an outsourcer.

Image via WikipediaWhile the mid-size market remains active, “we also see much more of a trend at the larger end,” says Joseph Gelly, Russell Investments Investment Outsourcing Practice Leader. “It is less around ‘I do not have buying power’ or ‘I do not have the resources or the technical competence’ and more around ‘I need to focus on running my company,’” he says, adding that many of those larger employers have frozen DB plans and want to devote their time and resources to core parts of their business rather than legacy benefits.

2. It is just about managing managers. Many sponsors traditionally see outsourcing in terms of investment oversight, says Clint Cary, Senior Vice President at Aon Investment Consulting. “It is not just managing assets; it is managing the funded status,” he says. Sponsors of active DB plans “are migrating to a risk-management approach, where they are trying to improve the funded status of the plan and de-risking the plan as they get better funded,” he says, “and they do not have the risk managers internally.”…

Image via Wikipedia3. Only defined benefit plans get outsourced. These plans have used outsourcing the most, but defined contribution (DC) sponsors increasingly consider it, says Jennifer Tretheway, a Senior Vice President and Managing Director at Northern Trust Global Advisors. “The most common thing we see from DC plans is an interest in having some type of oversight done, anything from overseeing the mutual fund options on a recordkeeper’s platform to something more proactive, in terms of having discretion on which investment-management firms to utilize,” she says.

DC plans may need outsourcers’ expertise even more than DB plans, Masters says. “Historically, DC plans did a kind of outsourcing by hiring recordkeepers that provided a bunch of options, mostly in mutual fund form and often, frankly, at a fairly high cost,” he says. However, DC plans have become most Americans’ primary retirement-savings vehicle, leading employers to want to limit the cost to participants as much as reasonably possible.
“The single biggest thing that people will get help with is customizing target-date funds,” Masters predicts. “In the next 10 years, virtually all growth in DC assets will be in target-date assets. So, as that unfolds, it becomes increasingly important for plan sponsors to get the target-date decision right.” Designing and implementing a customized target-date structure so that it comes as close to the cost of a DB plan as possible “is a fairly specialized task,” he says, and many employers lack that in-house expertise.
4. It costs a lot, or saves a lot. “Another primary misconception is that outsourcing is more expensive than doing it in-house,” Tretheway says. “The majority of our clients do recognize some savings, in the form of hard-dollar expenses for investment management, custody, and performance measurement. On average, clients might recognize a savings of around 10%.”…
“[Sponsors] do not go in thinking the overall fees are lower; they go in thinking they will get a more comprehensive service set,” Cary says. “They see it as a cost-neutral solution. Cost is not a main driver, and is also not a hindrance.”
Remember that the cost of administration for a DB plan pales compared with the cost of funding the plan, Dietch says. The argument for outsourcing a pension plan is “you reduce your cost of funding if you generate higher returns and less volatility, and reduce tracking error,” he explains.
5. Sponsors can offload their fiduciary responsibility. Dietch wonders if most employers realize that they retain significant fiduciary obligations if they outsource. Even if they think they can transfer that responsibility legally, Masters says, “I think you cannot morally: The reputational risks are too great.”
Yet, the desire to forgo as much fiduciary responsibility as possible “is a big motivator” to outsource, Dietch says. “It is certainly being aggressively marketed.” However, an ERISA plan sponsor remains a fiduciary, he adds, and has to operate with that standard in selecting and monitoring an outsourcer.
“That fiduciary role does not go away,” Gelly says. “The responsibility shifts from day-to-day to more strategic. Their involvement is extremely critical, but it is more at the strategic level,” such as approving the investment policy. The employer also still needs to evaluate the investment outsourcer’s performance regularly, Tretheway says, and most clients look at quarterly committee meetings as a good time to cover that.
6. It means giving up all control. “One thing I hear a lot is that people feel like, ‘Oh, I am giving up control,’” Gelly says of employers thinking about outsourcing. In reality, Tretheway says, clients’ ongoing involvement level really ranges. For instance, some clients delegate to Northern Trust the authority to hire and fire investment managers but, in other cases, it does not have complete discretion. For those with less day-to-day involvement, she believes, they ultimately have more control because they can track progress more closely to meet their goals.
There is no one right answer on how involved in day-to-day workings a sponsor should stay after outsourcing, Masters says. …
7. Outsourcers only sell pre-packaged solutions. “There is a little bit of a myth out there around, ‘This is a black box,’” Gelly says. “Unfortunately, some people think that everybody is treated the same.” Sometimes yes and sometimes no. For instance, Gelly says that Russell highly customizes the weighting among plan clients’ asset classes based on factors such as a plan’s liabilities.
Outsourcing has a lot of different permutations in the marketplace, Dietch says, but to do this business profitably, outsourcers have to create something scalable. As for customizing to specific clients, he says, “a lot of it comes down to what the contractual terms say.” Some outsourcing providers take a more-standard approach: “They have one fund, and everybody goes into that fund,” Tretheway says, “but all of our clients have a unique asset allocation, and a unique investment policy statement. We really have a hard time believing that any two organizations have identical needs.”
Judy Ward
editors@plansponsor.com

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The Pros and Cons of 401(k) Annuities

Retirement Income Journal

By Kerry Pechter Thu, Sep 16, 2010

One witness at the DoL/Treasury hearings this week asserted that mandatory annuitization of DC assets at retirement is needed. The government, as well as sponsors and plan providers, have largely ruled that out.
The prominence of the witnesses testified to the significance of the DoL/Treasury Department hearings this week on so-called "401k annuities" and other tools that can help plan participants turn their savings into income--either while they save, when they reach retirement, or in retirement. …
Trade, labor, and consumer advocacy groups also contributed their thoughts. The AFL-CIO, the Investment Company Institute, the Profit-Sharing and 401(k) Council of America, the American Council of Life Insurers, the American Society of Pension Professionals and Actuaries and the Spark Institute all gave testimony. Other groups and firms can contribute statements via e-mail over the next month.
Some witnesses praised in-plan annuities, while others, like Steve Utkus of Vanguard, tried to bury them. To be sure, there are plenty of good reasons for putting income options in plans, either as savings vehicles (deferred annuities) or exit options (immediate annuities, payout funds).
Big plan sponsors have economies of scale and bargaining power that lower the costs of products, administration, and education. Plan sponsors are also in a unique position to set up a program that applies the employer match to the purchase of future income… . Like contributions to a defined benefit plan, that kind of program would leverage the time value of money and mitigate the interest rate risk and timing risk associated with the lump sum purchase of an annuity at retirement.   
Counter-arguments
But there are plenty of … counter-arguments for putting annuities in DC plans. For plan sponsors, there are potentially huge expenses associated with evaluating the costs and benefits of different income product vendors and in educating employees. Above, all liability for picking the wrong provider or for giving employers bad (in retrospect) advice scares them. “Fiduciaries are paranoid and rightly so,” says Sheldon Smith, an ERISA attorney and president of ASPPA.
As for participants, most of them won’t retire from their current employer/plan sponsor. From the participant perspective, the average person spends only 4.2 years in any particular job and might participate in several 401(k) plans. There are also portability issues. Participants may want to change employers or get out of income products. Employers may want to change annuity providers.
Adapting recordkeeping systems to multiple income options, or options that might change suddenly, could also pose problems, especially for small employers. Ninety-percent of plans have fewer than 100 participants. Only the largest 10% of plans, which account for 85% of all participants, may be able to cope with the legal, educational, and recordkeeping challenges of in-plan options.  
Other problems: most 401(k) accounts, even at retirement, are too small to annuitize at all, let alone big enough to allow for the ideal solution: partial annuitization. Annuity purchases can also trigger the need for spousal approval, potentially increasing paperwork for sponsors. Gender-neutral pricing rules in 401(k) plans also mean that retail annuities, which have gender-specific pricing, can offer men much higher payout rates than in-plan annuities.
Alternate vision
The zeal for putting guaranteed income options in DC plans is limited mainly to insurers. Asset managers … which are the custodians of millions of rollover IRAs, believe that most people will consolidate their tax-deferred savings in an IRAs and then buy an annuity—or simply take systematic withdrawals. Investment advisors think along the same lines, and millions of Americans are likely to take this path.
Even if you build in-plan annuities, will they come? There’s a lot of disagreement over whether Americans want in-plan annuity options. Even in DB plans, 90% of retirees who have the option choose lump sum payouts over lifetime income streams. Shlomo Benartzi of UCLA, and an Allianz Life consultant, cited evidence of high annuitization rates in some companies, and MetLife said participants like a partial annuitization option. But the evidence is inconsistent. Most people don’t want to give up control over their assets or even part of their assets, especially not at time they stop working, when their retirement plans are still unsettled.
There’s also the crowding-out problem. Thanks to Social Security, most middle-class plan participants will get at least half of their retirement income coming from an annuity, and have no compelling reason to annuitize their DC savings. On the contrary, they may need their DC assets to stay liquid for emergencies, bequests, weddings or simply long-deferred pleasures.
To overcome this resistance or inertia, some witnesses said, the government might have to approve a qualified default annuity option, analogous to auto-enrollment and the qualified default investment options in 401(k) plans. One witness, Josh Shapiro of the National Coordinating Committee for Multiemployer Plans, asserted that nothing short of mandatory annuitization of DC assets at retirement will really change the game. The DoL and Treasury, as well as sponsors and plan providers, have already ruled that out.
© 2010 RIJ Publishing LLC. All rights reserved.

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PSNC 2010 Benchmarking Fee Data Still a Challenge

August 3, 2010 (PLANSPONSOR.com) – While benchmarking your plan fees may be considered a basic part of carrying out your fiduciary responsibilities, it can be a bit easier said than done because of a shortage of strong plan fee databases.

That was one conclusion of a fee disclosure panel discussion at the recent PLANSPONSOR National Conference held in Chicago.
Panel members told attendees that comparing plan fees to their peers' plans can be helpful in determining whether such expenses are “reasonable” under the Employee Retirement Income Security Act (ERISA), but that the process depends on having a reliable database to use in the comparison.
Jennifer Flodin, Chief Operating Officer and Co-Founder Plan Sponsor Advisors, said the continuing issue of whether plan sponsors understand the nuances of plan fees means some will give bad answers to polls used to build the benchmarking databases.
“Eventually there will be better sources of information, but right now it’s a bit mystical,” agreed fellow panelist Stace A. Hilbrant, Managing Director 401k Advisors, LLC.
Stephanie Napier, Vice President & Senior Trust Counsel, Marshall & IIsley Trust Company, said the Form 5500 was originally intended to provide benchmarking data but that the business has gotten so complex that the form hasn’t lived up to its potential.
When it comes to revenue sharing, Hilbrant said for a sponsor or adviser to ask about the fees was considered extremely unusual at one point. “The business is coming full circle: what used to be a crazy question (about revenue sharing) is now part of the new (fee disclosure) legislation,” he said.
Panel moderator James E. Graham, partner, CapTrust Advisors, said particularly disclosing revenue sharing information could generate more than its share of problems. “I shudder to think about giving revenue sharing information to participants,” Graham said. “It’s like giving car keys and whiskey to teenage boys. It’s just not a good thing.”
Graham added: “They’re going to get all this information they don’t want and they don’t understand and they are going to make even worse decisions than they are now."
A sponsor who runs into problems getting revenue sharing data should consider it a bad sign of things to come. “You need know what they’re earning and what is being generated by the investments in your plan,” Flodin declared.
While the panelists agreed that the notion of further educating participants about fees was a good idea in concept, several expressed reservations about how it will play out.
“From a consultant perspective, we think it’s a step in the right direction to get everybody on the same page about what are the fees, who’s getting what, where do the revenue streams go?” Flodin said.”(But) it’s far from perfect. There are a lot of things we think are going to be missed on this (required fee disclosure) document.  While it helps with disclosure, at the end of the day, how is this information going to be utilized? We don’t think it’s been thought through about what everybody is going to do with this document now that everyone is required to report.”
Hilbrant added: “That the different governmental entities are not in lockstep about what the end point is going to look like is even more frightening.  If you’re a plan sponsor who doesn’t like to talk about these details and just meet with the vendor every once in a while to discuss how the investments are performing, this is going to be a big deal.”
The audio from the conference session is at http://www.plansponsor.com/MmediaContent.aspx?id=6442472847.
Fred Schneyer
editors@plansponsor.com

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Tips for Documenting the Selection and Monitoring of Your Advisers

Reish & Reicher

By Jason Roberts (July 2010)

…[While] most [plan sponsors] go to great lengths to establish procedures to select and monitor plan investment options, many do not have adequate processes or documentation regarding the selection and monitoring of consultants or advisers that often assist the plan fiduciaries in investment-related matters.
Fiduciaries of employee benefit plans are charged with carrying out their duties prudently and solely in the interest of participants and beneficiaries of the plan and are subject to personal liability to, among other things, make good any losses to the plan resulting from a breach of their fiduciary duties. In selecting service providers, the responsible plan fiduciary must engage in an objective process designed to elicit information necessary to 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. In addition, this process should be designed to avoid self-dealing, conflicts of interest or other improper influence. The following steps are designed to assist fiduciaries in evaluating the adviser and the services to be provided.
Step 1: Evaluate the credentials of the adviser and his or her experience with servicing employee benefit plans, the services to be provided and the fees to be charged.

• You should also consider obtaining competing bids from other providers offering equivalent services and document the basis upon which you have selected your adviser, including any relevant industry experience and/or retirement-specific designation(s).

Step 2: Evaluate any potential conflicts of interest and the adviser’s policies and procedures designed to address those conflicts.

• The SEC has warned that “business alliances” among pension consultants and money managers can give rise to serious potential conflicts of interest under the Advisers Act that need to be monitored and disclosed to plan fiduciaries.

Step 3: Periodically review the performance of your service providers to ensure that they are providing the services in a manner and at a cost consistent with the agreements.
Step 4: Review plan participant comments or any complaints about the services and periodically ask whether there have been any changes in the information you received from the service provider prior to hiring (e.g. does the provider continue to maintain any required state or federal licenses).
Step 5: Prepare a written record of the process you followed in reviewing potential service providers and the reasons for your selection of a particular provider.

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Any U.S. federal income tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.

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© 2010 Reish & Reicher, A Professional Corporation. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish & Reicher does not warrant and is not responsible for errors or omissions in the content of this report.

DoL Claims No Safe Harbor in Fiduciary Breach Case

PLANSPONSOR.com

May 6, 2010 (PLANSPONSOR.com) –

Secretary of Labor Hilda L. Solis has warned a federal appellate court that protections for plan participants could be harmed if it does not overturn a lower court ruling giving a directed trustee safe harbor protection against wrongdoing allegations.

Solis issued the warning in a friend of the court brief filed with the 6^th U.S. Circuit Court of Appeals in Tullis v. UMB Bank, in which Solis argued that the lower court misread the safe harbor clause in the Employee Retirement Income Security Act (ERISA). The 404(c) provision was never intended to remove all legal liability from a fiduciary against the impact of their own failures in carrying out their plan duties, Solis contended in the brief. …

Solis asserted that the 404(c) safe harbor defense applies only where a participant exercises control over his or her investments and the loss caused by imprudent conduct “results from” such exercise of control, which was not true in the current case.

Physicians David H. Tullis and Michael S. Mack participated in the Toledo Clinic Employees' 401(k) Profit Sharing Plan. In the early 1990s, Tullis and Mack chose William Davis of Continental Capital Corp. as their investment adviser (see Case Sensitive:Shield Law).

In 1999, the Securities and Exchange Commission (SEC) entered a temporary restraining order against Continental Capital because two of its brokers were engaged in fraudulent activities. Tullis and Mack alleged that the plan's trustee, UMB Bank, knew of this fraud, yet failed to inform them of it.

In 2001, UMB Bank filed a lawsuit against Davis and Continental Capital on behalf of the plan alleging that several investments made by David and Continental Capital were improper or simply never took place. Tullis and Mack asserted that UMB, even after filing the lawsuit, never informed them of the fraudulent activities.

Tullis alleged that as of February 2003, UMB had represented that his plan account was $724,561, when in fact it was only $142,269. Mack asserted that UMB represented that his account was valued at $1.6 million when it was worth only $420,794.

Also included in the DoL brief was an argument that the losses stemming from UMB's actions resulted from UMB's breaches of its ERISA fiduciary duties. …

The DoL brief is available at http://www.dol.gov/sol/media/briefs/tullis(A)-04-15-2010.htm.

Fred Schneyer editors@plansponsor.com

Negotiation the fiduciary delegation minefield

PLANSPONSOR.com

ERISA requires every employee benefit plan to [have] a “named fiduciary.” The named fiduciary—typically a fiduciary committee or board of trustees—is the person or entity that has the ultimate authority to control and manage the operation and administration of the plan.

…ERISA permits named fiduciaries to delegate responsibility for managing plan assets to an investment manager. … Where an investment manager is properly appointed under ERISA, a plan’s named fiduciary will not be liable for the investment manager’s day-to-day management of plan assets, resulting in protection for the named fiduciary. In order to be appointed properly, an investment manager must acknowledge in writing that it is a fiduciary with respect to the plan. The named fiduciary’s only responsibility is to select the investment manager prudently and to monitor the investment manager’s performance periodically to determine whether continuing to retain the investment manager is prudent.

Investment Manager Responsibilities Investment managers have traditionally taken full responsibility for the portfolio of assets they are appointed to manage … . However, as investment managers increasingly have begun to implement more-complex investment strategies, … managers frequently are requesting that named fiduciaries execute ancillary documentation with third-party service providers to facilitate the investment managers’ services.

For example, we recently encountered several instances where an investment manager asked plan fiduciaries to execute a contract with a third-party futures commission merchant to facilitate the investment manager’s use of futures in the portfolio it managed on behalf of the plan. … However, the named fiduciary did not have the expertise to determine whether the terms of the contract were appropriate for the plan or whether the futures commission merchant selected by the investment manager was a good choice … .

When confronted with this kind of situation, named fiduciaries ought to consider whether, by signing ancillary contracts, they potentially are taking on additional liability for the responsibilities they previously delegated to an investment manager. In the previous example, a named fiduciary who signed the contract with the futures commission merchant could later be deemed responsible for the terms of the contract and for the selection of the particular futures commission merchant. …

Strategies for Plan Fiduciaries Several options may be available for named fiduciaries in this situation. Named fiduciaries, … may wish to retain an experienced investment professional to whom they can delegate this authority. In addition, the plan’s directed trustee may have negotiated agreements with providers like futures commission merchants, and may be willing to take direction from the investment manager to execute such agreements on behalf of the plan.

Regardless of the approach selected, named fiduciaries ought to be aware that they may be subjecting themselves to potential liability when they execute ancillary documentation at the request of investment managers.

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Stephen M. Saxon is a Partner with the Washington-based Groom Law Group. Groom is one of the preeminent employee ­benefits firms in the country. Steve and his colleagues have worked on virtually every major legislative and regulatory initiative affecting employee benefits since the enactment of ERISA.

Indemnification Garrotte

PLANSPONSOR.com

Are you indemnified for a fiduciary breach? 
…The beginning of the year is a good time to examine or assess your indemnification and insurance coverage. It … appears that the position recently taken by the Labor Department … has put into question the ability of plans … to indemnify plan fiduciaries in instances where there has been an allegation of fiduciary breach. …
In one recent 9th Circuit decision, the court actually admitted that prohibiting the advancement of attorneys’ fees created difficult hardships for fiduciaries who are trying to defend themselves. Nevertheless, the court concluded that advancement was precluded and the defendant trustees would have to fend for themselves. …
Moreover, it gets worse. We had always thought that, while the provision of indemnification by a plan is tricky, primarily because “plan assets” are being used to defend fiduciaries of plans, indemnification using corporate funds would not be subject to the same level of ERISA scrutiny. However, in some recent cases, courts have been willing to go much further and actually impose fiduciary responsibility on decisions not directly involving plan assets. In that 9th Circuit decision, which involved an ESOP, the appeals court said that, while decisions relating to corporate matters generally do not fall within ERISA’s purview, where an ESOP fiduciary also serves as a corporate officer or director, “imposing ERISA duties on business decisions” does not “seem unworkable.” …
In summary, I am worried that, in cases involving a Labor Department investigation and the like, the agency or plaintiffs around the country will now try to cut off the payment of legal fees for plan fiduciaries from a company’s assets because such payment would adversely affect, albeit indirectly, the financial strength of the plan. If other courts jump on this bandwagon, continued reliance on corporate indemnification by fiduciary members of plan boards of trustees or investment committees will be undermined.

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Stephen M. Saxon is a Partner with the Washington-based Groom Law Group. Groom is one of the preeminent employee ­benefits firms in the country. Steve and his colleagues have worked on virtually every major legislative and regulatory initiative affecting employee benefits since the enactment of ERISA.
PLANSPONSOR staff
editors@plansponsor.com

401(k) plans: Achieving the Lake Wobegon effect

Channeling the serene Minnesota town from

Employee Benefit Adviser
By Roger Levy
December 1, 2009
One might imagine in regard to the 401(k) plans found in Lake Wobegon that all the employers are models of fiduciary conduct, all investment expenses are low and all investment returns are above average. In the rest of the country, however, much work needs to be done to improve 401(k) investment performance.
This article suggests some alternatives consultants, 401(k) providers, employers and participants might consider…

Professional management

…What's really needed is a basic acknowledgment that participant-directed accounts don't work. The signs were there even before the market meltdown. …
While few investors survived 2008 unscathed, there is evidence to suggest that professionally managed pension investments fared better than investments that were participant-directed.
According to Milliman, investment returns within the largest 100 U.S. pension plans were -18.9% in 2008, compared to a -28.3% median rate of return in the same year for 401(k) plans, as reported by Hewitt, another pension consulting firm. …
… [These] statistics suggest that where investments are managed by investment professionals, … investment returns will be better. …
The solution to the problem is not to add more bells and whistles to what is an already overly complex employee benefit, but to take the investment decision out of the hands of plan participants and put it in the hands of professionals on a trustee-directed basis. This is perfectly permissible and, by following prudent investment practices, can be achieved without increasing the employer's fiduciary exposure.
First, the plan must be amended to make it trustee-directed. Then, the following steps should be taken:
* The employer appoints a trustee who will accept responsibility for investment direction. This could be a corporate trustee or members of management.
* The trustees(s) name the plan fiduciaries to manage the plan assets. The fiduciaries could be members of the investment committee that oversees the selection and monitoring of the plan's current participant-directed investment options.
* The investment committee adopts a new investment policy statement. This sets out the investment guidelines which will control how contributions are to be invested.
* The investment committee then selects an investment manager. Then it delegates to him or her the day-to-day management of the prudent investment of the plan assets according to the new investment policy statement.
As long as the manager to whom investment authority is delegated is a Registered Investment Advisor, bank or insurance company that acknowledges in writing its fiduciary status, the plan trustees and fiduciaries are relieved of their fiduciary responsibilities for managing the assets.
However, they remain responsible for prudently selecting managers, establishing appropriate investment guidelines and monitoring investment performance, just as they are for the participant-directed plan. …

Embrace annuities

Another alternative for employers who want to help participants protect themselves from large losses is to introduce annuities as an investment option within the plan.
Annuities provide a guaranteed rate of return and a guaranteed income upon retirement, which can increase under some annuities if market returns exceed the guaranteed floor.
However, annuities are a tax-deferred investment vehicle, and some see them as a bad idea because they potentially add cost.
…The answer is because of the guaranteed income and the potential to take full advantage of market upswings.
Also, today, a variety of annuity arrangements are emerging from reputable insurance companies which are not as costly as those of yesteryear, and improvements in recordkeeping and the design of annuity products is making them increasingly attractive as a 401(k) investment option. Such an option could be included in both a trustee-directed plan as well as one that is participant-directed. … info@cambridgegroup.net.

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Levy, LLM, AIFA, is CEO of Cambridge Fiduciary Services, LLC, a fiduciary adviser and audit firm with offices in Greenwich, Conn. and Scottsdale, Ariz. He can be reached at (480) 607-2608 or

Removal “Spot”: the duty to remove investments

PLANSPONSOR.com

It is commonly accepted that fiduci­aries of participant ‑ directed plans, such as 401(k) plans, have a duty to select, monitor, and remove investments prudently.
The threshold question is whether a fiduciary’s duty to remove investments applies to individual investments or whether the decisions are judged on the basis of the investments in the aggregate. The trial court in DeFelice v. US Airways, Inc., applied an aggregate test. …
The court was wrong. The duty of fiduciaries is to select, monitor, and remove individual investments prudently, in addition to considering the portfolio as a whole. …
The DoL made it clear in the preamble of a regulation that its view is that the prudent selection of investments incorporates both a consideration of the individual investments and the portfolio.

The regulation, however, is not intended to suggest either that any relevant or material attributes of a contemplated investment may properly be ignored or disregarded, or that a particular plan investment should be deemed to be prudent solely by reason of the propriety of the aggregate risk/return characteristics of the plan’s portfolio. Rather, it is the Department’s view that an investment reasonably designed—as part of the portfolio—to further the purposes of the plan, and that is made upon appropriate consideration of the surrounding facts and circumstances, should not be deemed to be imprudent merely because the investment, standing alone, would have, for example, a relatively high degree of risk.

… While participants can decide which of the offered investments to use, they cannot decide which investments are offered—that job belongs to the fiduciaries. In fulfilling that responsibility, ERISA requires, in effect, that the fiduciaries make a legal “promise” to the participants that each of the investment options is selected and monitored prudently (and removed, if it is no longer a prudent choice) and that the lineup of options offered to the participants is prudent in the aggregate.
Why is this the case? Unless a participant’s account is professionally managed, the participant must put together a portfolio in his account that is allocated among different categories of investments to create an appropriate blend of risk and return. If the investment choices are not prudent in the aggregate (for example, if the investments do not constitute a broad range that allows participants to balance risk and reward by selecting among them), the participants could not construct portfolios according to their needs. On the other hand, if some or even all of the investments were individually imprudent, then even a well-constructed portfolio would likely underperform. Thus, each investment must be prudent and suitable on a stand-alone basis, and the lineup of investments must be prudent in the aggregate. …
Returning to my earlier statement that “the court was wrong,” it was not as brazen as it may have seemed. The 4th Circuit Court of Appeals subsequently reversed the trial court saying:
“[A] fiduciary must initially determine, and continue to monitor, the prudence of each investment option available to plan participants.”

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Fred Reish is Managing Director and Partner of the Los Angeles-based law firm of Reish & Reicher. A nationally recognized expert in employee benefits law, he has ­written four books and many articles on ERISA, IRS and DoL audits, and pension plan disputes. Fred has been awarded the Institutional Investor Lifetime Achievement Award and PLANSPONSOR’s Lifetime Achievement Award. He is also one of the 15 individuals named by PLANSPONSOR magazine as “Legends of the Retirement Industry.”
PLANSPONSOR staff
editors@plansponsor.com

The four stages of an annual review

A top-down approach to assembling, analyzing and acting on portfolio data is advisable

Investment News
By Blaine F. Aikin
December 6, 2009
As the year draws to a close, fiduciaries should be turning their attention to one of their most important responsibilities: the annual portfolio review. This is a prime event conducted in the process of fulfilling the continuing fiduciary duty to monitor. It is the time when the fiduciary undertakes a comprehensive assessment of whether the investment objectives of the investors they serve are being met.
Monitoring involves four stages: gathering material information, analyzing the implications of the information, acting appropriately on the findings of the analysis and documenting the basis for actions considered and actions taken. Effective monitoring hinges on deciding at the outset what information is relevant to determining whether the current portfolio management process is meeting investor objectives and is likely to continue to do so. A top-down approach is generally recommended to assemble, analyze and act upon this information.
Start by addressing what has changed at a level above portfolio composition and holdings. Most importantly, consider whether the investor's objectives have changed, in which case there is a direct effect on what information is material, as well as on the decisions that will bring the portfolio management process into alignment with the new objectives.
Change in laws or regulations, the economy and the financial markets is also relevant to most portfolios. For example, 22 states this year introduced or enacted the Uniform Prudent Management of Institutional Funds Act. This should be a major discussion topic in the annual portfolio review process of most endowments and foundations in those states.
Similarly, the implications of historically high unemployment, unprecedented government stimulus spending and extraordinary market volatility have profound implications for domestic investments. While no one can say with certainty the precise nature and magnitude of these implications, the annual review process should demonstrate thoughtful deliberations of these matters and how they influenced investment decisions.
Next, examine portfolio composition and asset allocation issues. Performance of the broad asset classes over the past year and longer time periods is generally the focus of attention, but unusual volatility within certain asset classes and apparent changes in the correlation among asset classes are important factors for analysis. Even if certain asset classes are not represented in the investment portfolio being reviewed, it is advisable to consider a wide range of accessible asset classes for potential introduction to the portfolio.
Simply by improving the asset allocation of the portfolio, it may be possible to achieve higher-than-expected returns for the level of risk the investors are prepared to take. To make this determination, Monte Carlo simulation, mean-variance or re-sampled efficiency optimization, or a comparable analytical tool may be applied. Model portfolios supported by sound research and analysis may serve as the basis for decision making.
For participant-directed plans, changes in the available asset classes may be warranted, based upon findings from this stage of review.
If tactical asset allocation (a form of market timing) is employed in managing the portfolio, the value added by asset allocation moves should be carefully analyzed at this stage. The value of this approach can be assessed by comparing the results of tactical decisions against what would have been achieved by using a strategic benchmark allocation.
Finally, revisit the due-diligence criteria used to select the specific investments held in the portfolio and evaluate each position for shortfalls that may have developed. With respect to performance, each portfolio holding should be compared with an appropriate index and peer group benchmark. While manager performance is often the focus of attention during quarterly portfolio reviews, the annual review should be more comprehensive and balanced. In rough order of priority, an effective annual review process should result in sound decisions with respect to: current investor objectives and investment policy provisions, investment philosophy and strategy, asset allocation, re-balancing activities, and investment manager watch listing and replacement.
The annual review will be incomplete until the deliberations and decisions of the process have been recorded. These records help ensure that planned actions are taken and subsequent moves planned with the benefit of information previously considered, and demonstrate that a prudent process has been followed. That is especially important at a time such as the present, when an extraordinary investment environment lends itself to rampant second-guessing.
Blaine F. Aikin is chief executive of Fiduciary360 LLC.

The Plan Sponsor’s Ability to Evaluate Conflicts of Interest

Reish & Reicher

By Fred Reish and Joe Faucher

When making decisions about their retirement plans, plan sponsors have a duty to understand and evaluate conflicts of interest that could impact the plan. In some cases, plan sponsors are prohibited from entering into transactions that involve conflicts of interest.
Those conflicts fall into two broad categories. The first is where the plan sponsor has a conflict. The second is where a service provider has a conflict of interest.
On the former, a plan sponsor must put the interest of the participants ahead of its own when making decisions about retirement plans. For example, if a bank told a plan sponsor that it would get a lower interest rate on its corporate loans, or a larger extension of credit if the administration of the plan was placed with the bank, the plan sponsor would have a conflict in making that decision. That is because, from a corporate perspective, it would be in the plan sponsor’s benefit to get the better loan. However, from a retirement plan perspective, it may or may not be in the best interest of the participants. But, in this case, the plan sponsor cannot avoid the conflict simply based on the quality of the bank’s 401(k) services. That is because ERISA strictly prohibits the plan sponsor from gaining any advantage from its use of plan assets. Even if the arrangement is favorable to the employees, it is strictly prohibited by ERISA.
Some conflicts are not prohibited by law, but even then, a plan sponsor must evaluate the conflict and act in the best interest of the participants. …
The balance of this article is about the second type of conflicts – those involving service providers.
So that you fully appreciate the legal responsibility, let’s look at what the DOL says:

With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence.

That is a difficult job because, while the provider knows about its conflicts, a plan sponsor may not. So, the starting point is for the plan sponsor to ask the provider to describe, in writing, all materials conflicts of interest that could impact the plan and/or the participants. …
What are material conflicts of interest? Typically, but not always, a material conflict involves money. For example, is your adviser receiving money from one of the providers or from the investments? If so, that creates a conflict where the adviser may favor the provider or the investment over the plan and the participants. It doesn’t mean that the adviser will make biased decisions (and, in our experience, most do not), but it does mean that there is the potential for a biased decision. …

…[If] your provider refuses to give you the information (but you want to continue to work with that provider), you have a fiduciary duty to investigate in order to determine whether there are any conflicts. Among other things, that means that you need to carefully read all of the materials that the provider gives you—and you should probably have your ERISA attorney review those materials and advise you on potential conflicts as well. …

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Any U.S. federal income tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.

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© 2009 Reish & Reicher, A Professional Corporation. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish & Reicher does not warrant and is not responsible for errors or omissions in the content of this report.

The Different Flavors of ERISA Fiduciaries

Morningstar Advisor

by W. Scott Simon  | 12-03-09

…The significance of the added protection afforded a plan sponsor when it utilizes the services of an advisor serving as a fiduciary under section 3(38) of the Employee Retirement Income Security Act of 1974 as opposed to an advisor serving as an ERISA section 3(21) fiduciary

ERISA Selection, Monitoring, and Replacing Functions
…A critical duty is the sponsor's legal responsibility (and therefore legal liability) to select, monitor, and (if necessary) replace the plan's investment options. This duty is so central to any ERISA-qualified retirement plan that its breach is often pleaded in the recent cases filed against plan sponsors involving plan investment options bearing costs that are not reasonable. … The appropriate fiduciary of a plan must (affirmatively) find costs to be reasonable in order to justify their expenditure for the corresponding services rendered. …

An ERISA Section 3(38) Fiduciary
ERISA provides that a plan sponsor can delegate the significant responsibility (and therefore significant liability) of the selection/monitoring/replacing functions to an ERISA section 3(38)-defined "investment manager" who, upon delegation, then becomes an ERISA section 405(d)(1)-defined "independent fiduciary." An ERISA section 3(38) fiduciary can only be (a) a bank, (b) an insurance company or (c) a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940. This means that a stand-alone broker-dealer, for example, cannot be an ERISA section 3(38) fiduciary. …

An ERISA 3(38) fiduciary has ERISA legally defined "discretion" that makes it a decision-maker. This means that a 3(38) fiduciary actually makes decisions for which it is legally culpable (and for which the plan sponsor is no longer legally culpable). An ERISA 3(38) fiduciary decides what investment options such as stand-alone mutual funds or model portfolios should be placed on a plan's menu, whether to remove them from the menu and, if it does remove them, what investment options will replace them. …

An ERISA Section 3(21) Fiduciary
In sharp contrast to the legally culpable, discretionary decisions made by an ERISA section 3(38) fiduciary are the legally blameless, nondiscretionary recommendations made by an ERISA section 3(21) fiduciary. To the extent that an advisor is even named as any kind of fiduciary in an investment management agreement between a plan sponsor and an advisor, in most cases the advisor is an ERISA 3(21) fiduciary tasked with "recommending," "assisting," "helping," or "advising" the sponsor as the sponsor itself goes about making selection/monitoring/replacement decisions.

Such contracts make clear that an advisor who is a 3(21) has no legally defined "discretion" to actually make decisions about plan investment options but only to be a helpful gnome to the plan sponsor who continues to retain the significant responsibility (and therefore the significant liability) to select, monitor and (if necessary) replace plan investment options. …

In many agreements, of course, the advisor is not even named as a fiduciary and its roles are simply described as "assisting," the plan sponsor in making investment option selections (for which the sponsor is legally responsible and liable).

Summing UpIn a nutshell, here is the difference between ERISA section 3(38) fiduciaries and ERISA section 3(21) fiduciaries:

* An ERISA section 3(38) fiduciary must make decisions for which it has legal responsibility (and therefore legal liability), because such a fiduciary is charged with ERISA-defined "discretion." … This gives a plan sponsor significant cover from fiduciary risk.

* An ERISA section 3(21) fiduciary makes only recommendations for which it has no legal responsibility (and therefore no legal liability), because such a fiduciary has no ERISA-defined "discretion." This does not give plan sponsors cover from fiduciary risk.

An Important Caveat
It's important to understand that the part of the preceding discussion referring to an ERISA section 3(21) fiduciary concerns what can be described as a "limited scope" 3(21). …
Distinct from a limited-scope 3(21) fiduciary (the kind which is almost always discussed in the investment media) is what can be described as a "full scope" ERISA section 3(21) fiduciary. The full scope 3(21) is the "named fiduciary" of a plan; that is, the person who has ultimate authority over a plan. All qualified retirement plans governed by ERISA have a named fiduciary, and that person is always a 3(21) fiduciary, representing the plan sponsor. The plan sponsor, as the originating full scope 3(21) fiduciary of the plan, can delegate all the duties associated with same to an entity that will assume them. …