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201205211604010400

Fiduciary Links: Be ready to be the chosen advisor

By fi360 Team

“How to choose an investment advisor.” In the course of monitoring the media for relevant articles, we come across some iteration of this headline on a nearly weekly basis. Just this past week, it was a personal finance columnist from Reuters letting her readers know what they should be on the lookout for as they vet candidates for help with managing their investments. Just try doing a search at your favorite consumer news or finance site. You are bound to find multiple results among the archives with words of wisdom for the advice-shopping investor.

While the lists of questions to ask an advisor are usually pretty good, they typically aren’t that different from one another, especially now in the volatile, post-Madoff era. But despite not offering much unique in terms of content, these articles continue to be written over and over again. The reason for this is presumably because they are being read. A look at Google's search statistics confirms that the cumulative total of the various iterations of “how to choose a financial advisor” that are being searched online reaches well into the tens of thousands each month.

Knowing both that investors are doing their homework before beginning their search and that the advice is rather ubiquitous, you can put together a pretty consistent picture of the questions a potential client might ask:

  • Is the advisor operating under a fiduciary standard of care?
  • How is the advisor compensated?
  • What is the advisor’s educational background, including industry credentials?
  • What does the advisor's disciplinary history from regulators or industry organizations look like?
  • Does the advisor specialize in or otherwise have experience with clients who are similar to me?
  • What’s the advisor's strategy?
  • How do I “connect” with the advisor and does he or she seem trustworthy?

Armed with that knowledge, there are a number of steps advisors can be taking to prepare themselves to win new business.

Now on to the rest of the best links from the past week:

In the news: 

From the blogs:

From the organizations/associations/government/academia:

Articles your clients are reading (or should be):

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

201205171319550400

Excerpts from the recent participant disclosure bulletin

By Rich Lynch

Last week the Department of Labor issued further guidance about the requirements of the new 404(a)(5) participant disclosure rule.  Field Assistance Bulletin No. 2012-02 provided this guidance in the form of questions and answers that is very helpful.

The bulletin is worth the read for anyone involved with the management or administration of participant-directed retirement plans.  Some highlights:

  • The regulation applies only to tax-sheltered annuity programs under section 403(b) of the Internal Revenue Code ("403(b) plans") that are ERISA-covered plans.  (Q-2 in the bulletin)
  • It explains the difference between a "designated investment alternative" and a "designated investment manager."  (Q-4)
  • It reinforces the general point that disclosure is required for any fees and expenses for general plan administrative services (e.g., legal, accounting, recordkeeping), which may be charged against the individual accounts of participants and beneficiaries and are not reflected in the total annual operating expenses of any designated investment alternative.  (Q-7 - Q-9)
  • It addresses the disclosure of investment-related information online.  (Q17 - Q-19)
  • It discusses how one should consolidate investment-related information that is supplied from the plan's various service providers or investment issuers.  (Q-21 - Q-24)
  • It explains that a model portfolio ordinarily is not required to be treated as a designated investment alternative under the regulation if it is clearly presented to the participants and beneficiaries as merely a means of allocating account assets among specific designated investment alternatives.  (Q-28)
  • It provides a very interesting discussion of self-directed brokerage windows (or similar arrangements), how they relate to designated investment alternatives, concerns about failure to designate a manageable number of investment alternatives, and what if the number of designated investment alternatives exceeds twenty-five.  (Q-30)

Fiduciaries of all flavors (advisors, managers, and stewards) are concerned about the looming deadlines [July 1 for 408(b)(2) and August 30 for 404(a)(5)] for the new plan and participant disclosure regulations.  In the case of participant disclosure, most plan sponsors will look to the professionals (the recordkeeper in most cases) for help.  Those involved should digest the contents of DOL's bulletin and seek answers to additional questions they may have from peers, legal counsel, and/or the DOL.  CEFEX has also added a separate schedule to their assessment methodology that will determine whether plan sponsors are meeting the requirements of the 404(a)(5) regulation.  In short, there are numerous resources available to help with the transition to these new requirements.

201205141332420400

Fiduciary Links:The future on the minds of both advisors and their regulators

By fi360 Team

In a nice symmetry, “the future” was a featured talking point in both dialogues about the advisory business and as part of the ongoing discussion of who will be regulating that business.

>>>>At the FPA Retreat in Scottsdale last week, Darla Sipolt, vice president of sales at TD Ameritrade, discussed the potential of the X and Y Generations, which are currently coming of age as investors and will soon begin to experience vast transfers of wealth from their Boomer parents.  To prepare for and capitalize on that opportunity, Dipolt recommended hiring young advisors from the same generation as a way of helping establish relationships with clients that are based on common perspective. Citing survey results, Dipolt recommended using electronic communications and social media as a way out reaching out to younger investors.

These sentiments were also echoed by TD Ameritrade Institutional President Tom Nally at NAPFA’s national conference, also last week. He advocated the hiring of young advisors not only for the benefit of reaching new audiences, but also as a means of succession planning, saying “Wouldn’t you rather leave your clients in the hands of someone you trained yourself?”

>>>>Also at FPA, prominent blogger Michael Kitces focused on how technology will continue to evolve the nature of advisory relationships, again, particularly as it pertains to younger investors. Unsurprisingly, this led to some push back as Kitces’s comments were taken as a prediction of the end of the human advisor. Kitces added further comment on his own blog this morning, explaining that while he sees technology changing the way we receive advice, human nature won’t ever allow for a complete divorce from planners.

>>>>While advisors are already contemplating their future with new technology and the next generation of investors, Wall Street Journalist columnist Jason Zweig commented on how regulators have so far failed to consider technology enough in their oversight role. With inadequate frequency of examinations and cost playing a central role in the entire SRO debate, it only makes sense that technology solutions factor into the conversation. Zweig quotes a number of sources on their thoughts as to how technology can be used to verify transactional and performance data and how the SEC is already using technology to identify hedge funds that warrant closer examination.

Now on to the rest of the best links from the past week:

In the news: 

From the blogs:

From the organizations/associations/government/academia:

Articles your clients are reading (or should be):

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

201205071134040400

Fiduciary Links: 408(b)(2) Rules are Really about Plan Sponsor Fiduciary Obligations

By fi360 Team

While much of the coverage on new ERISA fee disclosure rules, including coming from us, has understandably been focused on compliance measures for advisors, it is important to remember the reason for these rules in the first place. They are designed to help and set minimum standards for and help plan sponsors perform required due diligence in selecting service providers.

ERISA requires that contracts and fees between a plan and a service provider be “reasonable” and “necessary.” While DOL’s stated view has been that, “In choosing among potential service providers, as well as in monitoring and deciding whether to retain a service provider, the trustees must objectively assess the qualifications of the service provider, the quality of the work product, and the reasonableness of the fees charged in light of the services provided,” little definition has been given as to what constitutes “reasonable” and “necessary.” That is, until now.

As Blaine writes in his latest Fiduciary Corner column, the new rules clarify that a plan sponsor’s due diligence process will be deemed inadequate and unreasonable if specific information about the services, compensation arrangements, and fiduciary status of the service provider are not obtained and evaluated. This, of course, opens up both the service providers and plans themselves to additional scrutiny and liability.

Blaine uses the recent Tussey v. ABB, Inc. court decision to illustrate the severe consequences that both the plan sponsor and service providers face if a prudent due diligence process isn’t followed. The failure to monitor costs, conflicts of interest between plan services and corporate services, and exclusive benefit violations were all cited in the decision that favored the plaintiff and are all examples of the types of problem 408(b)(2) is designed to address. (The case also demonstrates how important it is to follow the plan’s investment policy statement.)

For additional discussion on this topic, join us this Wednesday for a webinar with the Global Economic & Investment Analytics website, where Blaine will be discussing the new DOL disclosure rules, due diligence requirements, and how they affect advisors, plan sponsors, and participants.

Now on to the rest of the best links from the past week:

In the news: 

From the blogs:

From the organizations/associations/government/academia: 

Articles your clients are reading (or should be):

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

201205031613120400

SRO Proposal Leaves Fiduciary Status in Limbo

By Bennett Aikin

 Shortly after Congress passed the Maloney Act of 1938, SEC Commissioner George Mathews met at the Greenbrier Hotel in White Sulphur Springs, West Virginia, before an uneasy convention of investment bankers.  He was before them, as he had been the previous year, to discuss how broker-dealers would be regulated in the post-Depression world.

Mathews reminded the group that there had been “continuing consultation for four years” between the industry and SEC regarding a “cooperative scheme of regulation.”  In his opening remarks he stressed that “such cooperation is well-nigh indispensable if we are both promptly and effectively to unite the technical skill and experience of the industry with the strength and prestige of Government.” 

The self-regulatory organization born from those discussions  was the National Association of Securities Dealers.  Today it is largely the same industry-driven organization, but with a more broadly descriptive moniker, the Financial Industry Regulatory Authority.  FINRA is now the only SRO registered under the Maloney Act, although now the organization would like to see history repeat itself in the form of a sister SRO for investment advisors.

The comity displayed in years past is nowhere evident today.  In particular, the legislative vehicle that would create the new SRO, H.R. 4624, or the Investment Adviser Oversight Act of 2012, introduced on April 25, 2012, was received with a cold reception by independent advisors. 

The framework of an SRO under the Maloney Act  in its current legislative construction is designed to allow for flexibility in setting rules and responding to industry developments in the marketplace. 

In a perfect world, and reading the bill’s provisions in that unlikely context, H.R. 4624 could readily adapt existing SEC rules under the Investment Advisers Act of 1940.  At the same time, it could simply accelerate the examination cycle for advisors from 11 to four years, which on its surface, is the crux of the current debate.  In fact, an SRO would not be needed for the latter purpose, just legislative authority for the SEC to outsource.

In a worst-case scenario, which is far more likely under H.R. 4624, a FINRA clone is created, one that is rules-intensive and, along with incumbent costs and other inefficiencies that reduce attention to client needs,  may ultimately create winners and losers under the advisor business model.  Yet, even before reaching this stark conclusion, in just scanning the 38 pages of H.R. 4624 it becomes painfully obvious that the proposal is designed for an intensive rules-based regimen.  The term “fiduciary standard” is mentioned only once in the bill, while the words “rule,” “rules” and “rulemakings” associated with the SRO are inscribed throughout no less than 73 times.

Summary Highlights

Specific provisions of the bill (See fi360 Executive Summary for additional details) shed further light on future regulation of investment advisors for the near- and long-term. 

  • SRO applicants must have the “capacity,” meaning resources, to carry out and enforce compliance with the rules of the association, and be approved by the SEC.  This may effectively prohibit start-ups like SROIIA.
  • Industry participants, including members of FINRA,  would be barred from serving on an SRO board of directors.
  • Most retail investment advisors, both SEC and state-registered, would be required to register.
  • Most pooled fund advisors -- mutual, hedge and private equity -- would be exempt.
  • States would continue to retain authority to register, regulate  and take enforcement action against state RIAs.
  • The adviser SRO would not conduct examinations in states where the securities commissioners conduct on-site inspections once every four years, on average.
  • The adviser SRO would stage an annual conference with the states and SEC to review the viability of state examination programs and submit an annual report card to Congress.
  • Notwithstanding state inspections, the adviser SRO would be able to conduct ‘for cause’ inspections of state RIAs as well as periodic inspections of dually registered broker-dealer RIAs.
  • If more than one adviser SRO were in place, advisers would only have to be a member of one.
  • Each adviser SRO, however, would be required to maintain “substantively equivalent regulation” of advisory firms, including their “business conduct requirements and examinations.”
  • A mandatory cost-benefit analysis of new SRO rules, while receiving significant emphasis in Congress for Dodd-Frank agency rulemakings, would not be required for adviser SROs.

Legislative Prospects

The bill is controversial enough that it may take several years or longer to pass Congress, even if the Senate and House are controlled by Republicans after the November election.  While it has a good chance of passing the Republic-controlled House this year, it is unlikely to be taken up by the Democratic-controlled Senate.  It would then have to start from scratch in the 113th Congress next year. 

Even if Republicans control both Houses next year, without a commanding 60-vote majority in the Senate, which is unlikely, Democratic opponents may be able to successfully oppose passage.  The question is whether industry opponents will be able to recruit a champion or champions on Senate Banking committee with enough clout to block it.

Assuming the bill does eventually become law in its present form, given the notable absence of any attention to fiduciary breaches in FINRA enforcement cases, it is hard to imagine that the spin-off SRO affiliated with FINRA would have an institutional preference for principles-based regulation.

Near-Term Impact on Advisors

Advisors accustomed to a mix of disclosure rules, recordkeeping requirements, and others under the ’40 Act would be in for a rude shock when many operational activities that they once took for granted – client communications, outside business activities, and marketing – may abruptly have to be reviewed first by the new SRO.  Major events such as the 2008 financial crisis might impede urgent client communications, except on a one-on-one basis, at a critical time.  Ironically, a flood of new rules could indirectly discourage adherence to a duty of care, under which a fiduciary culture of ongoing client communications are regularly performed.

FINRA examiners transferring to work in the new adviser SRO may bring old habits with them, including a misunderstanding of investment strategies applied by fiduciary advisors.  At fi360’s recent annual meeting, two attendees mentioned to me problems with allegations of reverse churning in their client portfolios during recent inspections.  The examiners raised questions as to whether a commission account might save their clients more money, and apparently failing to appreciate that a conservative buy–and-hold investment strategy with quarterly rebalancing was not “reverse churning” and in fact consistent with Modern Portfolio Theory.  And these questions came from SEC and state examiners.  Imagine how much more difficult it would be explaining this to examiners accustomed to reviewing only commission accounts.

Finally, state-registered investment advisers would face compliance with two sets of rules – one administered by their state securities commissioner and one by the advisor SRO.  Additionally, for those affiliated with a broker-dealer, they would also face the potential for separate inspections by each regulator if uncoordinated.

Long-Term Impact

The costs for registration and other user fees, including examinations, could be staggering over the long-term for small advisory firms.  Although the estimated cost for advisors has been hotly debated, it is expected to increase significantly with estimates ranging into mid-five figures annually.

Such compliance costs could indeed change the face of the advisory profession from one of boutique shops and one or two principals to buy-outs and mergers.  Thus, where we currently see about 4,400 brokerage firms and 162,000 branch offices overseen by FINRA, the new advisor SRO could ultimately oversee thousands of financial planning branch offices – each one formerly an independent advisory firm – and now part of regional advisor firms or independent broker-dealers as part of the new normal.

Unable to absorb the new compliance costs internally, even with mergers, most costs would be passed on to consumers and thus, ironically, leading to an undesirable outcome that broker-dealer opponents of a fiduciary standard predict would occur if a higher standard were imposed, not an SRO.  The FINRA proxy, then, may create the worse of both worlds: reducing the number of advisors in the marketplace, increasing costs for consumers, and reducing the existing fiduciary standard to cookie-cutter rules.

Even if the SEC did approve a second SRO for small investment advisors, H.R. 4624 appears to dampen any efforts to depart from the rules regime by promoting strong fiduciary principles.  Each SRO, according to the bill language, shall provide for “substantively equivalent regulation and oversight of advisory firms, including their business conduct requirements and examinations.”  Whether “substantively equivalent” allows leeway in promoting higher standards is anyone’s guess.

Conclusion

Although history may repeat itself with the creation of another SRO in the wake of a market crisis, industry views and political dynamics have clearly changed since the Great Depression.  Congress and the SEC, which Commissioner Mathews characterized as having “strength and prestige,” is diminished today in the wake of the Ponzi scandals that tarnished the SEC’s reputation and the record low favorability ratings of Congress due to political gridlock.  Moreover, even though the lines between brokerage and advisory services continue to blur in the marketplace, the initial reaction to H.R. 4624 has been crystallized along those same lines.

History does not record the response of the investment bankers to Commissioner Mathews speech in 1938.  However, it’s clear that the indispensable need for a public-private partnership that he called for  nearly three-quarters of a century ago no longer exists today.  While FINRA Chairman and CEO Rick Ketchum conducted a fairly extensive outreach program with advisor groups recently, the increasing intensity of the debate has led to a hardening of positions and less interaction between the two camps.

By most accounts, the current dialogue is nothing compared to the four years of deep conversations recounted by Commissioner Mathews.  And with today’s securities industry hopelessly at odds, the end-product may be an SRO built on division, not consensus.

201204301650290400

Fiduciary Links: Dispatches from the fi360 Conference

By fi360 Team

 >>>>Last week was the center of the fiduciary universe was in Chicago, as many of the leading fiduciary thinkers, practitioners, and advocates gather for the eighth annual fi360 Conference. We already shared with you last week some of the big announcements we made on the opening day of the conference (if you’ve already looked at that post, make sure you check again as we’ve made some updates and additions). Today we want to share with you recaps of our three general sessions:

Blaine Aikin: As happens each year, we begin the first day of content with opening remarks from our CEO. Those remarks serve as a State of the Fiduciary Landscape address. Blaine began by highlighting unmistakable evidence that the market wants more fiduciary advisors and that the competitive landscape is responding to that demand with more advisors moving to fee-based advisory models over commissions.

While seeing the market drive change is always an encouraging sign, Blaine called on the audience to continue their work advancing a fiduciary culture, saying that it is fiduciaries who should lead an “occupy” movement in the following areas of influence:

  • On Wall Street, professionals should 1) adopt a fiduciary ethics, whether or not there is a regulatory imperative to do so; 2) recognize their responsibilities to clients, their profession, capitalism, and society; and 3) lead, not obstruct, reform.
  • On corporate boards, stewards should 1) commit to understanding and meeting their fiduciary responsibilities; 2) act in the best interests of invests; 3) recognize their key role in preserving the integrity of capitalism; and 4) take special pride in fiduciary excellence.
  • Those serving in elected offices should 1) perform due diligence on the issues; 2) avoid conflicts of interest; 3) understand and adhere to their fiduciary responsibilities to serve the best interests of the American citizens; and 4) use their position to focus and civilize political discourse.

If the best in our profession and audience continue to advance this message and seek to instill these virtues, we can continue to affect change with much greater efficiency and effectiveness than regulation ever could.

Justin Fox: The opening day keynote speaker was Justin Fox, who is the author of The Myth of the Rational Market and is the editorial director of the Harvard Business Review Group. You can learn more about Justin on his website and highly recommend you check out his HBR blog.

Justin's speech traced the evolution of thought regarding efficient markets, right up until the present day and what we should think now in light of what's happened over the past four years. In short, there are three lessons that have held true:

  1. It is hard to outsmart the market
  2. If you swing for the fences, sometimes you'll miss and sometimes you'll hit
  3. There is merit in diversification

There are also three efficient market tenants that have failed to hold true:

  1. ?The price is not always right and companies shouldn't necessarily do what markets tell them
  2. Financial markets are not inherently stable
  3. Risk cannot always be quantified, risk is not always equivalent to historic volatility and being a prudent man is more than following simple rules

Taken together, this leads us to three truths:

  1. Index funds work because fees are low and that puts you ahead at the start versus other investments.
  2. Diversification works when there is a good reason why it should work.
  3. Investing is always predicting, you just need to understand what it is that you're predicting

Doris Kearns Goodwin: For the second day’s general session, we did something a little different from past conferences by featuring a speaker from outside of the investment fiduciary realm. Doris Kearns Goodwin came to speak about leadership lessons from Abraham Lincoln, a speech that comes from her best-selling book Team of Rivals. While Ms. Goodwin’s remarks didn’t focus on industry expertise and were largely from 150-year-old history, her remarks nonetheless felt very relevant and timely.

Her account of how Lincoln incorporated his defeated rivals from the presidential election of 1860 into his cabinet spoke to how effective leaders are able to see past differences and personal history in order to find the best individuals for the job at hand. She broke down his skillful job of constructing his cabinet and managing the Civil War into the following leadership lessons:

  1. Listen to different points of view and let your advisors argue with you and question your assumptions until a decision is made, at which point the decision should be considered final.
  2. Learn on the job, acknowledge errors, and learn from mistakes.
  3. Share credit for successes.
  4. Shoulder the blame for the errors of subordinates.
  5. Be aware of your own weaknesses so that you are able to compensate for them.
  6. Control your emotions (Think: don’t send your angry email until you’ve given yourself time to cool down).
  7. Relax, replenish your energy, and shake off your anxieties.
  8. Don’t lost sight of your most important connections, to those you serve.
  9. Resolve to stick to your long-term goals regardless of circumstances.
  10. Strategically communicate your long-term goals.

Each of these lessons was illustrated by anecdotes from Lincoln’s presidency. She also spoke to the current political culture versus in past eras and how much of the partnership that once existed in American politics has seemingly dissipated. She described how both money and being in Washington creates a bubble around politicians that both prioritizes survival over service and dissuades many of our best potential candidates from deciding to become involved at all.

In addition to these three outstanding general sessions, this year’s agenda also featured 32 breakout sessions covering a wide array of topics, from the practical to the conceptual; for the professional advisor, the plan committee member, and everyone in between; coming from multiple points of view and for a multitude of business models and portfolio types. You can see overviews of each of this year’s sessions on our agenda page, as well as many of the presentation slides themselves.

If you have any questions or feedback about this year’s conference, make sure you let us know at resources@fi360.com. And while the fiduciary universe revolved around Chicago this weekend, it wasn’t the only relevant news, so on to the rest of this week’s best links:

In the news: 

From the blogs:

From the organizations/associations/government/academia: 

Articles your clients are reading (or should be):

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

201204262314060400

Announcements from the 2012 fi360 Conference

By Bennett Aikin

The first day of our 2012 conference is underway. The first thing we do at each conference (besides the first night's cocktail reception), is our annual State of fi360 and State of the Fiduciary Landscape opening remarks. Included in that is a number announcements that we also want to share with all of our followers who couldn't make this year's event:

  • The winner of our annual article competition was announced. Greg Kasten, who is also a speaker at this year's event, was honored for his article,  Creating Tangible Value in Your Fiduciary Practice: Combining Fiduciary Best Practices with Actuarial Implementation Can Consistently Improve 401(k) Participant Outcomes. He is the recipient of a $1,000 prize and will have his article published by AdvisorOne. Three other finalists will also have their articles published. You can see all submitted entries on our article competition page.
  • The Committee for the Fiduciary Standard honored Scott Simon, author of the Fiduciary Focus column for Morningstar Advisor, as its Fiduciary of the Year. The award was presented by Ron Rhoades, who was the 2011 recipient. The award honors outstanding contributions to advancing the vital role of the authentic fiduciary standard to investors, capital markets, and society.
  • For the second year in a row, we have partnered with AdvisorOne to conduct a survey of advisors to gauge trends and attitudes regarding the fiduciary standard of care. The results once again reflect a belief that investors don't understand the differences in the standard of care available to them from different service providers. In addition, a majority of respondents believe that it does not cost investors any more to work with an advisor under a fiduciary standard than a broker under a suitability standard. The first article of findings from AdvisorOne came out today. There will be two more additional articles, as well as a report from fi360, in the weeks to come.
  • Growth at fi360 continues at a rapid pace. We have added a number of positions already this year, with a number still coming. The most significant recent hire is for our newly created Subject Matter Expert position, filled by Kathy Stewart, formerly of Wells Fargo. While there are a number of fiduciary experts already on staff, Kathy's position is the first dedicated solely on tracking fiduciary law-making, regulation, court decisions, best practices, etc., and applying that knowledge to our training programs and member support. You can read about Kathy's arrival in this interview she did with RIA Biz.
  • Fi360 and CEFEX have partnered with The Board Institute on a new Fiduciary Board Index for corporate boards of directors to evaluate their fiduciary processes for managing retirement plan investments. The new index is a confidential, online tool that helps boards assess their strengths and weaknesses in fiduciary governance. You can learn more about the new project by downloading a one page overview.
  • Speaking of CEFEX, it was also announced that the plan sponsor and service provider fiduciary Certifications had been updated to cover 408(b)(2) and 404(a)(5) fee disclosure regulations. New checklists for each regulation will serve as step-by-step guides for disclosing appropriate plan information. These updates were assisted by attorneys Kevin Wiggins and Fred Reish. In addition to this service enhancement, CEFEX has also begun a more proactive sales and PR approach to create greater awareness of both themselves and the the individual analysts who are performing CEFEX assessments.
  • fi360 is currently in the process of a revising our Prudent Practices handbooks. Included in the updates will be some changes to the Practices themselves, the inclusion of Investment Advisers Act of 1940 legal citations, updates reflecting new ERISA rules since the last edition, expanded sections on suggested procedures and practice tips to improve fiduciary performance and firm culture, and much more. Stay tuned for additional updates as the publishing date approaches later this eyar.

If you weren't able to make it to this year's conference, we hope you'll consider coming in the future. In addition to a deep lineup of great content, the conference offers opportunities to earn lots of CE and to network with an elite audiene of advisors and prfoessionals. Keep an eye out for more updates tomorrow and make sure you follow us on Twitter using the fi360 Conference hash tage #fi360_2012.

201204231437120400

Fiduciary Links: How advisors should approach long-term care issues

By fi360 Team

>>>>Coincidentally, two pieces came out in the past week that both addressed long-term care issues for advisors and their clients. An InvestmentNews webinar featured several experts discussing long-term care issues in the context of financial planning. Among the subjects they covered are how to have these conversations with clients; examples of the effects long-term care needs can have on the individual who needs care, his or her family, and his or her financial assets; options available for long-term care; and available long-term care insurance products.

On his blog, Michael Kitces took a look at the relative merits of “long-thin” versus “short-fat” long-term care insurance products, arguing that short-fat policies generally provide more flexibility and align better with the known realities of long-term care.

From a fiduciary perspective, these articles provide a decent primer on how advisors should consider long-term care as part of a client’s overall financial plan and/or investment portfolio. It always starts with the facts and circumstances of the beneficiary and continues through a due diligence process of the best available options to fill the individual’s needs. 

>>>>This week is conference week here at fi360. Events kick off today in Chicago with AIFA Designation Training and continue through Friday. In the middle, we’ll be conducting two AIF programs, doing special pre-conference session for Toolkit users, hosting multiple networking cocktail receptions, and presenting dozens of conference sessions from fiduciary scholars, experts, and practitioners on wide variety of topics. In addition, look for more information about the following events and announcements to be made throughout the week:

  • Keynote speeches from Justin Fox and Doris Kearns Goodwin
  • The winner of our 2012 Article Competition
  • The results of the second annual fi360-AdvisorOne fiduciary survey of investment advisors
  • Upcoming fi360 activities
  • The Committee for the Fiduciary Standard’s Tamar Frankel Fiduciary of the Year award winner

Check back here on the blog, or follow us on Twitter @fi360 for updates. If you’re on Twitter and at the conference, make sure you include the #fi360_2012 hash tag to your updates so that we can share your experience.

Now on to the rest of the best links from the past week:

In the news: 

From the blogs:

From the organizations/associations/government/academia: 

Articles your clients are reading (or should be):

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

201204191618470400

Court Finds a Neglected IPS can be Costly

By Duane Thompson

For most fiduciary practitioners who read this blog, the importance of maintaining and adhering to a sound investment policy statement is widely embraced as the guiding document from which other fiduciary responsibilities flow.  At times, though, it is instructive to see how the courts reinforce the importance of this concept in a judicial review.

On March 31, in one of the few ERISA cases to reach trial on the reasonableness of investment management, recordkeeping, and administrative costs in a 401(k) plan, the U.S. District Court for the Western District of Missouri ruled that manufacturing company ABB Inc. breached its fiduciary duties by failing to monitor the fees it paid to Fidelity Management Trust Co. in addition to other fiduciary violations (Tussey v. ABB Inc., W.D. Mo., No. 2:06-CV-04305).

The case against ABB was one of 15 class action lawsuits filed by a St. Louis law firm and others in 2006 and 2007.  Only two cases survived to reach trial, the others being dismissed or settled earlier in the process. 

In Tussey, Judge Nanette K. Laughrey of the Missouri district court released an 81-page decision that at times included fairly scathing language, noting the court’s “suspicions” that the relationship between plan sponsor and service provider “infected more than the specific instances” identified as fiduciary breaches.  However, while awarding specific damages for losses and ill-gotten gains, the court stated it could not rely on suspicion alone in rejecting the plaintiffs’ global damage theory. The facts of the case involved two 401(k) plans, one union and the other non-union, that in 2000 held more than $1.4 billion in plan assets.  Fidelity not only provided recordkeeping and other administrative services to the plans, but through its investment affiliate, Fidelity Research, managed many of the plan’s investment options and was the 3(21) investment advisor.  Over time, Fidelity also took over ABB’s defined benefit plan, health benefits, and payroll services. 

In 2000, without informing plan participants, the plans’ investment committee took several steps that proved to be in conflict with its IPS and fatal to its legal defense.  First, by switching from paying a hard-dollar, per-participant recordkeeping cost to a revenue-sharing offset from fund assets, and ignoring the actual change in recordkeeping costs over time, the court found that ABB caused the plans to pay excessive fees as well as failed to benchmark costs. 

Based on expert witness testimony, the court found that the plans paid, on average, between $65 and $180 per participant during a six-year period when a reasonable fee would have been between $44 and $70.  Part of the analysis was based on comparisons with the hard costs charged by the Texa$aver Plan to its participants.  While not an ERISA plan, the court noted that the Texas plan also held over $1 billion in plan assets, and was therefore an appropriate yardstick for comparison.

Exacerbating ABB’s due diligence problem were two other issues.  First, in 2005 ABB hired Mercer, a pension consulting firm to review its administrative costs, but ignored Mercer’s analysis that ABB was overpaying for recordkeeping services and that one of the plans was subsidizing other corporate services provided by Fidelity.  Secondly, under the new payment arrangement, the court noted that as assets in the plan grew, so would Fidelity Trust’s fees, although it did not provide any additional services to the plan.  However, when the plan’s assets declined, Fidelity Trust asked for hard dollars to make up the difference.

As a result, “ABB permitted Fidelity to take the revenue sharing to cover recordkeeping costs but this did not lower administrative costs,” the court said, noting that revenue sharing by itself was not imprudent.

Finally, the court pointed to the plain language of the IPS,  which stated that, “at all times…rebates will be used to offset or reduce the cost of providing administrative services to plan participants” as further proof of ABB’s failure to comply with its fiduciary duty.

In another count of breach of fiduciary duty related to managing investments, the court found that ABB ignored its own process for de-selecting funds from its investment platform when it abruptly removed Vanguard’s Wellington Fund in 2000 for “deteriorating performance” and replaced it with Fidelity’s target-date Freedom Fund.  The IPS required a review of a fund’s 3 to 5-year performance, and if there were five years of underperformance, the fund was supposed to be placed on a watch list and removed within six months.  Wellington, in fact, had a “stellar” 70-year track record through 2000, and outperformed Morningstar’s benchmark by 400 basis points during the 3- to 5 year time period, the court said.  And the Wellington Fund was never placed on a watch list prior to de-selection.  In addition, when replacing Wellington with the Freedom Fund, ABB’s investment committee made only a cursory review of two other competing funds, which the court found suspicious.

Finally, the court found that ABB’s decision to use more costly shares of certain Fidelity funds with higher expense ratios ran contrary to the IPS objective of using a share class with the lowest expenses, violating ABB’s fiduciary duty of prudence.

In failing to monitor recordkeeping costs, the court found ABB liable for $13.4 million in lost fees to the plan, and $21.8 million lost by the plans in ‘mapping,’ or replacing, Wellington with the Freedom Fund.

Fidelity Trust was found in breach of its ERISA duties by retaining the ‘float,’ or interest on plan benefits by transferring the income to the investment options instead of directly to the plans, resulting in $1.7 million in lost float revenue.

The lengthy court opinion holds additional lessons in how a company failed to follow a prudent process in its investment decisions, in monitoring plan costs, and in the penalties involved in ignoring its own IPS.  Although it did not find that ABB concealed its fiduciary breaches, the court seemed troubled by what it called a “conflicted relationship” with Fidelity. 

Although the plaintiffs’ bar itself may have overreached, considering the larger proportion of cases dismissed by other courts, it seems likely that once DoL’s 408(b)(2) disclosure rule of service providers’ costs goes into effect this summer, plan sponsors who ignore the issues raised in Tussey will do so at their own peril.

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Fiduciary Links: New SRO Bill draft on the horizon?

By fi360 Team

 >>>>We learned last week that an updated SRO bill draft is expected to be released by the House Financial Services Committee sometime soon. In September, Rep. Spencer Bachus released a draft bill that would have authorized the creation of one or more SROs for investment advisers. The bill was never formally introduced, likely due to prohibitive opposition in the Senate, as well as a vocal outcry from adviser groups. Fi360 was generally opposed to the bill, arguing that adequately funding the SEC to perform adviser examinations is the best solution to improving adviser oversight. We were pleased, however, that the bill did leave room for a new adviser-specific SRO, rather than simply empowering FINRA to do the job.

We don’t know what the new draft will look like, though fi360 Senior Policy Analyst Duane Thompson speculates that new bill could be “somewhat different from the original discussion draft.” If that is the case, we hope it is because Congress has realized that the SEC isn’t only the better-suited regulator, it is also the cheaper option. However, if they remain committed to the SRO route, we would remind Congress that there is a startup adviser SRO readying itself to be a true self-regulator for advisers, rather than hoping the suitability/rules-focused FINRA can adapt to the fiduciary/principles-focused world of RIAs. 

>>>Last week, our fiduciary links post touched on SIFMA's fiduciary comments to the SEC. This week, the conversation continues with comments from The Institute for the Fiduciary Standard, The Derivative Project, and an article in RIABiz. Links to each are below.

Now on to the rest of the best links from the past week:

In the news: 

From the blogs:

From the organizations/associations/government/academia: 

Articles your clients are reading (or should be):

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

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