fi360 Blog

How fiduciaries can help confront investor overconfidence

In one of his recent blog posts for the New York Times' Bucks Blog, Behavior Gap's Carl Richards looked at the problem of investor overconfidence. An overconfident investor will often trade too frequently, trade at the wrong time and fail to diversify, a classic recipe for underperforming compared to the markets. Carl suggests two questions for investors to consider before making an investment decision: how would being right affect you and how would being wrong affect you? 

Unfortunately, most of the information being digested by investors from outside sources will focus on the potential for return. Therefore, it is not surprising that many investors focus on the first question and perhaps even individual managers they are feeling confident about when discussing the investment strategy. It is up to the fiduciary to force investors to consider the second question and refocus the conversation on the ultimate objectives for investing (i.e., retirement, education, charitable giving, etc.).

To do this, we suggest an exercise for testing the investor's risk tolerance. Show them models for optimistic, most likely and pessimistic return scenarios of an investment strategy over time. For each of these possible outcomes, ask the client, "if this happens, can your objectives still be met?" and fill out the following matrix:

	Optimistic	Most Likely	Pessimistic
1-year	Yes / No	Yes / No	Yes / No
3-year	Yes / No	Yes / No	Yes / No
5-year	Yes / No	Yes / No	Yes / No
Longer	Yes / No	Yes / No	Yes / No

If the answer to any of the scenarios is "no," then the investment strategy needs to be reexamined and possibly altered to fit a risk-return profile that the client is more comfortable with. Otherwise, the investor is likely to fall victim to the traits of an overconfident investor and alter the strategy at the wrong time and for the wrong reasons.

Fiduciary Links: Will participant advice rules create too many obstacles for participants to receive advice?

When the Pension Protection Act was passed, one of the primary goals was to provide a greater number of plan participants access to individualized investment advice. Now that we are getting closer to the investment advice rules finally being implemented, there is a great deal of debate as to whether that intent will be realized. An article this week looked at the skepticism that exists, asking that if most advisors don't see enough compensation in the model to make it worth it and if brokers stay away due to compliance concerns, then how exactly will that void of participant advice be filled? On top of that, the question remains as to whether many plan sponsors will want to pay for it.

Rich Lynch, our COO, was quoted in the article arguing that advisors who focus on the area will make it work by having sufficient retirement plan clients that they'll create efficient processes and drive down the cost. Another solution is for brokers to create package products that are participant advice rule compliant.

While we don't believe that conflicted advice is an acceptable trade off for the sake of greater accessibility, it is an interesting question to consider how the new rules will shape the market for participant advice. We'd love to hear what your thoughts are on the advice regulation and whether or not providing participant advice is something you would consider. Let us know in the comments section.  

Now on to the rest of the best links from the last week.

In the news/commentary: 

• Evan Cooper supports the idea of a fiduciary pledge and says the free market will ultimately put fiduciaries at the front of the pack. [InvestmentNews]
• Jason Roberts says to expect broadening of the definition of fiduciary from regulators [PlanAdviser]
• Blaine discusses how the fiduciary standard is moving forward despite not being included in the Senate reform bill [Financial Planning] 
• New participant advice rules could push brokers out of the retirement space. The question is, who will replace them? [Reuters]
• Being a fiduciary when you don't have to be can create an opportunity to differentiate yourself in the market [Financial Planning]
• For participants, identifying the fiduciary is the first step to improving your retirement plan [Main Street]

From the organizations/associations/government/academia:

• SEC Commissioner Aguilar backs the fiduciary standard again. [SEC]
• Senator Dodd has a few words to say about his reform bill as markup begins [Senate Banking Committee]

From the blogs:

• A model for 401(k) advice, it must be ongoing [The 401(k) Fiduciary Advice Blog]
• Asset allocation for strategic retirement planning [eRollover]
• At least one RIA firm (one with a number of AIF and AIFA designees, by the way) has taken the fiduciary pledge idea to heart [Sink or Swim]
• Too many investment options inhibits retirement plan participation [R. Dean Piccirillo]
• Protecting portfolios from inflation [The Investment Fiduciary]
• An interview with CAPTRUST's Fielding Miller [Bright Scope Blog]

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

Practice 1.5: Have recourse if the money disappears

Practice 1.5 is the final Practice in the Organize step of the fiduciary quality management system. The purpose of this Practice is to ensure that legal recourse exists in the event that it is determined fiduciary assets are not being prudently managed.

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

When the Department of Labor stepped in and appointed outside trustees to replace Enron's pension committe, it was a perfect example of how important the first criteria can be. It may not have prevented abuse, but it at least gave the victims recourse when it did happen. If assets are held out of country or outside the purview of any regulator, then little can be done when mismanagement or fraud occurs.

A permissible exception would be when advisors are managing the personal assets of an individual client or private trust. They are not precluded from considering the establishment of foreign accounts. However, the fiduciary should be able to demonstrate that this is in the client's best interest, does not conflict with any trust documents, and explain what protections do or do not exist in the event of mismanagement.

In the case of an ERISA-qualified retirement plan, fiduciaries are required to ensure a surety bond is in place to ensure that the assets of the plan are protected from loss due to theft or embezzlement.

While specific requirements for this Practice are not always defined in the major legislation, the law firm of Reish & Reicher notes in the Legal Memoranda handbook that each does imply a fiduciary duty to "preserve and protect assets from risk." A duty that would best be fulfilled by measures such as maintaining assets in the United States, insuring against losses from fiduciary violations, and bonding those who have acces to assets. Failure to do so could be considered a breach itself.

To learn more, consult the following resources:

• Complete text of Practice 1.5 from the Prudent Practices for Investment Stewards handbook
• Legal substantiation to Practice 1.5
• Visit the DOL's ERISA enforcement page for examples of the types of actions they may take to protect and preserve at-risk plan assets

 * * * * *

The Spotlight on Practices series highlights one of the Prudent Practices for Investment Fiduciaries in order each month. To learn more about the Practices, click "Spotlight on Practices" link in the categories list or visit the Practices page on fi360.com.  If you have any questions or comments, leave them in the comments section below each post, or email us at blog@fi360.com.

Talking fiduciary with Mercer Bullard

If you follow the latest developments in financial regulatory issues, you've no doubt become accustomed to seeing Mercer Bullard's name. Whether testifying before legislative committees and regulators, providing comments on regulatory reform proposals, or providing analysis to the media, he is one of the primary go-to sources for legal and regulatory insights and a champion of investor advocacy.

Mr. Bullard is an Associate Professor of Law at the University of Mississippi School of Law, where he teaches courses on securities, banking, corporations, corporate finance and law and economics. He is the Founder and President of Fund Democracy, an advocacy group for mutual fund shareholders. He is also an Accredited Investment Fiduciary designee and a general session speaker at the 2010 fi360 Conference.

Mr. Bullard was kind of enough to answer a few questions for us on the progress of the advancement of the fiduciary standard by Congress, regulators, the media and professional organizations.

Fi360: Once a financial regulatory reform bill gains both Senate and House approval and is finally passed into law, do you believe that it will include a provision to extend the fiduciary standard to brokers and other financial representatives who provide advice?

Mercer Bullard: It’s currently a toss-up.  As I write, the Senate bill approved by the Banking Committee would require only that SEC conduct a study on issues related to the fiduciary duty.  The bill orders the SEC to enact rules to the extent its study finds that there are gaps in the regulation of brokers (such as the absence of a fiduciary duty for investment advice), but the authority of the SEC under the bill to impose a fiduciary duty on brokers is unclear at best.  In contrast, the bill passed by the House last year would require the SEC to enact rules establishing a fiduciary duty for brokers when providing personalized investment advice to retail customers.  The question is which bill will survive the Senate-House reconciliation process.  That will depend primarily on how committed the House leadership is to its fiduciary provision.  Chairman Barney Frank has indicated his strong support for the House bill, so there is definitely a good chance that the fiduciary duty provision will become law.

Fi360: Given what has transpired to this point on Capitol Hill with financial regulatory reform, would the advancement of the fiduciary standard be better served if it were not addressed through legislation at this time rather than including less than ideal provisions?  

Mercer Bullard: To the extent that Congress actually tackles the fiduciary issue head-on, the outcome is likely to be an improvement.  The House bill is a good example of legislation that would clearly advance the fiduciary standard.  There is a risk, however, that proposals that start as an approach to the fiduciary issue will be steered to unrelated, anti-investor ends.  For example, the original version of the Senate bill would have eliminated the exclusion for brokers from the Investment Advisers Act.  This would have been a significant step forward, but it tried to do too much.  Its opponents replaced it with the study mentioned above, which may delay SEC action and yield bad results.  For example, there are aspects of the study that seem to pre-judge certain issues, such as the role of FINRA as the self-regulatory organization for advisers.

Fi360: There does seem to be some fiduciary momentum building from the regulators: SEC Commissioners have indicated a strong interest in advancing fiduciary measures and the DOL has advanced fiduciary principles in recent rulemaking. Absent Congressional action, do you foresee regulators continuing to have increased willingness and ability to institute strong fiduciary provisions through rulemaking?

Mercer Bullard: Regardless of what Congress does, the SEC will likely move to impose some kind of fiduciary standard for brokers.  If Congress does not expand the SEC’s authority, then SEC reforms will comprise rules governing broker disclosures and other specific areas of conduct where the SEC’s jurisdiction is clear.  These rules will have the effect of enforcing aspects of a fiduciary standard but without being expressly characterized as such. 

If Congress gives the SEC express authority to impose a fiduciary duty on brokers, then the SEC probably would do so, but not without asking for comment on how the fiduciary standard as historically applied to investment advisers may be “incompatible” with brokers’ business practices.  While this process might result in something less than the application of a full fiduciary standard on brokers, it is still likely to be an improvement over current law.  My most significant concern is the SEC’s ability to get its work done.  Its point-of-sale disclosure rule, for example, was proposed over six years ago and has yet to be finalized.  It has promised 12b-1 reform for a decade without any result.  It has never issued guidance on brokers’ disclosure of revenue sharing payments.

Regarding DOL’s rulemaking on conflicted investment advice, there has been a significant improvement over the previous rule.  The new rule effectively narrows the conflicted advice by limiting the financial incentives that advisers have to provide self-interested recommendations.  It still allows conflicted advice, however, because Congress required, in the Pension Protection Act, that conflicted advice be permitted.  DOL could do a better job neutralizing or limiting a series of court decisions that apply an overly narrow view of the fiduciary standard under ERISA (e.g., Hecker v. Deere).

Fi360: To what extent can the influence of the media and professional organizations help create competitive pressures that will force a shift to fiduciary conduct from those who provide investment advice? Would such competitive pressures be enough to counteract investor confusion over who is and who is not a fiduciary?

Mercer Bullard: The media has been very effective at communicating the importance of the fiduciary duty in the context of personalized investment advice.  Its support of that standard has been virtually universal and had a significant effect on legislators.  The media can’t speak in a vacuum, however, and it is professional organizations that have been one of the most effective spokespersons for the fiduciary standard.  This is a particularly important role because professional organizations have not been as effective in their direct lobbying efforts as the brokerage and insurance industries.  Professional financial planning organizations have been able to achieve some direct success in Washington, however, and need to continue to strengthen the coordination of their efforts on the Hill.

Competitive pressure can make investors aware that they should only rely on personalized advice from someone who is subject to a fiduciary standard.  This message has already established a good foothold.  I am less optimistic that competitive pressure will enable investors to distinguish fiduciaries from non-fiduciaries.  When a broker offers a full range of financial planning services, investors generally will expect those services to be subject to a fiduciary duty as are other types of professional services.  I am skeptical that many investors will ever go beyond that general expectation to determine that it is well-founded.  The best way to counter investor confusion would be to ensure that the standard that investors naturally expect is the one that actually applies: the fiduciary standard.

Fi360: You are currently serving as the chair of the Investor as Purchaser Subcommittee of the SEC Investor Advisory Committee.  Can you give us some insight into the mission and priorities of the committee? What additional work and recommendations can we expect to see from your subcommittee with regard to the fiduciary issue? 

Mercer Bullard: The Subcommittee has taken up the fiduciary duty and mandatory arbitration as the first two issues that it will address.  Both issues were discussed at length at the Feb. 22 meeting of the full Committee.  Two background memoranda were circulated prior to that meeting that can be accessed at: http://www.sec.gov/spotlight/investoradvisorycommittee.shtml. I expect that the Committee will host a panel of outside experts on mandatory arbitration at its next meeting on May 17, which will be broadcast live on the SEC’s website.  The arbitration memo sets forth the key issues that the panel and the Committee will be tackling.  The Subcommittee is currently discussing its next step on the fiduciary duty issue, which I hope will be to approve for recommendation to the SEC some of the less controversial positions discussed in the last section of the fiduciary duty memorandum.

Fiduciary Links: Dodd bill not all it could be, but other good news surfaces on fiduciary issue

The big news in fiduciary over the past week was, of course, the release of Senator Dodd's financial reform bill and its lack of a fiduciary standard for investment advice. The immediate reaction was that this is a big win for the anti-fiduciary broker and insurance industries. More optimistic reviews found partial wins in the bill as well as some thought that it may be a blessing in disguise.

However, it was not all bad news for the fiduciary issue. Over the weekend it was reported that SEC Chairman Mary Schapiro wrote to the Senate Banking Committee to include the fiduciary standard in their bill. The SEC is being called one of the winners in bill, potentially gaining more rule-making powers and self-funding status. If this is the case, an empowered SEC with greater resources has the ability to make a big difference in advancing fiduciary standards through rulemaking.

Not directly related to the reform bill, but still good news for the fiduciary cause are stories that Fidelity will soon be leveling fees to advisers so they may act as fiduciaries to 401(k) plans and FINRA CEO Richard Ketchum saying in a speech that brokerages should begin instituting disclosure and documentation procedures in line with fiduciary processes in anticipation of a more fiduciary future.

Now on to the rest of the best links from the last week.

In the news/commentary: 

• John Bogle once again promotes fiduciary standards in a speech [InvestmentNews]
• DOL expected to release 401(k) fee disclosure rules in June [InvestmentNews]
• Committee for the Fiduciary Standard asks Wall Street to make fiduciary pledge [InvestmentNews]
• Blaine's latest Fiduciary Corner column also looks at the idea of a fiduciary pledge for advice [InvestmentNews]
• An alternative to Obama's auto-IRA plan for small companies [InvestmentNews]

From the organizations/associations/government/academia:

• A target date fund study finds that open-architecture funds may not have an advantage over closed-architecture [Morningstar]
• SEC Commissioner Aguilar speech says TDF recommendations are coming and promotes SEC self-funding [SEC] 

From the blogs:

• Fiduciary debate full of misinformation and misunderstandings, but at least NAIFA now sees the inherent conflicts [Wealth Manager Web]
• Good fiduciary stewardship begins with education [FiduciaryPro]
• AIFA designee Robb Smith anti-fiduciary lobbying in two posts last week, here and here.

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.

Dodd proposal a fiduciary disappointment

Though not a surprise, the absence of the extension of the fiduciary standard in Senator Christopher Dodd's new proposal for financial regulatory reform is still a disappointment.  On Monday, Dodd spoke of plugging gaps and creating greater regulator accountability, but failed to back up these promises on the fiduciary front. And while groups like FSI and NAIFA pushed for and now applaud the proposed study of investment adviser and broker-dealer regulation, it's investors that would remain out there unprotected while the SEC studies issues of which it already has expert knowledge.  

The looming question is what's next?  Well, the truth is financial reform legislation is far from being a foregone conclusion.  Dodd must still gain bipartisan support for his proposal in order to successfully push it through an aggressive Senate Banking Committee mark-up schedule and then guide it through the Senate floor.  And let's not forget that a final Senate bill will still need to be reconciled with the bill passed by the House last December. As a lawyer, it's often my job to be the Debbie Downer in the room, and while this run down of the legislative process may sound dismal for investor protections, there may be hope just yet.  

Fiduciary Links: NAIFA letter a fiduciary ghost story

A blog post last week from Insurance and Financial Advisor reprinted a letter from Thomas Currey, the president of the National Association of Insurance and Financial Advisors (NAIFA), in which he warned their members of the danger financial regulatory reform posed to their way of business if adoption of a fiduciary standard is included. Unfortunately, it seems that their push for a study of the issue will make it into Dodd's Senate reform bill when it is released as soon as today. The letter is worth reading anyways though for the revealing look at how the anti-fiduciary message is being crafted as a story of unmanageable expectations and frivolous lawsuits. The claims that advisors would have to select from the entire universe of options and that results, not process, determine fiduciary appropriateness certainly tell a scary story of how a fiduciary standard would unfairly target well meaning advisors who are only trying to do what's best. However, it's a false one as these claims simply don't mesh with the legal history established in the enforcement of a fiduciary standard under the Investment Advisers Act of 1940.

Now on to the rest of the best links from the last week.

In the news/commentary: 

• Senator Herbert Kohl, D-Wis., proposed a new amendment imposing a fiduciary standard, but with a financial-planning oversight board [InvestmentNews]
• DOL's participant advice rules aim to separate advice from sales [InvestmentNews]
• Main stream newspaper coverage of the fiduciary standard debate! [Washington Post]
• Thanks for nothing, Senate [MarketWatch]
• Great article on the professionalization of investment advice [RIABiz]

From the organizations/associations/government/academia:

• The National Association of Insurance and Financial Advisors (NAIFA) responds to last week's New York Times article on the fiduciary standard [NAIFA]
• CFP Board introduces new financial plan development course to their requirements for certification [CFP Board of Standards]
• What's the difference between 3(21) and 3(38) fiduciaries? [fi360]

From the blogs:

• NAIFA warns its members that they may have put their clients' interests first [IFA Webnews]
• "Status quo isn't going work" for participant advice under the DOL rules [WSJ Financial Adviser Blog]
• Carl Richards asks investors to confront their overconfidence [NYT Bucks Blog]
• Which is better, 3(21) ERISA fiduciaries, or 3(38)? [Pozek on Pension]

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.

Different fiduciary roles bring different amounts of liability

While advisors share common standards for how they manage investment decisions, there are nuances to the amount of liability being assumed based on the type of fiduciary you are.

Starting at the broadest level, investment advisers who advise others in the buying and selling of securities are deemed to be fiduciaries under the Investment Advisers Act of 1940 (1940 Act) and are regulated by the SEC or individual states.  The 1940 Act and its associated rules provide guidance for advisors that can be exercised with or without assuming discretion.

For retirement plans, the scope of the advisor’s fiduciary duty is defined under ERISA based on the specific functions performed and the amount of discretion it exercises:

1. Limited-scope ERISA 3(21) fiduciary: Those who acknowledge a fiduciary role without taking discretion; they provide investment advice, but leave the ultimate decision to the plan sponsor.
2. ERISA 3(38) fiduciary: Those who select, monitor, and replace investment managers as appropriate; who have authority to buy and sell securities. This role is effectively the outsourcing of the role of hiring and firing the managers.
3. Full-scope 3(21) fiduciary: Those who take discretion for all fiduciary decisions including the selection, monitoring, and replacement of all other service providers, including the 3(38) fiduciary. Although this is rare, in this case the plan sponsor is only responsible for the prudent selection of the 3(21) fiduciary, who then takes over all other investment fiduciary duties of the plan sponsor.

Most retirement plan advisors are typically filling the limited-scope 3(21) fiduciary role, although many might not even realize that the differences exist. Probably the biggest question on most advisors’ minds is under what circumstances they should serve as the various types of fiduciary, how their processes should be structured accordingly, and how to differentiate their services in the marketplace.  Legal counsel should be consulted as you sort this out because your liability is commensurate with the scope of services provided.  More responsibility ensures more liability and should equate to more compensation.

Tomorrow, March 11th, we will be presenting a webinar on this subject in which we will go into greater depth in explaining how these types of fiduciary differ and what advisors can do to take greater advantage of their status.

UPDATE: The recording and slides from the webinar are now available at www.fi360.com/webinars. Look for follow up blog posts answering questions submitted during the presentation in the coming weeks, as well.

For further reading on the subject see:

• Scott Simon's Morningstar article "The Different Flavors of ERISA Fiduciary"
• Fred Reish's outline regarding fiduciary roles and the associated liability

Fiduciary Links: The effect of mainstream media coverage of the fiduciary debate

On the front page of the New York Times' Business section last week was an article about the fiduciary debate in reform. The article isn't anything new for anyone following this blog. It asks the same questions about whether or not brokers are trusted advisors or sales people. While the coverage doesn't make more stringent reform any more likely, what it does do is continue to expose the issue to a broader audience. 

The most significant finding in the RAND Report on adviser vs. broker-dealer regulation is investor confusion. While it seems less likely that reform is going to do anything to clear up that confusion, more coverage of the debate itself, along with coverage of the scandals of the past few years probably does go a long way in arming investors with some insight into the types of questions they should be asking related to compensation, fees, conflicts of interest, etc.

As long as the differentiator between regulatory standards isn't whether advice is involved, confusion is bound to exist. But pressure to meet the demands of the market could be just what is needed to change the culture of the industry. Absent a change in momentum towards the legislation of the fiduciary standard, continued coverage of the debate along with education by advocacy groups and leadership from the professional organizations will continue to drive progress towards the professionalization of financial advice.

Now on to the rest of the best links from the last week.

In the news/commentary: 

• Our own Kristina Fuasti was part of a recent regulatory roundtable to discuss regulatory reform and the fiduciary standard [Financial Planning]
• The cost of owning a mutual fund isn't always so transparent [WSJ]
• Jason Zweig says investors lose in the reform bill expected from Dodd [WSJ]
• This is a couple of years old already, but still worth watching. Chris Hansen uses his trademark hidden camera treatment on unscrupulous products sales people [MSNBC]
• Advisors with nothing to hide shouldn't have a problem with disclosure [Transitions]
• Fiduciary Benchmarks thinks investors are better prepared for retirement than they think and have a new tool that let's them check [Reuters]
• The good news: regulatory reform bill seems more likely than ever. The bad news: the bar has been lowered. [CBS]

From the organizations/associations/government/academia:

• We are doing a webinar this week on the different types of fiduciaries. Two experts from our membership and our COO will discuss under what circumstances an advisor would want to act as an ERISA 3(21) or 3(38) fiduciary, or as a non-ERISA fiduciary, what this means for your business model and how to market the distinction. [fi360]

From the blogs:

• Differentiating better business practices from trust [WSJ's Financial Adviser]
• Mercer Bullard says the new investment advice rule will promote objective advice [NYT's Bucks Blog]

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.

To provide or not to provide an IPS?

Ideally, a well-crafted investment policy statement (IPS) will be in place and be a guiding force before the selection of service providers. However, as many advisors out there can attest to, this is not always the case. Often portfolios have no IPS in place or have one provided by vendors that have already been selected. These scenarios present advisors with an interesting decision to make as to whether they should provide their own IPS. 

I spoke with an advisor recently who was looking for insights based on his encounters where the IPS either did not exist or was not created by the fiduciary that owns or has primary control of the assets, i.e., the steward. While he understood the importance of the IPS and had one that his company provided him with, it also came with a disclosure that basically said, "use an IPS, but don't blame us when things go wrong," which, to him, didn't seem like much of a recommendation at all.

This led him to ask the following questions: 

1. Why do some providers want nothing to do with an IPS for the end client?
2. Are fiduciaries better off not having an IPS governing their portfolio management activities, as they don't have a template to be accountable to?  He paraphrased this question by noting he didn't believe it, but it was still the story he was up against, the argument being if you have one, you have to stick to it, if you don't have one, nothing to worry about.
3. Is there a conflict in offering his company-approved IPS when one already exists through the vendor? If you have two separate IPSs, which one is the dominant one/overriding one?

While the first question involves speculation about the motives of providers and the other two depend on the facts and circumstances of each case, I believe my answers are fairly reliable based upon my experience on these issues.

Some providers steer clear of the IPS because they are trying to steer clear of any fiduciary role. They recognize that the IPS ultimately is “owned” by the steward. They may be concerned that by providing the IPS they are setting themselves up for the argument that they have assumed the duties to craft and maintain an IPS that is appropriate for, and in the best interest of, the beneficiaries. I believe this could be managed in other ways but that’s my best guess as to what it going on.

The argument that the portfolio would be better off without an IPS is particularly dangerous and pathetic, but all too common. It is pathetic and dangerous because, in the event of a DOL audit or a complaint from a beneficiary, it is difficult to demonstrate that prudent processes are being used in fulfillment of the steward’s fiduciary obligations. Moreover, a specific requirement under ERISA is to have an investment policy. The steward is immediately on the defensive if they have to argue that the portfolio is being operated according to an investment policy that has not been committed to paper. The steward will be called upon to demonstrate that the claim is true – no small task. It is pathetic because it suggests that (a) the fiduciaries to the plan are so incompetent as to be presumptively negligent in their willingness or ability to follow a written plan and (b) the beneficiaries are not deserving of having their assets managed according to a well developed and documented business plan (which is effectively what the IPS is). A steward without a written IPS may be called upon to concoct some story of how they really have a mental IPS that they have been following. This doesn’t square very well with the premise that the best reason for not having an IPS is based on acknowledged incompetence or propensity for negligence. To summarize, the “don’t have an IPS” school of thought doesn’t paint a very flattering portrait of the fiduciaries serving the plan, is likely to increase regulatory and litigation risks, and is inconsistent with the obligation to serve investors’ best interests.

As for the situation when a vendor-provided IPS already exists, I mentioned previously that the IPS is “owned” by the steward and it's ultimately up to them to either create or select and adopt a single IPS from the available options. Your role in assisting them should be based upon your engagement. If you are an advisor to the portfolio, you may include advice on the IPS as part of your service set. If you exclude anything having to do with the IPS from your engagement, you should still be able to recommend that they decide upon the IPS that will guide management of assets. A disclosure, such as the one the advisor’s company has included, is a good idea as it should help focus the plan sponsor on the importance of them giving serious thought to the IPS and taking ownership of it.

In short, it is our belief that the IPS is the single most important document in the management of investment decisions. Without one, the steward would be hard pressed to argue that they even have an investment policy. As an advisor, if you encounter a portfolio without one at all or with one that you believe may be inferior, you absolutely should inform them of the importance of taking ownership of the investment policy and provide them an IPS to get them started.