fi360 Blog

Have you looked at your investment committee lately?

We received a question last week related to investment committees that was straight forward enough,  is there a requirement for investment committees to rotate their members?  This particular advisor typically recommends doing so to his clients and just recently was getting some resistance.  The client's concern was captured by the old adage "if it ain't broke, don't fix it."

We are not aware of any requirement to rotate investment committee members, although we do think it is a good idea.  Getting a new committee member periodiocally with a fresh perspective, who may be more likely to question the existing process, is healthy and helps combat problematic behavior like group think.  You can rotate non-permanent members and still have permanent members that fill key roles. 

Our fiduciary practices address investment committees in Practice 1.2 under two criteria:

• Criterion S-1.2.3:  All parties have acknowledged their status in writing.
• Criterion S-1.2.4:  Investment committees have and follow a defined set of by-laws.

All committee members should acknowledge their fiduciary status in writing, although many (probably most) do not.  It's not unusual to get reactions of concern and even outright refusal when you approach committee members with this letter requiring their signature.  It will lead to a discussion of what fiduciary responsibility really entails; possibly for the first time.  This is a good thing, even if it turns out you need to look for others that are willing to replace the member(s) who is not up for the task.  In the end, you'll most likely have a competent and engaged committee.

The committee by-laws are essential for establishing the process by which the committee operates.  Other industry best practices with respect to investment committees include:

• Recruit individuals that are interested in participating.
• Choose members comprised of senior personnel from HR, finance, and operations, as well as other staff as deemed appropriate. (Note: Taft-Hartley (Union) plans require equal representation from management and labor.)
• Keep the number of members between 3 and 10; this is largely driven by the plan or portfolio size.
• Select a committee chair who has strong investment skills; typically a senior executive like the CEO, COO or CFO.
• Include permanent (CFO, VP of HR, etc.) and non-permanent members who rotate regularly (every three years is about right).
• For larger committees, stagger the rotation of non-permanent members.
• Avoid becoming too dependent on a single member (Vanguard recently published the results of a survey on committee leadership styles.
• Require regular attendance and that members take their duties seriously; signing a fiduciary acknowledgement letter helps to get this point across.

How does your committee measure up?

Fiduciary Links: In support of the DOL expanded definition of fiduciary

Highlights from last week:

In his monthly Fiduciary Corner column that came out over the weekend, Blaine voiced his support for Department of Labor’s fiduciary definition proposal. In the article, Blaine argues that DOL is right in its decision that even advice that is merely occasional and influential, rather than the current standard of being regular and central to decision making, should be held to the same fiduciary standard. Blaine also gives a practical summary of what the rule change would mean, goes after some of the most common arguments against the definition expansion and asks how we can put a price on integrity anyways. When you give the article a read, make sure you hit the “Recommend” button at the top of the article if you like it. We have seen even some of the staunchest fiduciary advocates have issues with the rule, but in our opinion it is the right step for ensuring all advice is delivered by professionals who adhere to the fiduciary standard.

Blaine is also the most recent guest on the Don Davidson 401k Podcast. In the interview, he discusses all things fiduciary with Don, including his thoughts on what differentiates an advisor who adheres to the fiduciary standard versus the suitability standard, how recent trends have shown a greater focus on the fiduciary duties of the plan sponsor, how plans and advisors need to be preparing for the upcoming 408(b)(2) disclosure requirements and more on DOL's proposed amendments to the definition of fiduciary. The whole thing only takes 20 minutes to listen to or can be downloaded onto your iPod. Both the interview with Blaine and the archive of past interviews are worth a listen.

Finally, we’d also like to acknowledge Roger Wohlner, a long-time friend of fi360 who recently began blogging for U.S. News & World Report. One of his most recent posts was picked up by Yahoo! News, which we’re sure must be very good for those page hits. Roger frequently speaks out for pro- fiduciary and fee-only topics and his posts, along with the others on the U.S. News’ Smarter Investor blog, are worth passing on to your clients. He’s also worth a follow if you’re on Twitter.

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

Fiduciary safe harbor protection and the duty to share

Last month, the Sixth Circuit affirmed the decision of a trial court that a trustee could rely on the ERISA Section 404(c) safe harbor to shield itself from fiduciary liability.  The main issue in the case was whether 401(k) participants seeking to recover damages were prevented from exercising “independent control” over their accounts as a result of a failure of the trustee to disclose material nonpublic information.

Prior to this case, it was clear that the participants’ investment advisor had breached his fiduciary duty.  As the court states in the opening of its opinion, the participants “lost substantial amounts of money from their pension accounts because their investment advisor … was a crook.”  However, because the investment advisor was insolvent, the participants sought to recover their losses from the trustee by claiming that the trustee knew of the investment advisor’s fraudulent conduct and failed to disclose it to the participants. 

The trustee claimed it was shielded from liability by ERISA Section 404(c).  The participants argued, however, that all but one of the prerequisites to the safe harbor were met.  In particular, the participants claimed that the requirement that they exercise independent control with respect to the investment of assets in their individual accounts had not been met due to the trustee’s failure to disclose what it knew about the investment advisor’s misdeeds. 

Fiduciary Links: What the J.D. Power fiduciary survey means

Two stories in particular caught my eye this past week, one on investor understanding of the fiduciary standard and another on a segment of the population who apparently aren’t being afforded pure fiduciary protections:

>>>InvestmentNews covered a J.D. Power survey that suggests investors don’t understand the differences in standards of care and, perhaps, don’t care. J.D. Power’s director of investment services suggests that the results may make firms consider whether the costs of compliance to a higher standard are worth it, given the lack of enthusiasm from clients. However, we would counter that a) lack of understanding is one of the major reasons a fiduciary standard of care is so necessary and b) despite claiming not to care, many will inevitably seek advice and expect their advisors to be held accountable for that advice. The survey also highlights how a few customer service-related best practices can go a long way in creating a satisfied client.

>>>An interesting story from The Atlantic looked at a Supreme Court decision on attorney-client privilege in a discovery dispute between the Jicarilla Apache Nation and the U.S. government. While we can’t pretend to know much about the case, both the majority and opposing opinions reveal a troubling loophole in the government’s fiduciary responsibility as trustee to Native American tribes. While the actual decision was fairly narrow in scope, the majority opinion acknowledges that the government may at times be conflicted as to what is in their best interests and what is in the best interests of the tribes. This acknowledgement leads Justice Sotomayor, alone in her opposition to the decision, to worry about a dilution of the government’s fiduciary obligations to Indian tribes.

>>>We'd also like to acknowledge two of our own AIF Designees, Phil Fiore and Jeff Farrar, were recipients of PlanSponsor Magazine's 2011 Retirement Plan Advisory Team of the Year award!

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

Philanthropy; an Inspired Process: How values conversations can change your relationships

This week we have a guest post from Mike Skrypnek, AIF, who is Director, Wealth Management at Richardson GMP, ltd., in Calgary, AB. His role as a provider of advisement, both investment and educational, to non-profit organizations has positioned him as an authority on the subject of fiduciary roles and responsibilities as stewards of charitable funds. Mike is also the author of Philanthropy: An Inspired Process, which is currently available in the Fiduciary Store.

* * * * *

Fiduciary roles extend beyond stewardship for financial advisors; they are the guidelines for action AFTER you have connected with the values of your clients.  While advisory process and the demonstration of a sound methodology are important for your credibility, the question is: how do you gain the position as trusted advisor with the clients you desire to work with? 

We are all in a service industry.  Our clients are the cornerstone of our business.  We provide intangibles for a living and do not make widgets.  We are not craftsmen.  Our actions are intended to secure future hopes and dreams and fund ongoing liabilities using the current and expected financial assets of individuals and institutions who are our clients.  In order to grow our practices in a rapidly commoditized industry, we must differentiate ourselves beyond our credentials.  Our prospective clients may work with multiple advisors because they’re unsure of what distinguishes one advisor from another.  We need to elevate our practice to demonstrate we have more value and are uniquely positioned to help our clients achieve their goals.

For my practice, this effort has come in the form of connecting with the deep personal values of my clients where their life experiences connect with the world around them--their desires to have a greater impact and explore their philanthropy.   But how do you engage in these discussions?  Many advisors see this as an “end-of-life” discussion or an exercise in estate planning.  While this is often the case, it extends deeper than that. 

Fiduciary Links: How behavioral finance supports a fiduciary standard

Behavioral finance suggests that one of the reasons markets don’t behave rationally and that investors often underperform relative to investments is that investors tend to act on emotions such as fear, regret, confidence, and risk-aversion. Morningstar Advisor is currently running a series of articles on the theory being written by the authors of the Applied Behavioral Finance Blog, including the most recent entry titled, “How neuroscience supports a fiduciary standard for financial advisors.” In it, they make the case that the best client relationships are based on “factual data, trust in the expert, and a personal relationship re-enforced by the advisor’s ability to recognize and address the cognitive and emotional barriers a client faces in decision making.”

In short, their belief is that part of the advisor’s job is to help overcome negative behavioral traits of the client by encouraging self-determination and facilitating informed consent. They discuss Self-Determination Theory in the context of how external factors influence and interfere with the ability to make rational decisions. The advisor should empower the client to make decisions for his or herself by both providing their own expertise and moderating the client’s decision-making to remove external forces and focus only on achieving goals.

Investors largely are seeking to unload the burden of complex financial decision-making onto someone whom they believe has more knowledge and experience than themselves, who is worthy of their trust and who understands their unique needs and perspective. Given that investors largely don’t recognize the difference between a non-fiduciary and fiduciary, and assuming one believes much of what is coming out of the study of behavioral finance, it would be hard to argue that a fiduciary standard for investment advice wouldn’t be for the benefit of investors.  Otherwise, their own biases are merely being substituted for those of a conflicted advisor.

Now on to the best links from the past week:

Answering your questions on risk management & life insurance planning

Last week, we presented a webinar on a fiduciary approach to risk management and life insurance planning with guest presenter Joseph Maczuga, founder and executive director of Fee Advisors Network. During the session, Joe discussed how to identify risk, the shift of life insurance risk and its fiduciary impact, and fiduciary risk management through policy design. A recording of the webinar and the slides are now available for download on our website.

There were several questions during the webinar looking for further insights into fiduciary risk management that we were not able to answer during the allotted time. Joe kindly answered all of those questions, which we are happy to present in the following Q&A:

Q. Does an advisor need to hold licenses for fee advising on insurance products for each state he or she operates in? 
A. Most States have a reciprocal arrangement for Licensed Counselors. 

Q. How many insurance firms offer fee-based insurance products, especially life insurance? 
A. There are four companies that provide advisor-designed life policies, plus a larger number of entities that provide no-load variable annuities. Keep in mind that policy placement is the LAST action in the fiduciary process.

CFP Board Case Histories: Analysis of a Planner’s Fiduciary Duty can be Unnerving at Times

For the brokerage industry, still bracing for the impact of a sweeping fiduciary standard by the SEC, there is a new canary in the coal mine.  It’s called Anonymous Case Histories, or ACH, courtesy of the CFP Board of Standards.  As a compilation of various disciplinary events covering the waterfront of advisory issues, a search of the ACH site is a must for financial advisors and their compliance officers.

Granted, to-date only a small number of the CFP case histories posted are related to fiduciary issues, but that is bound to change over time.  A recent search using the term ‘fiduciary duty’ turned up eight fiduciary cases, and of these, only six had practical application to client situations.  These were informative, nonetheless, even though all  of them preceded the Jan. 1, 2009, effective date of a broad fiduciary duty for CFP certificants and, as summaries, were lacking at times in the kind of useful detail to be found in court cases. 

One case in particular highlights the travails that can face a well-meaning fiduciary advisor, depending on your interpretation of due diligence.  The case in question was a litigation matter self-reported by a certificant.  The CFP designee – let’s call him Smith - and his partner were sued by the wife of the deceased client, the wife alleging negligence and misrepresentation on the part of Smith, resulting in a consequential error on the husband’s life insurance application.  The case began with Smith recommending the couple increase their life insurance coverage by purchasing new term policies.  Smith completed the husband’s $1 million policy application by phone, and a $250,000 policy for his wife, mailing both to the couple for their signatures.  In the initial client interview, the husband had indicated he did not have any DUI convictions in the past five years and confirmed this in the telephone call with Smith.  The old $300,000 policy was allowed to lapse, and sometime later the husband died in a single-car accident.

Fiduciary Links: Goldman Sachs a case study on raising the bar of professionalism

In mid-April, the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs released this report on the financial crisis. The whole thing is an interesting read, including a background on the rise of too-big-to-fail financial institutions and how we got from the basic 30-year fixed mortgage to the complex system of securitization.

The other major part of the report is case studies that highlight some of the major causes and effects of the 2007 financial crisis, including one on Goldman Sachs that shows alleged conflicts of interests in their simultaneous role in selling mortgage-backed securities, taking a short position against the mortgage market and being a market maker. Now, New York state district attorneys are using some of the same findings from the report as the basis for potential fraud charges against Goldman. Goldman, for its part, apparently plans to fight the charges by showing that the Senate report was incomplete or at least an exaggeration.

The case will surely be one to keep an eye on, as questions linger as to whether Goldman had any fiduciary duties, what its suitability duties were, and whether either of those duties were violated. However, perhaps more importantly than the outcome of the case itself, is the attention it draws to the mere fact that we need to split hairs so finely. The case is clearly an example that the bar for financial services as a profession clearly has room to be raised. A general imperative in line with the AIF, CFP or CFA codes of ethics, the latter of which even includes a specific imperative to consider the integrity of the capital markets in one’s professional conduct, would go a long way in moving the conversation beyond whether the letter of the law is being fulfilled to include consideration of what is healthy for our professional relationships and the overall health of the industry.

Now on to the best links from the past week:

Selecting a QDIA is a fiduciary decision

Since the Pension Protection Act of 2006 and the associated Qualified Default Investment Alternative (QDIA) Regulation were passed, many plan sponsors have added a QDIA option to their plans.  Of the three choices for options, 1) age-based (target date funds - TDFs), 2) risk-based (balanced funds), and 3) managed accounts, TDFs are the most popular to date by far; but they remain a work-in-progress.  Two presentations at our recent fi360 Conference argued that "one size fits all" target date funds do not work and are often misused.  We'll describe the alternative solutions they suggest after a brief update on TDFs.