fi360 Blog

It's a good time to review your gift policy.

With the holidays upon us, we've reached the time of year when most gift giving takes place.  Fiduciaries are often the recipients of gifts and they need to be careful as they consider whether to accept them. I addressed this question several years ago and thought it worth revisiting and updating our previous post for those of you who will face this question soon.

DOL's Employee Benefits Security Administration (EBSA) provides guidance to investigators or auditors (See No. 12) evaluating if a fiduciary violation has occurred, stating that the investigator should determine if "the receipt of gifts, gratuities, or other consideration were for the fiduciary's personal account and received in connection with a transaction or transactions involving the assets of the plan."  They go on to say that the "Investigator/Auditor should also determine whether the fiduciary of the plan maintained a reasonable written policy or plan provision governing the receipt of items or services from parties dealing with the plan and whether the fiduciary adhered to that policy." 

When considering whether or not to accept a gift, a fiduciary should always ask his or herself whether they believe it will impair their ability to carry out their duties objectively.  Of course, the policy could be that no gifts of any type or amount can be accepted, period; although this simplifies things, it may not be practical.  Most policies allow gifts of a nature that could not reasonably be interpreted as influencing decisions as a result.   EBSA's guidance (referenced above) sets a threshold of $250 as "... insubstantial, and not an apparent violation of ERISA Sec. 406(b)(3) ..." assuming receipt does not violate any plan policy or provision.  So, in general, think fruit baskets, rather than Stanley Cup Final tickets.  

EBSA's guidance is instructive for all fiduciaries, not just plan sponsors.  The first step is to have a gift policy that provides guidance regarding their acceptance.  A typical policy would set parameters under which gifts can be accepted and may include:

• the maximum monetary value allowed ($250 would match EBSA's guidance)
• prohibition from certain types of gifts, such as high profile sports events (Super Bowl, World Series, etc.)
• a requirement to keep a record of all gifts received (this would not normally include things like an occasional lunch)

Be sure to consult legal counsel when drafting policies on gifts to ensure they are in compliance with ERISA and all relevant laws.

So enjoy the holidays and graciously accept those gifts that are allowed.  Just make sure make that you record their receipt and they meet the the parameters of your gift policy.

Would LeBron make a good fiduciary?

Last night, LeBron “King” James, the two-time league MVP and past NBA scoring champion, and arguably the most sought after free agent player in the league, made a decision on where he would play the next segment of his short, but superstar career.  The press coverage was astounding, reaching crescendo with his live announcement on ESPN entitled “Decision 2010.”  As I watched the broadcast, it occurred to me that LeBron may make a good fiduciary.

LeBron needed to decide where to continue his career.  As a free agent, the ball was largely in his court.  He set his priorities: winning an NBA championship was number one.  He and his trusted advisors defined a due diligence process to be used to help make the best decision for him to meet his objective.  The process consisted of quantitative and qualitative factors, to be sure.  He applied the process.  Meetings were held; presentations were given by the finalist candidates.  He took his time and considered all the facts and factors that would play into his decision.  He smartly consulted with his trusted advisors.  Finally, he made the decision that lined him up best to obtain his goal of winning an NBA championship. 

Whether or not he knows it, by setting his objective, doing his due diligence, following a process, and focusing on his goal, LeBron exhibited the skills of a good fiduciary.  For example:

He set priorities. The foremost of which was putting him in a situation where he had the best opportunity to win an NBA championship. Having a clearly defined objective lended well to his next step.

He defined a due diligence selection process. Factors likely included:

• The organization, management, coach, and teammates;
• The team history of success; and  
• The compensation he would receive.

Note the parallels with the fi360 Fiduciary Score™ factors that evaluate: Stability of the organization, track record of the investment, and performance relative to peers.  

Importantly, he followed the process.  He faced enormous pressure, but stuck to his process and kept his focus on his objective.  This enabled him to be disciplined and rational, avoiding potential mistakes, including:

• Listening and reacting to “market noise.”  For example, the incumbent lobbied hard for his return.  
• Chasing performance in terms of money or ego.  Certain finalist candidates offered him an opportunity to make much more money than others and also be the sole superstar on the team.
• Being complacent.  He had an opportunity to remain with the incumbent who was familiar and easy.  LeBron grew up in that location, had his family there, and all the comforts of home.

He consulted with trusted advisors throughout.  Knowing that his skills were on the basketball court, he smartly sought counsel from professionals.

He met the call to action and decided.  Executing your decision in a timely manner is important.  And remember, he has no guarantee of success (winning an NBA championship), however he has put himself in the best position to do so with the facts and circumstances now known

Let me know what you think.  Does LeBron have a future career as a fiduciary?

[By the way, if you’ve somehow managed to avoid the newscasts, radiocasts, email alerts, blog posts, tweets, and office water cooler, LeBron selected the Miami Heat.  Other finalist candidates included: the Cleveland Cavaliers (the incumbent), the New York Knicks, the New Jersey Nets, and the Chicago Bulls.  Time will tell whether LeBron's decision ultimately yields him an NBA championship.]

The fiduciary role of investment managers

Thus far in our look at the different types of investment fiduciaries, we have been primarily concerned with those fiduciaries who manage investment decisions for investors. Now we will take a look at those who manage money or make investment decisions, the investment managers. And, yes, they too owe a duty to the end investor.

We define investment managers as "those responsible for buying and selling individual securities for an investment portfolio." This would include money managers who are responsible for separate accounts, mutual and exchange-traded funds, commingled trusts and unit trusts.  Their defining characteristic is they are prudent experts who have investment discretion of assets. And, of course, anyone who is able to act with discretion is clearly a fiduciary.

It is not technically required to use managers for making individual stock and bond selections to implement the investment strategy. However, it would be foolish not to. The stewards and advisors who manage the investment process are held to a "prudent expert" standard if under ERISA or a "prudent investor" standard if under UPIA or UPMIFA, basically meaning they would be expected to implement the strategy with the same competence as a professional money manager. If they are unable to meet that standard, then they become the managers of the managers, if you will, and are instead charged with the prudent selection and monitoring of professionals who can.

The fiduciary practices for investment managers are mostly qualitative and may not be as apparent nor as standardized as is the case with other fiduciaries. So instead of trying to make a qualitative-based selection of a manger, it is better to look at quantitative due diligence screens that reflect adherence to fiduciary standards. The following are the quantitative fields we suggest be used in evaluating investment managers:

1. Regulatory oversight
2. Minimum track record
3. Stability of the organization
4. Assets in the product
5. Holdings consistent with style
6. Correlation to style or peer group
7. Expense ratios/fees
8. Performance relative to assumed risk
9. Performance relative to a peer group

For more information on basic fiduciary responsibilities for investment advisors, check out the following resources:

• CEFEX/fi360's Self-Assessment of Fiduciary Excellence for Investment Managers: http://safe.actifi.com
• CEFEX/fi360's Prudent Practices for Investment Managers handbook: http://www.fi360.com/main/practices_im.jsp
• The CFA Institute's Asset Manager Code of Professional Conduct: http://www.cfainstitute.org/centre/codes/asset/
• The European Fund and Asset Management Association's Code of Conduct for the European Investment Industry: http://www.efama.org/index.php?option=com_docman&task=doc_details&gid=150&Itemid=35
• The Risk Standards Working Group's Risk Standards for Institutional Investment Managers and Institutional Investors: http://cmra.com/risk_standards_working_group.php
• United Nations' Principles for Responsible Investment: http://www.unpri.org/

The fiduciary role of investment advisors

As the overall manager of the investment process, investment stewards have a responsibility to delegate to professionals roles they are not equipped to handle themselves. The regulated investment professionals to whom they turn for assistance in the management of a plan or portfolio are what we call investment advisors. We define investment advisors as "professionals who are responsible for providing comprehensive and continuous investment advice, including wealth managers, financial advisors, trust officers, financial consultants, financial planners and fiduciary advisers."

"Comprehensive and continuous" is the operative term here. There are many service providers, sales people, etc., who make their living servicing investment portfolios in some fashion, but not all of them operate as fiduciaries. Those who are giving ongoing advice to the stewards on the management of the plan are deemed to be fiduciaries. In that case, they will be held to standards of conduct as defined by the appropriate rules. (Note: The purpose of this post is not to go over in detail the standards of conduct for advisors, as that is what we do in this blog on a day-to-day basis. Rather, it is to put into context the overall role of the advisor in the investment process and fits into our "Fiduciary Basics" category. For more information on the rules for fiduciaries, start with our post on Practice 1.1)

Basically, an advisor can be engaged to fulfill any role that defaults to the investment steward. Whether that means engaging in a limited scope capacity, advising over the entire process while leaving discretionary decisions to the steward, or even being engaged to take discretion of all the steward's duties, it is critical that the scope of services is agreed upon in writing at the outset of the engagement, specifically addressing the assumption of fiduciary responsibility.

Unforunately for the investing public, it is not always evident who does or does not assume a fiduciary role. Investment advisors operate under a wide range of job titles and are governed by a fragmented and outdated regulatory structure. Non-fiduciary service providers often operate under job titles that include the words "advisor" or "consultant" and can even give "incidental" advice without assuming any fiduciary responsibility. An influential and controversial report by the RAND Corporation highlighted these issues when it found that even when explained to them, most investors still could not differentiate between fiduciary and non-fiduciary advisors. Also, because of the disjointed regulatory structure and lack of uniform advanced education requirements, even the advisors who are fiduciaries often have a limited understanding of the fiduciary code of conduct.

Clearing up this confusion and enhancing consumer protections are among the goals of financial regulatory reform that is currently being debated by Congress. It remains to be seen, however, just how effective new legislation will be. You can keep up to date with the progress of regulatory reform, which will have major implications on how advisors operate and how investors identify them, by following the "regulatory update" posts on our blog.

For more information on basic fiduciary responsibilities for investment advisors, check out the following resources:

• fi360's Self-Assessment of Fiduciary Excellence for Investment Advisors: http://safe.actifi.com
• fi360's Prudent Practices for Investment Advisors handbook: http://www.fi360.com/main/practices_sa.jsp
• The RAND Report on Investor and Industry Perspectives on Investment Advisers and Broker-Dealers: http://www.rand.org/pubs/technical_reports/TR556/
• Scott Simon, AIFA® describes the different flavors of investment advisors for Morningstar Advisor: http://advisor.morningstar.com/articles/article.asp?docId=17902&pgId=rss
• The definitions section of ERISA: http://frwebgate3.access.gpo.gov/cgi-bin/TEXTgate.cgi?WAISdocID=09927814470+0+1+0&WAISaction=retrieve
• The Investment Advisers Act of 1940: http://www.sec.gov/rules/extra/ia1940.htm
• The Department of Labor's Employee Benefits Security Administration: http://www.dol.gov/ebsa/
• Reish article on the hazards of investment advice to both advisors and participants: http://reish.com/publications/article_detail.cfm?ARTICLEID=457

The fiduciary role of investment stewards

Last month, we looked at how investment fiduciaries could generally be broken down into three different categories. Now we'll begin looking at each type in more depth, starting with the investment steward.

As noted in that first post on the types of investment fiduciaries, investment stewards are the trustees, investment committee members, plan sponsors and others in similar positions who are responsible for managing the money of others. The Department of Labor defines their basic responsibilities thusly:

[T]o run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses. Fiduciaries must act prudently and must diversify the plan's investments in order to minimize the risk of large losses. In addition, they must follow the terms of plan documents to the extent that the plan terms are consistent with ERISA. They also must avoid conflicts of interest. In other words, they may not engage in transactions on behalf of the plan that benefit parties related to the plan, such as other fiduciaries, services providers or the plan sponsor. 

Investment Stewards make for an interesting case because they carry the most risk and are in charge of managing the entire investment process and yet are usually the least trained and experienced in investment decision making.  Beyond the basic tenets of fiduciary responsibility described above, statutes, regulations and case law have defined more specifically what the prudent management of investment decisions entails. Liability arises in the gaps where certain duties are potentially not being performed, exposing investors to unnecessary risk or to less than diligent decision making. The best way to reduce liability for stewards is to follow processes, document decisions, delegate to professionals the roles they are not equipped to perform themselves and, above all, remember what is at stake for those who have placed them in a position of trust and act accordingly.

While investment stewards can limit their liability, they can never fully abdicate their responsibility to be the true managers of the investment process. All decisions need to be made with proper due diligence and conscientious monitoring, including the decision to delegate responsibilities to professionals and the ongoing monitoring of their effectiveness. The steward starts with and retains all fiduciary responsibilities and will be held accountable for their being performed appropriately. In our classroom programs we illustrate the point by asking students to imagine themselves in "the chair" in a courtroom defending their decisions. Could you confidently say all duties were being performed? Could you articulate your decision making processes? Do you have documentation that proves you acted prudently? Would you be able to look others in the eye and say that you made decisions because they were right for those whose money you were managing?

Despite individually sitting at the top of the fiduciary pecking order and collectively managing a majority of all assets invested in capital markets, it is not uncommon for investment stewards to be virtually unaware of the scope of their duties, if they even realize their liability exists at all. One of the most important fundamental shifts needed to improve the management of retirement assets and other investment management is for a greater awareness among stewards of both the extent of their responsibility and the specifics as to what is required for prudent management.

For more information on basic fiduciary responsibilities for investment stewards, check out the following resources:

• fi360's Self-Assessment of Fiduciary Excellence for Investment Stewards: http://safe.actifi.com
• fi360's Prudent Practices for Investment Stewards handbook: http://www.fi360.com/main/practices_sa.jsp
• DOL site on fiduciary responsibilities: http://www.dol.gov/dol/topic/retirement/fiduciaryresp.htm
• DOL site for fiduciary education: http://www.dol.gov/ebsa/fiduciaryeducation.html
• The law firm Reish & Reicher's publications for plan sponsors: http://www.reish.com/publications/content.cfm
• TIAA-CREF's guidelines for fiduciary compliance http://www.tiaa-cref.org/administrators/compliance/guidelines/categories/fiduciary.html

How does the Investment Steward become concerned about and engaged in the fiduciary process?

Many financial services professionals, particularly investment advisors and managers, have realized the importance of fiduciary processes and the beneficial impact they can have for themselves and the investors they serve. Many more are coming around as a financial crisis and regulatory reform has changed the landscape. But can the same be said for investment stewards? Have the benefits of implementing fiduciary processes resonated enough to motivate them to make changes? An email we received last week from an advisor who was trying to convince a prospective client to engage him to conduct a fiduciary review highlighted suggests not. 

The prospective client, an investment steward for a retirement plan, had told them, "You've spent a lot of time over the what, how, when, where and who of fiduciary processes - particularly in the investment arena.  The one thing I'm not catching is the why."  This statement gets to the heart of what many advisors struggle with; how can I convince prospective clients (plan sponsors and participants, foundation or endowment investment committee members, trustees, and retail investors) that incorporating a prudent investment process is important?  Several thoughts were either articulated by the email originator or come to mind from previous conversations we have had related to this topic.  

Through this and other discussions, we focused on the following arguments for stewards implementing a prudent process:

• Helps to avoid complaints for breach of fiduciary responsibility that may lead to litigation or, in the case of brokers, arbitration 
• Reduces liability by helping to uncover investment or procedural risks
• Helps ensure compliance
• Should lead to better investment performance

The first three points indicate that the process can prevent bad things from happening and the fourth focuses on the potential and significant positive result.  We mentioned in a previous blog post that adherence to the fiduciary practices can lead to better performance.  With limited data to support this claim, we suggest discussing particular practices (S-1.4, 3.1, 4.1, 4.2, 4.4, and 4.5 immediately come to mind) with the skeptical steward to logically explain why one would expect that implementing a prudent process by adhering to the fiduciary practices will generate improved performance.  However, we expect there are other things we have not thought of.

For that reason we would love to hear from you.  If you are a financial service professional, have you been able to motivate the investment stewards with whom you interact to embrace the notion of improving their investment management process?  If so, how did you do so?  Investment stewards that are reading this blog post have probably already decided that carrying out your fiduciary responsibility is a high priority.  What was it that got your attention and drove you to establish and maintain a prudent investment process?

Types of investment fiduciaries

Not all investment fiduciaries are created equally. Generally speaking, there are three types of investment fiduciaries, each with specific roles in the investment process. This is an important point of distinction for those who are just beginning to become familiar with the fiduciary concept.

The first type is the investment stewards. These are the trustees, investment committee members, and plan sponsors. While these individuals may have the least amount of investment training, they have the most responsibility. As the first on the fiduciary scene, they are responsible for managing all of the fiduciary responsibilities for a portfolio. Because successfully managing every fiduciary responsibility is beyond the scope of the typical investment steward, the onus is on them to delegate certain responsibilities to professionals who can.  But regardless of what duties are delegated, their duties cannot be completely abdicated, as it is still their duty to manage the overall process, choose prudent experts appropriately, and monitor plan activities.

The second type of fiduciary is the investment advisor. They are the prudent experts who give advice to a plan. They fall under a wide variety of job titles, usually including the words "advisor," "consultant," or "planner." And, under current regulation, not all  professionals who have those titles can be considered a fiduciary. Rather, fiduciary duty in their case is determined by facts and circumstances, beginning with whether they are providing comprehensive and continuous investment advice, the hallmark of an investment advisor who is a fiduciary. The specific fiduciary duties to which they must adhere is dependent on the role they are serving. They may be engaged to perform a specific role, in which case they would only be responsible for fulfilling that role to a fiduciary standard. However, if an advisor begins performing a role, even one for which they are not contractually engaged, the expectation is they will fulfill that role to the fiduciary standard.

Finally, there are the investment managers. Managers are those who make individual securities selections to implement an investment mandate. This would include money managers for mutual funds, separate accounts, and exchange-traded funds. Their fiduciary duty arises from their discretion over assets.

This is a simplistic look at the three basic types of fiduciaries for the fiduciary beginner. In future Fiduciary Basics posts we'll look at the three types in greater detail and go over the specific duties each has to the individual investor and how their role fits into the overall investment process. 

Identifying the fiduciaries

Fiduciary duty is determined by facts and circumstances and it is not uncommon for fiduciaries to be unaware of their status. One of the first issues that will arise in breach of fiduciary duty litigation is determination of whether the defendent, in fact, owed a fiduciary duty. For the protection of the fiduciaries and investors alike, it is better to address this issue up front, by properly identifying the fiduciaries, documenting their status and role in the investment policy statement, and requiring the fiduciaries to acknowledge their status in writing. Not only will this help prevent misunderstandings, it ensures every step in the investment process is accounted for and that the fiduciaries are taking the proper steps to fulfill their role.

So what makes a person a fiduciary? There are four general categories of fiduciaries in regards to managing an investment process:

1. Those who are "named" in plan or trust documents
2. Those whose function equates to providing comprehensive and continuous investment advice
3. Those who have the discretion to buy and sell investable assets
4. Those who have the authority to appoint other fiduciaries

Where there can be some doubt as to fiduciary status is the case of hired investment advisors.  In the case of litigation or arbitration, a judge or panel would ask some form of the following three questions to determine status:

1. What were the scope of services being offered?
2. What was the client's level of sophistication in managing investments?
3. How many investment options were suggested to the client?

Again, it would be better for all parties if these questions were asked before any disputes arise that might lead to litigation or arbitration.  Better yet, the client and advisor should go over these questions and have a mutual understanding of fiduciary status before an engagement is solidified. If the advisor is brought on for a single, one-time purpose, such as a manager search, then the advisor is most likely not a fiduciary, whereas being hired on a retainer basis probably does arise fiduciary duty. The more sophisticated the client is, and therefore less dependent on the advisor, the less likely the advisor will be deemed a fiduciary. And, if an advisor only suggests a single investment option, that would probably indicate investment advice and the fiduciary status it carries.

Once the determination of fiduciaries is made, it is best to have the fiduciaries acknowledge their status in writing.  You can view a sample acknowledgement of fiduciary duty letter here. Not having a signed acknowledgement won't shield a fiduciary from their liability, but having one both prevents misunderstandings in the event of dispute and creates a greater awareness of the expectations of the fiduciary relationship.