fi360 Blog

Should advisors have an education policy statement?

It was only recently that we first heard of an education policy statement. But it is something we are increasingly being asked about by our members.  

The only documents we specifically recommend as part of the "fiduciary file" are applicable trust documents, custodial/brokerage statements, investment performance reports, service agreements with investment management vendors, the investment policy statement, investment committee minutes, asset allocation/asset liability studies, due diligence fields on funds/money managers and monitoring procedures for funds and/or money managers.

Although we do not see an education policy statement as an integral part of the fiduciary process, the best reasons for instituting one are for the value it can provide to you in clarifying the goals and strategy in your participant education activities or for marketing purposes, if it is something you are encountering as a demand of the market.

During our training programs, we do discuss participant education as part of 404(c) safe harbor compliance. Part of 404(c) requirements is to ensure participants receive sufficient education on the available investment options to make an informed investment decision. In that regard, we do recommend that a good education program should include providing each participant with:

• each investment option’s most recent prospectus or similar document
• a general description of the investment objectives and risk/return characteristics of each investment option
• information on the fees and expenses associated with each investment option
• a listing of the securities held by each option
• the performance of each investment option
• to be safe, MPT stats, such as the Alpha, Sharpe ratio, and standard deviation of each investment option

For more information on education policy statements and participant education, in general, check out some of the following resources:

• An article in Employee Benefit News on how to reinvigorate 401(k) plans, including a source from Transamerica who recommends an EPS: http://ebn.benefitnews.com/news/out-of-hibernation-2710045-1.html
• A look at what Fred Reish has written on a given subject is usually helpful. Here is the results page for a search on “participant education”: http://www.drinkerbiddle.com/publications/list.aspx?KeywordPhrase=participant%20education
• An article on how to develop an education policy and strategy, including a recommendation to formalize it with an EPS: http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401kEducation.aspx
• A blog post we did a while back on participant education: http://blog.fi360.com/fi360_blog/2008/12/a-question-on-p.html
• DOL guidance on participant investment education: http://www.dol.gov/ebsa/regs/fedreg/final/96_14093.htm

A unique end of the year review

The week between Christmas and New Year's Day is typically very quiet in the fi360 office and this year has been no exception.  So it was unusual for us to have a conference call scheduled with a local registered investment advisory firm to review the current status of legislative/regulatory reform.

This firm was conscientiously seeking to ensure they were keeping abreast of regulatory changes that had recently occurred (or were coming soon) so as to determine what changes they would need to make to their business model, service agreements, or disclosure documents.  Our presentation and the ensuing discussion covered the following topics:

• SEC's still yet-to-be-proposed Fiduciary Rule for brokers and advisers providing investment advice to retail investors
• Investment advisor oversight (SRO Draft Bill)
• The following Department of Labor (DOL) regulatory initiatives:
  • Proposed new federal fiduciary definition
  • Proposed Target-Date-Fund Disclosure (TDF) Rule
  • Fiduciary Advice Rule--individual participant advice
  • Interim Final 408(b)(2) Regulation (plan disclosure)
  • Final 404(a)(5) Regulation (participant disclosure)

Much uncertainty surrounds all of these regulatory/legislative initiatives.  The SEC has yet to write their new fiduciary rule, and there is much debate on how stringent it should be.  It's unlikely that an SRO Bill will clear Congress in 2012 so FINRA, SROIIA and others may have to be patient.  DOL's proposed federal fiduciary definition has encountered stiff political headwinds, and it is likely that the revisions in the next proposal will be material, particularly with respect to IRAs.  The TDF Regulation continues to languish, and most expect only a tepid industry response to the final participant advice regulation.  The plan [408(b)(2)] and participant [404(a)(5)] disclosure regulations will become effective on April 1 and May 30, respectively, but there are rumors of further delays.  In the case of 408(b)(2), it is still an "Interim Final" regulation so it is possible there may be additional changes; though probably minor if they do occur.

During the conference call, as we discussed this uncertain environment, it became clear that this particular firm was well-positioned to navigate these shifting waters. They are a registered investment adviser that only accepts asset-based fees; no commissions, 12b-1 fees or revenue sharing of any sort.  They have no affiliations that would create inherent conflicts of interest.  It became clear that their business model will not have to change regardless of how the aforementioned proposed rules unfold.  They realized that their primary focus should be on the plan and participant disclosure regulations which they considered to be a manageable endeavor.  In short, they were relieved.

It won't be as simple for the registered reps and insurance agents providing investment advice.

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.

Do you always read what you sign?

Each year, our AIF and AIFA designees are required to renew their designation by completing continuing education requirements, attesting to the Code of Ethics, and paying their designation dues.  Often times, they have questions about the process that are addressed via email or over the phone by our staff.  One such exchange turned into a prolonged dialogue via email and eventually a conference call to discuss our differences of opinion.  Ultimately, the designee renewed his designation, although it was not a given that would be the end result.

The primary point of contention was the first bullet in our designee Code of Ethics, which reads:

"I will employ and provide the client information on the Prudent Practices when serving as an investment fiduciary and/or advising other investment fiduciaries."

The designee did not feel comfortable attesting to this statement because he did not provide information on the Practices to all of his clients and, for various reasons, did not intend to do so; at least not in the short term. 

We often refer to our Prudent Practices (Practices) as a checklist that defines a fiduciary standard of care.  With the exception of CEFEX-certified firms, we are not aware of any firm that is aligned with all of them.  We explained to this designee that although we deemed the Code of Ethics very important and expected that it would be followed, we did not expect perfection.  We described how the Practices are based on ISO 9000, which defines a quality management system that is based on continuous improvement.  We explained how we routinely tell departing students that their new found fiduciary knowledge should be disseminated in bite size pieces so as not to overwhelm their co-workers, peers, or clients.  Improvements or changes to the investment management process should be made systematically over time so as not to be too disruptive to the ongoing operations.

If this designee was ignoring the Practices, that was a problem.  But if it was simply that it would take some time before he could be completely aligned with the Practices for all of his clients, we did not see why he could not attest to the Code at stated above.  He eventually agreed, attested to the Code of Ethics, and renewed his designation.

Admittedly, at times we felt that this designee was being a real pain; splitting hairs.  We joked with him that as an attorney, isn't being a pain a large part of what he is trained to do.  But upon reflection, we couldn't help but be impressed and will consider some of suggestions upon our next review of our Code.  Most all professional designations have a Code of Ethics and all of them have a percentage of designees that do not take the Code seriously or, worse, intentionally violate it.  Many could not tell you what it says.  It's those type of designees that keep us awake at night.  If only all were this deliberate before they attested to the fact that they would comply.

Do you read and fully intend to abide by what you sign?

Do investors really need investment advisors?

Anytime we receive the same or similar questions a few times within a short time frame, we're normally thinking that it is probably a good topic for a blog post.  This particular question is one we have heard in the past, but has taken on a different twist more recently.  Previously we would hear, "how can I convince prospective clients that they need to hire an advisor who will assume much of, or at least help them manage, their fiduciary responsibility?  They don't have a sense of urgency that this is important and needs to be addressed."  More recently, the question has changed to, "how do I respond to a current client that is questioning the need to keep me; not that they are looking for a better or cheaper advisor, rather they wonder if they need an advisor at all?"

The question has surprised us because our general sense is that investment stewards, the lay fiduciaries, are growing more uneasy in this volatile market and more likely to seek professional help.  But there are some who are feeling quite the opposite, in which case they may be thinking one or both of the following:

• We have sufficient internal expertise to do this ourselves.
• Eliminating our investment advisor or consultant could save us a lot of money.

Investors (plan sponsors, investment committees for foundations and endowments, and individuals) may have sufficient internal resources to oversee the investment management process and nothing in the law prevents them from doing so.  However, in their fiduciary role they are expected to ensure that investments entrusted to their care are managed with the skill and judgment of a professional.  If they can't meet that high standard, and most can't, they should hire outside professionals.  For plan sponsors, ERISA requires fiduciaries to get help when they need it.  A big part of mitigating fiduciary risk is to seek professional help as appropriate.

Fiduciary consulting--embrace it

We received a call from an AIF designee earlier this week asking for help.  He was updating his personal information in the CFP database and having trouble finding a category in the database drop down list that fit the fiduciary service he was providing to clients.  My impression was that there must have been an "Other" category that he could select, but he needed to provide a short description of what "Other" was.  His voice mail indicated that he was thinking of using "Fiduciary Adviser," but when we talked, we agreed that "Fiduciary Adviser" was too narrow as it typically refers to providing specific investment advice to qualified plan participants per the Pension Protection Act.  After listening to what services he was providing, my suggested description was "fiduciary consulting."  He liked the description and intended to contact the CFP Board and suggest it be added to the drop down list in their database.

Our sense is that the demand for fiduciary consulting is increasing.  We just completed AIF and AIFA programs at the University of Pittsburgh that had to be added to the initial schedule released at the beginning of the year.  CEFEX has seen a steady increase in phone calls asking about fiduciary assessments and certification programs.  Large insurance providers are partnering with registered investment advisory firms that provide ERISA 3(21) and 3(38) services to qualified plans.

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?

How often is the fiduciary required to review their service providers?

The question in the title of this post was recently posed by an advisor who understood the need for a fiduciary to review his service providers periodically, but he wanted to know what was considered the industry best practice.  It is a timely question in light of the recent issuance of the 408(b)(2) regulation, which requires covered service providers, as defined in the regulation, to ERISA plans to review their written agreements by the time new disclosure requirements become effective on July 16, 2011.  Technically, these additional disclosures can be made in a separate written document, but most will utilize their service agreement to comply with the new rule.

There are two practices that apply to this question:

• Practice SA-1.4 - "Service agreements and contracts are in writing and do not contain provisions that conflict with fiduciary standards of care."  One criteria under this practice states that "Consideration is given to putting vendor contracts back out for bid every three years."
• Practice SA-3.4 - "A due diligence process is followed in selecting service providers, including the custodian."

Both of these Practices are established in law and regulation. For ERISA plans, DOL interpretive bulletin 2509.75-8 states the following:  "At reasonable intervals, the performance of trustees and other fiduciaries [such as investment managers] should be reviewed by the appointing fiduciary in such manner as may be reasonably expected to ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan.”  UPIA, which applies to private trusts, Sec. 9(a) states:  "[t]he trustee shall exercise reasonable care, skill, and caution in (1) selecting an agent, (2) establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust, and (3) periodically reviewing the agent’s actions in order to monitor the agent’s performance and compliance with the terms of the delegation.  UPMIFA, which applies to charitable organizations, Sec. 5(a) has similar language.

So, it is established that fiduciaries for retirement plans, foundations, endowments, and private trusts should periodically be reviewing and evaluating what their service providers are doing.  When we discuss in class the fiduciary requirement to prudently select and monitor service providers, such as money managers, investement advisors, and custodians, it usually gets advisors' and reps' attention when we suggest that, as an industry best practice, they should advise their clients to evaluate the relationship every three years. Needless to say, many aren't so receptive to the idea.

Even though there may be some risk to suggesting that clients review whether you are still the best person or organization for the job, we believe it is typically a win-win for both parties, and most feedback confirms that assertion. In follow up conversations with designees who have helped their clients put out formal RFPs (Request for Proposals) or informal RFIs (Request for Information), we have received the following responses:

• My clients were surprised and very impressed that I suggested conducting this review.
• The client needed my help to navigate this process, which kept me in the driver's seat.
• I learned that although my fees were higher, I was providing additional services that justified the higher fees.
• I needed to lower my fees to keep the client as it became clear that I was higher than most who were providing similar services.
• It forced me to keep abreast of what my competition is doing, which ultimately made me more competitive.
• The fact that I suggested we go through this process will probably ensure that I keep this client for life.

How does a fiduciary review make us safer?

We received a call from one us our designees recently who was caught off guard by a basic question they received from a prospective client, when they suggested that the client consider a fiduciary review: How does a fiduciary review make us safer?  Maybe it caught the advisor off guard because the question was so simple and straight forward and he stumbled over his response.  That gave us the opportunity to discuss and reflect on what the appropriate answer might be.

Essentially, a fiduciary review examines the investment management process of an individual or organization that is in place (assuming there is one), holds it up against fiduciary practices to determine what is and is not working, then creates a prioritized list of deficiencies that need to be addressed.  This review can be done in three ways:

1. Self Assessment – the individual or organization examines their own process to identify and correct deficiencies.
2. Consultant’s Assessment – the individual or organization engages an outside consultant to help them identify deficiencies; usually to help correct them as well.
3. Independent Assessment – the individual or organization engages an outside consultant to assess whether they meet all fiduciary practices with the intent of receiving a formal certification, along with the associated recognition.

We recommend that these three reviews be done in this order, although not all will deem it necessary to proceed to independent certification of their investment process.  Virtually all that have obtained formal certification through the Centre for Fiduciary Excellence (CEFEX) to date have prepared themselves by going through a consultant’s review first.

We believe the review will make the responsible fiduciaries safer because it will help them identify and correct deficiencies.  Some fear going through this process as they are afraid that identifying shortfalls in their process will expose their organization to greater liability.  The problem with that approach is that the fiduciary will not be excused because they didn’t know.  So sticking your head in the sand is not the answer.  Keep in mind that when a beneficiary, participant, or client complains, the investment fiduciary is judged by the process they have in place, as opposed to the investment results.  A fiduciary review helps a fiduciary establish and/or maintain a prudent process, and practically speaking that’s the best insurance against litigation or arbitration there is, although we are not suggesting that a fiduciary go without fiduciary liability insurance.

Your questions on monitoring client and investment fees

For our last webinar in June, we addressed the topic "monitoring client and investment fees." Both during the webinar and in follow-up, we received a lot of questions asking for further clarification. In this post, you'll find answers to the majority of questions submitted during the session written by the panelists from the original webinar. 

A recording of the webinar can be viewed on the webinars page of our website. If you still have any questions, let us know in the comments below.

Our next webinar will be on Thursday, September 9 from 4:00-5:00 p.m. EDT on the topic of how regulatory reform will change the way advisors and brokers do business. To register, click here.

Now on to those questions:

Q: For the mutual fund companies, the management fee is normally included in the expense ratio, correct?
A: Yes, the management fee is included in the expense ratio.  We typically use the Prospectus Net Expense Ratio in our analysis and it includes the management fee, 12b-1 fee, administrative fee, and all other asset-based costs incurred by the fund.

Q: Where do you get the information for the sub t/a fees? We have found that different custodians negotiate different sub t/a fees from fund families.
A: The sub t/a fees used in the presentation were examples.  You are correct in stating that the sub t/a fees can change from custodian to custodian and from plan to plan.

Q: For an individual with a 403b annuity plan, it sounds like all annuity fees are included in the published "expense ratio," correct?
A: When evaluating an annuity expense ratio we look at the expense ratio for the underlying investment and the M&E risk charge for the annuity component.  There are other fees and expenses that are not part of this "expense ratio" that should be considered such as contract charges, annuity administration fees and surrender fees.  These components are not part of the expense ratio.

Q: What resources do you recommend (books, websites, etc.) to determine what are reasonable plan fee's, industry avg's  etc.
A: Fiduciary Benchmarks, Brightscope, icifactbook.com, and 401k Averages Book

Q: Please clarify how the ERISA bucket works, why created, etc.