fi360 Blog

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.

The Difference Between Suitability and Fiduciary

I recently read an industry organization's account of a presentation by a FINRA official who promoted a "uniform fiduciary standard" but questioned its efficacy for brokers because he believes that the sum of FINRA’s rules are equivalent to the fiduciary standard.  In addition, he believes that FINRA's suitability rule incorporates a fiduciary duty.  

While FINRA has taken steps to strengthen its suitability rule, I still find it hard to swallow a tale where suitability combined with sales practice rules equals fiduciary.  Nonetheless, while working at the SEC, I often interacted with FINRA staff members and officials and do in fact respect many of them on a personal and professional level, so I thought why not do some research on this. 

Being a sophisticated attorney, I first turned to my most trusted research tool and typed "suitability" into Google.  Interestingly, the link at the top of the search results led me right to the SEC website where I found suitability defined as follows:

"When your broker recommends that you buy or sell a particular security, your broker must have a reasonable basis for believing that the recommendation is suitable for you. In making this assessment, your broker must consider your risk tolerance, other security holdings, financial situation (income and net worth), financial needs, and investment objectives."

With such easy results, I quickly typed "fiduciary" into both Google and the SEC search engine, but my trusty tools failed me, which also disconcerted me considering that the SEC has now concluded more than once that investors are confused about when a financial professional has a fiduciary duty (see Rand Report and Fiduciary Report).  Fortunately for me, though, I have spent quite a bit of time searching resources on the SEC website and turned to another trusty source, an outline on the regulation of investment advisers written by SEC staff (which curiously is buried under the Office of International Affairs webpage).  In that outline, I found this familiar description of fiduciary duty: 

"Fundamental to the [Advisers Act of 1940] is the notion that an adviser is a fiduciary. As a fiduciary, an adviser must avoid conflicts of interest with clients and is prohibited from overreaching or taking unfair advantage of a client’s trust. A fiduciary owes its clients more than mere honesty and good faith alone. A fiduciary must be sensitive to the conscious and unconscious possibility of providing less than disinterested advice, and it may be faulted even when it does not intend to injure a client and even if the client does not suffer a monetary loss."

Social media for advisors

Last week for our quarterly webinar, we covered the topic of effective and compliant social media for advisors. The hour long session covered which social media applications offer the most potential for advisors, how they can be of benefit to advisors, understanding the liability and exposure associated with social media, and what regulations have to say about its use.

Joining our own Kristina Fausti us for the event were guest presenters Jessica Weiner from The Value Quotient and Tom Henell from NAPLIA. Some of the highlight included:

• Jessica covering the "Big Three" of social media applications for financial professionals: LinkedIn, Facebook and Twitter and how they have changed marketing from an outbound activity focused on explaining your value proposition to an inbound activity that focuses on growing your list of potential clients.
• Tom covering the differences between first and third party risk exposure via social media, why a social media policy is essential and how the greatest risk in social media is not partaking in it at all.
• Kristina explaining that the basic stance from the regulators is that social media is a form of advertising, so long-standing advertising rules apply and why, no matter who your regulator is, advisors should know and understand FINRA guidance, as it is the most comprehensive to date.

If you would like to view the entire presentation, the recording and slides are now available for download off our website. If you have any additional questions on the topic, leave them in the comments below or send an email to resources@fi360.com and we'll get them to one of the presenters to follow up on.

Monitoring client and investment fees

The fifth Global Fiduciary Precept is to control and account for all investment expenses. It is a fundamental duty of a fiduciary to ensure that all forms of compensation are reasonable for the services being rendered. As such, it is important that fees are evaluated as part of selection, benchmarked against similar options, and regularly monitored to ensure they continue to be reasonable given the alternatives available and as circumstances change.

Yesterday, Mike and Rich presented a webinar that went over why fees and expenses need to be monitored closely; the scrutiny fee transparency is currently receiving from the various lawmakers, rulemakers, media and investors; and the three main fee areas to look at when evaluating investments: client-level fees, operational fees, and shareholder fees.

The recording of the session and slides can both be found on the webinars page of our website. In addition to what is available as part of the recording, we also wanted to highlight some additional reading and materials that were mentioned throughout the webinar as good resources for monitoring fees:

• Practice SA-4.4 from the Prudent Practices for Investment Stewards handbook
• Practice SA-4.5 from the Prudent Practices for Investment Stewards handbook
• The American Jobs and Closing Tax Loopholes Act, which is the House bill currently in the works that will include a fee transparency provision.
• An update on DOL activities from Reish & Reicher, including 408(b)(2) fee disclosure rules expected later this year.
• Information on important, recent fee-related lawsuits:
  • Hecker v. Deere
  • Braden v. Wal-Mart Stores, Inc.
  • Martin v. Caterpillar, Inc.
  • Jones v. Harris
• Reporting and benchmarking tools available from:
  • fi360 Toolkits (the Fee & Expense Report was specifically mentioned in the webinar)
  • Fiduciary Benchmarks
  • Investment Company Institute's Factbook (free resource)
  • Brightscope
  • Ann Schleck & Co.'s Fee Benchmarker

UPDATE: RegisteredRep was in attendance and wrote a nice story about our webinar. Read it here.
  

How many investment options are too many?

Last week we received a call from an AIF designee who was working with a plan that had over 75 investment options available for participants to choose from. He knew it was too many, but asked for our help in putting together a compelling case as to why too many options is not a good thing and what a reasonable number might be.

In the Prudent Practices handbooks, most of Step 2 instructs on designing an optimal asset allocation strategy based on the portfolio's goals and objectives. And in our classroom program, we include considerations of the “1/n” phenomenon, where investors divide equally among investment options available, as well as participants who will go to the opposite extreme and select a single investment option. These common behaviors illustrate why careful management of the number and type of investments offered in a participant-directed plan are critical plan design considerations.  A particularly helpful slide suggests an order for adding asset classes to a portfolio based on factors such as the size of the portfolio, the investment expertise of the fiduciary, the ability of the fiduciary to properly monitor the number and variety of options considered, and the sensitivity of the fiduciary to investment expenses.

Other than this guidance that the number of investment options should be based on facts and circumstances, we don’t offer any kind of formula or benchmark as to the specific number of options. To try to find more specific information, I turned to research to find how the number of investment options available can affect either investment behavior or portfolio performance.

First, a study from the Journal of Finance found investors tended to choose a small number of funds to invest in, no matter how many were offered, and that they tend to invest roughly equal amounts in each of the funds they select. So, at least in this one study, a large number of options does not correspond in participants taking advantage of them.

So what's the harm in making a large number of options available? The negative effects are most felt in investor behavior. A study from Columbia University found that when the number of investment options went up, enrollment went down, all the way to just 60% participation when the number of investment options approached 60.  (This study and others are cited in an Executive Summary from Vanguard on the subject).

Not only does the number of options affect participation rates, it can also affect how investors make their choice. One study from AllianceBernstein shows that as the number of investment options go up, so does the conservative nature of the funds chosen. The only factor that should be influencing selection should be which options help the beneficiary achieve their end goal.

Another important factor to consider is the number of options within a certain asset class.  In a review of its own state employee retirement system plan, the state of Missouri found that offering too many similar options was contributing to overlap and therefore improper diversification. It also found that by decreasing the number of options available and introducing target-date funds, it would be able to save on management fees and, potentially, administrative costs to the plan.

But perhaps the best case study I found demonstrating an effective and thorough process for selecting asset classes and investment options came from an investment option review by the Federal Thrift Savings Plan. The review found the plan to be comparable to peer plans with 10 available options.  The TSP review also includes great insight into their evaluation of investment options and why the individual asset classes either were or were not included among available options, and why some asset classes had only one option versus multiple options. You may find the 80+ page report excessive to reproduce for your own needs, but it demonstrates the type of thought process and documentation that a plan should be considering when building a prudently built portfolio of fund options that suits the goals and objectives of the end beneficiaries.

Other Resources:

• Plan design is just one of the metrics measured by Fiduciary Benchmarks, Inc., see this sample report.
• TIAA-CREF put together a research summary on plan investment options and investor behavior.
• Fi360 Tools offers an asset allocation optimizer for building diversified portfolios.

Have you had similar experiences where a plan has excessive investment options, seemingly just for the sake of having a lot of options? How did this affect the plan? Were you able to get the plan to revise their offerings to a more reasonable number? Let us know in the comments section below.

If you have a fiduciary question you need answered or would like to see addressed in a future blog post, let us know in the comments section or send an email to blog@fi360.com. 

Go to sources re: 403(b) plans

A question came in last week about fiduciary processes in the sponsoring and advising of 403(b) plans.  In their question, they provided some context:

We have many government entities as clients, and some of these have 403(b) plans not subject to ERISA.  They are structured in many cases such that each participant has a “stand alone” plan using insurance contracts.  Plan sponsors, historically, have no responsibility for the operation of these contracts, other than to submit contributions.  What references do you have for this type of environment? 

While we haven't focused directly on 403(b) plans, we were able to dig up some useful information for them.  Perhaps most pertinent to our audience is a white paper on Principal's website, including a section from our good friends Fred Reish and Bruce Ashton, that indicates the "no responsibility" assumption that has existed historically may no longer apply under recently updated regulations.  In fact, their conclusion is that most 403(b) plans will be subject to ERISA fiduciary provisions.

Speaking of Reish, they have touched on various aspects of 403(b) in their bulletins and reports.  To see the list, search publications on Reish.com for "403(b)".  Don't forget the parentheses and make sure you expand your search dates to "All".

We also found what looks like a pretty good source in 403bwise.com.  It includes information for participants, employers and advisors.  If you, like our question-asker are already familiar with the basics, I'd suggest skipping right to the page on new regulations, which itself contains links to all the pertinent links on the IRS's website. 

Finally, at our 2008 conference, we had Robb Smith as a speaker on 403(b) updates.  Our designees can access a recording of the session, by visiting the Online CE section of the designee portal.  For any non-members out there, we'll give you a sneak peak at his presentation materials and handouts.  It should be noted that this session was presented with knowledge of the then-pending new regulations, but before they had gone into effect, so some information may be dated.

Welcoming an AIF designee to the blogosphere!

AIF designee Joshua P. Itzoe, who released his book Fixing the 401(k) in October, launched his Fixing the 401k blog last week.  The blog is focused on further expanding on the premise of the book,
"What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully."

Joshua writes in his first post, "This blog is intended to provide you, the reader, with timely and useful information concerning fiduciary responsibility, ERISA, and developments in the rapidly changing 401(k) industry. It is based on my strong belief that our country's retirement system is broken and in critical need of repair and transformation."

We congratulate Joshua on the success of his book and look forward to following his blog.  Josh is another great example of AIF and AIFA designees who are leaders in advancing the fiduciary cause.

If you are or know an AIF/AIFA designee who is making a difference in the industry, let us know.  We'd also like to know of other great blogs and sources of information that you go to for more information.  Make sure you leave them in the comments section below.

Uniform Law Commission Website a great place for information

I recently received an email from an AIF designee with a question about under which laws do foundations and endowments fall in the state of Washington.  Now this is a fairly specific question that won't apply to almost everyone who would be reading this.  However, it is worth pointing out a very valuable resource for this type of question: the National Conference of Commissioners on Uniform State Laws (NCCUSL).

The NCCUSL is a 117-year-old organization that drafts laws for states to adopt in order to promote uniformity of law across state lines.  Using the Final Acts and Legislation link from their home site, you can search through all of the acts drafted by the NCCUSL (which is not limited to investment or financial-related legislation) or search your state to see which acts have been enacted by your state.  For the case of our audience, the most relevant searches would be the Prudent Investor Act (UPIA), the Prudent Management of Institutional Funds Act (UPMIFA), or the Management of Public Employee Retirement Systems Act (MPERS).  Each of these acts are used as substantiation for our Prudent Practices handbooks, with full legal substantiation derived from these acts found in our Legal Memoranda handbook.  And, on the respective page for each of these acts, you can find the full text of the act, a legislative fact sheet on an act (including a list of the states who have adopted it), a summary of the act, and other important information.

To use the original question above as an example, UPMIFA is the current legislation on the governance of foundations and endowments.  A quick search of UPMIFA on the NCCUSL site revealed that Washington has not enacted UPMIFA.  One possible explanation for this is that UPMIFA is relatively new, is replacing UMIFA, and maybe Washington just hasn't reached the point of enactment yet.  By checking the NCCUSL site's related sites page, we found that UPMIFA had its own page that included a comparison of UPMIFA with the laws governing each state.  After checking on Washington, it was confirmed that the state was still going by the predecessor, UMIFA.

Not every uniform act has its own page, and I wasn't able to confirm why Washington has not introduced UPMIFA for consideration yet.  Further research on the subject would need to be done by perhaps visiting the State of Washington legislature's Website. But, if you are looking for information on one of the uniform acts or the relevant legislation in your state, the NCCUSL page is an excellent starting point.