Hiring a Fiduciary Can Reduce Company Owners’ Headaches


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Owners of small companies want their corporate retirement plans to serve their employees well and are legally required to do so. Unfortunately, it is commonly recognized that many owners of companies with less than $50 million in retirement assets don’t really get what it means to be a fiduciary. Employers need to understand what they’re up against—and the solution for these challenges. To help them, this report discusses the following:

- Definition of a retirement plan fiduciary and employer\' duties as fiduciaries
- Risks of not acting as a fiduciary
- Owner\'s ability to delegate some fiduciary responsibility, thus strengthening risk management

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Hiring a Fiduciary Can Reduce Company Owners’ Headaches

  1. 1. Rational. Objective. Independent. White Paper Hiring a Fiduciary Can Reduce Company Owners’ Headaches and Improve Employees’ Retirement Prospects By Allan Henriques, AIFA®, J.D. Smart Investor — A Registered Investment Adviser  9  Visit us online at www.smart-investor.cc
  2. 2. Hiring a Fiduciary December 2009 Hiring a Fiduciary Can Reduce Company Owners’ Headaches and Improve Employees’ Retirement Prospects By Allan Henriques, AIFA®, J.D. Smart Investor 5800 Stanford Ranch Road, Building 800 Rocklin, CA 95765 (916) 435-2100 www.smart-investor.cc
  3. 3. Hiring a Fiduciary Can Reduce Company administration of the plan, all members of a plan’s  Owners’ Headaches and Improve administrative committee (if it has such a committee),  and those who select committee officials… The key  Employees’ Retirement Prospects to determining whether an individual or entity is a  O wners of small companies want their corporate  fiduciary is whether they are exercising discretion  retirement plans to serve their employees well.  or control over the plan,” according to the U.S.  Indeed, once employers adopt corporate retirement  Department of Labor (DOL).1 The DOL administers  plans, they are legally required to do so. Putting  the Employee Retirement Income Security Act of  employees’ interests first is part of their fiduciary duty  1974 (ERISA), the most important law governing  under U.S. law.  corporate retirement plans. Unfortunately, it is commonly recognized that many  Some corporate employees may be surprised  owners of companies with less than $50 million in  to learn that they are fiduciaries. For example, a  retirement assets don’t really get what it means to be  human resources professional learned that he was  a fiduciary.  considered a fiduciary simply because he handled  questions about a participant’s benefit claim,  It can be a time-consuming responsibility, involving  according to a case cited by the law firm of Winston &  intensive analysis and ongoing monitoring of the  Strawn.2 Moreover, the DOL says, “…Fiduciary status  retirement plan. Even when owners understand their  is based on the functions performed for the plan, not  duty, they typically don’t have the time or skills to  just a person’s title.”3 Thus, it’s important to be aware  fulfill every requirement.  of the responsibilities and actions that fall under the  fiduciary umbrella (see Exhibit 1).  Many owners muddle through, although their  employees may struggle to save in substandard  The penalty for breaching any of these fiduciary  retirement plans, and executives may expose  responsibilities could be more than a metaphorical  themselves to legal risks that imperil their personal  slap on the wrist. The DOL says, “Fiduciaries  savings.  who do not follow the basic standards of conduct  may be personally liable to restore any losses to  Fortunately, there’s a cost-effective solution:  the plan, or to restore any profits made through  delegating duties to an independent fiduciary. improper use of the plan’s assets resulting from their  Employers need to understand what they’re up  actions.”4 Fiduciaries are also potentially liable for  against—and the solution for these challenges. To  their co-fiduciaries’ failures. A lawsuit could result in  help them, this report discusses the following: fiduciaries  •  Definition of a retirement plan fiduciary and  losing their personal — as well as retirement plan  employers’ duties as fiduciaries — assets. Moreover, legal fees for individuals could  •  Risks of not acting as a fiduciary •  Owner’s ability to delegate some fiduciary  responsibility, thus strengthening risk  1  “Meeting Your Fiduciary Responsibilities,” U.S.  management Department of Labor, Employee Benefits Security  Administration.  What Is a Fiduciary? 2  Michael S. Melbinger and Michael P. Roche,  “Benefit Plan Sponsors Need to React to the  A retirement plan fiduciary is anyone who is named  Supreme Court’s Decision in the LaRue Case,”  as a fiduciary in the retirement plan documents or  Winston & Strawn Lunch Briefings (March 19, 2008),  who exercises control over the plan’s operation. This  p. 49. This presentation is helpful in understanding  typically includes “the trustee, investment advisers,  the employer’s perspective on fiduciary issues. and all individuals exercising discretion in the  3  “Meeting Your Fiduciary Responsibilities.” 4  “Meeting Your Fiduciary Responsibilities.” page 1
  4. 4. Hiring a Fiduciary December 2009 Exhibit 1: Conditions and Responsibilities of a Fiduciary An individual, committee, or company may be a fiduciary if it: • Is named in plan documents as a fiduciary, though this is not necessary to be considered a fiduciary  — these fiduciaries are called “named fiduciaries” • Exercises control over the management or administration of the plan or its assets • Provides ongoing investment management or advice to the plan or to plan participants • Selects or supervises other plan fiduciaries The DOL says fiduciaries’ responsibilities include   1.  “Acting solely in the interest of plan participants and their beneficiaries and with the exclusive  purpose of providing benefits to them” — Duty of Loyalty (also known as the Exclusive Benefit Rule) 2.  “Carrying out their duties prudently” — Duty of Prudence (also known as the Prudent Expert Rule), described in more detail below 3.  “Following the plan documents (unless inconsistent with ERISA)” — Duty to Follow Plan Documents 4.  “Diversifying plan investments” so as to minimize the risk of large losses, unless under the  circumstances, it is clearly prudent not to do so — Duty to Diversify (also known as Duty to Avoid Large Losses) 5.  “Paying only reasonable plan expenses” — Duty to Pay Reasonable Plan Expenses Relative to Services Provided Elaborating on #2, the Duty of Prudence, it is important to note that fiduciaries are held to the high  standard of a Prudent Expert — not simply a Prudent Person. ERISA explains that this requires “acting  with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent  person acting in like capacity and familiar with such matters would use.” The familiarity clause elevates  the requirement to the level of a Prudent Expert. easily run into six figures or more. In November 2009,  fiduciaries, states that there are generally three types  in Martin v. Caterpillar, the litigants filed a settlement  of investment fiduciaries. proposal calling for a payment of $16.5 million where  it was claimed that the fiduciaries had breached their  First is the Investment Standard — trustees,  duties by maintaining imprudent investment options  investment committee members and plan sponsors  and paying excessive fees. The settlement fund  who usually have the least amount of investment  included $5.5 million in attorney’s fees.  training but are responsible for managing all of the  fiduciary responsibilities regarding the investment  portfolio. Types of Fiduciaries The second type is the Investment Advisor — the  The Foundation for Fiduciary Studies, a non-profit  prudent experts who give advice to a retirement plan. organization established in 2000 to develop and  advance practice standards of care for investment  Third are the Investment Managers — who make  page 2
  5. 5. individual securities selections to implement the  need not threaten the solvency of the entire plan to  investment mandate. reduce benefits below the amount that participants  would otherwise receive.”  Risks for Fiduciaries from Lawsuits and This has potentially huge implications for companies.  Politicians “The likely result of this decision is an increase in  Lawyers and politicians are paying more attention to  ERISA litigation against benefit plan sponsors and  fiduciaries — and most of the attention is negative.  other fiduciaries, including executive officers and  This happens as more people recognize that the shift  board members, who are favorite targets of plaintiffs’  from defined benefit to defined contribution plans has  lawyers,” according to the law firm of Winston &  endangered Americans’ retirement security.  Strawn.5 Now that individuals can file lawsuits, a  company could get stung with many small, yet time- Under defined benefit plans the employer assumed  consuming, costly lawsuits. all the risks and costs of providing the predetermined  level of benefits upon the employees’ retirement.  The LaRue decision also reinforces the point that  Accordingly, the details of costs, investment vehicles,  fiduciary duty is the “highest duty known to law.”  and so on didn’t matter much to plan participants  This means that fiduciaries must exert themselves to  because the details wouldn’t affect the level of their  understand and carry out their duties and to ensure  benefits.  that other fiduciaries are also doing so. In the event  of a fiduciary breach, no excuses are accepted. A  Today, defined contribution plans, such as 401(k) and  fiduciary can’t say, “I didn’t know.” The old saying,  profit sharing plans, outnumber defined benefit plans.  “The buck stops here” applies to all fiduciaries. This  In contrast to a defined benefit plan, the employer’s  makes it more important than ever for companies to  contribution to the plan is defined. Moreover, there  pay more attention to responsibilities in this arena  are no guarantees of the benefit the employee  and to hold all retirement plan advisors and vendors  ultimately receives, and the employee assumes  accountable. all risks. In a defined contribution plan, excessive  expenses, poor investment choices, and poor  Government Taking More Interest in Fiduciaries investment results subtract directly from the benefit  the employee will receive in retirement.  The word “fiduciary” now pops up regularly in news  stories about investments and retirement. Just a  National leaders are looking for someone to hold  couple years ago, the term was restricted to articles  accountable for this crisis. They could zero in on  aimed at a narrow group of professionals. This also  employers. The bottom line for owners of small  raises the likelihood of retirement plan fiduciaries  companies: there’s a rising likelihood of getting sued  coming under fire. and becoming subject to more legislative control. For example, the SEC Investor Advisory Committee  LaRue Case Raises the Stakes created in 2009 has expressed interest in  discussing fiduciary duty. There’s a hot dispute  The U.S. Supreme Court’s 2008 decision in the  among regulators, industry organizations, elected  case of LaRue v. DeWolff, Boberg & Associates,  representatives, and corporations about how and  Inc. changed the outlook for retirement plans and  when fiduciary duty should apply to brokerage firms’  their fiduciaries. It established for the first time that  registered representatives and registered investment  lawsuits can be filed when only one plan participant  advisors (RIAs). This discussion puts fiduciary duty  — rather than an entire plan — is affected by the  in the spotlight. Under current regulations, registered  breach of fiduciary duty. This recognizes the shift  reps are held to a lower standard than RIAs. As  from defined benefit to defined contribution plans.  RIAs see it, registered reps can put the interests of  As Justice John Paul Stevens wrote, “For defined  contribution plans, however, fiduciary misconduct  5  Melbinger and Roche, p. 4.  page 3
  6. 6. Hiring a Fiduciary December 2009 Exhibit 2: Costs Make A Difference Total Annual Fees & Costs 1.00% 1.50% 2.00% Annual Gross Rate of Return = 6.00%     Fixed Account Value at Retirement $173,596 $163,916 $154,846     Reduction in Final Value Due to Fees $  21,367 $  31,048 $  40,118     Percentage Reduction in Final Value Due to Fees 12.31% 18.94% 25.91% Annual Gross Rate of Return = 8.00%     Fixed Account Value at Retirement $219,326 $206,745 $194,964     Reduction in Final Value Due to Fees $  27,789 $  40,370 $  52,151     Percentage Reduction in Final Value Due to Fees 12.67% 19.53% 26.75% Annual Gross Rate of Return = 10.00%     Fixed Account Value at Retirement $278,823 $262,445 $247,115     Reduction in Final Value Due to Fees $  36,190 $  52,567 $  67,898     Percentage Reduction in Final Value Due to Fees 12.98% 20.03% 27.48% themselves and their companies first, whereas RIAs  to this hypothetical participant who made the “right”  have the duty of loyalty to clients, which dictates  investment decisions and earned a hypothetical  that clients’ interest must come first. Accordingly,  average 8% return by $67,898 (27.48%). some brokerage firms “have brokers recommend  their own in-house mutual funds, which carry heavy  Owners Can Delegate Most Fiduciary expense loads,” according to financial commentator  Responsibilities Bob Veres.6 When these funds appear in a 401(k)  plan, it’s clear this conflict has implications for plan  Some company owners are confused about the  sponsors. extent to which they can delegate fiduciary duty.  They’ve been scared into thinking there’s nothing  Costs and Fees Make a Difference — they can do. Owners — and other company  A Big Difference employees who serve as fiduciaries because they  exercise some control over their plans’ operations  The staff of the Joint Committee on Taxation  — will always have the duty to monitor other plan  prepared for the U.S. House of Representatives  fiduciaries. But they can delegate much of their  Ways and Means Committee on October 30, 2007,  fiduciary duty to carefully selected and monitored  a report of background information relating to  independent fiduciaries. In fact, one could argue  retirement plan fees in which it concluded that “the  that the company has a fiduciary duty under the  amount of fees charged against retirement plan  Prudent Expert Rule to hire an independent fiduciary,  assets has a significant impact on the amount of plan  if owners and employees lack extensive expertise in  assets that are available for retirement benefits.”7 It  fiduciary matters. provided the following illustration of the impact of fees  on a hypothetical participant who contributed $5,000  annually for 20 years as summarized in Exhibit 2. 6  Bob Veres, “A Swiftly Tilting Planet,” Financial  Planning (August 2009), pp. 23-24. Costs can add up. For example, plans with costs  7  “Present Law and Background Relating to Qualified  and fees totaling 2% reduced the amount available  Retirement Plan Fees,” Staff of the Joint Committee  on Taxation, (October 30, 2007), p 11. page 4
  7. 7. The first step in delegating fiduciary duty is to figure  is certification. For example, “The Accredited  out where it currently lies. All responsibility lies  Investment Fiduciary® (AIF®) designation represents  with the plan sponsor, at least initially, according to  a thorough knowledge of and ability to apply the  ERISA. However, it’s possible to spread some of  Fiduciary Practices,” says fi360 a Bridgeville, Pa.,  that responsibility among the trustee, committees,  company that offers training and the credential. The  named fiduciary, plan administrator, and investment  AIF® designation falls under the Centre for Fiduciary  manager, assuming that the proper procedures are  Excellence, an independent global assessment and  followed. certification organization. This ensures that standards  are set high. It’s easy to get confused about which outsiders act  as fiduciaries in the complete sense of the word.  The Standards of Fiduciary Excellence from  Brokers may be genuinely concerned about the  fi360 provide a detailed checklist of issues that a  plan’s interests, but, as discussed above, they’re  retirement plan trustee or independent fiduciary  not legally required to put client interests first. Some  should review to minimize their exposure to fiduciary  vendors may talk up their roles as “co-fiduciaries,”  liability. Companies should seek an independent  while limiting their actual responsibilities by adding  fiduciary that can assess their plan’s compliance with  technical legal language to their service agreements.  these standards and then fix things if the company  Unlike a fiduciary, a co-fiduciary has to act only when  falls short of satisfying the standards. This will  another fiduciary breaches their duty or when they  minimize the risks associated with the plan. are required to pursuant to their service agreement.  Also, contracts may favor the vendor at the  The goal of risk management for fiduciaries is to  company’s expense. For example, some registered  optimize plan participants’ results, while minimizing  reps working for brokerage firms call themselves  personal liability exposure. To manage 401(k) plan  “co-fiduciaries” but won’t acknowledge their fiduciary  risks effectively, companies need rigorous processes  status in writing. These reps “may be only assisting  that they and their vendors follow carefully, while  the fiduciaries in choosing investment options” and  documenting their actions. Once the company has  don’t have the authority or ability to buy or sell plan  selected an independent fiduciary, it can delegate  assets. As a result, the company owners sponsoring  much of this to the fiduciary. the retirement plan — not the brokers — still bear full  The independent fiduciary will manage risks (see  responsibility and liability for investment decisions. Exhibit 3) — especially the risk that the fiduciaries  Once a company sorts out the above-mentioned  may be sued for paying excessive fees or conducting  issues, it can select an independent fiduciary who will  insufficient due diligence — the two most frequent  assume all day-to-day investment and administrative  areas of claims against fiduciaries.  duties, including selecting the menu of investment  Hiring an independent fiduciary with the right  options and hiring/firing providers. A special rule  experience and knowledge leaves the company  allows companies to appoint an independent and  owners with the need only for residual monitoring.  qualified investment manager who is granted  That means owners can focus on running their  discretion and authorized to buy and sell plan assets.  companies instead of grappling with complex,  This manager is defined by ERISA as a registered  technically demanding analysis and decisions. investment advisor, a bank or insurance company  who acknowledges his or her fiduciary status in  writing. The acknowledgement of fiduciary status by  this person or firm is critical. When plan sponsors wish to delegate some or most  of the plan’s fiduciary responsibilities, they should  seek firms that understand the meaning of “fiduciary”  and that know how to measure risks. One measure  page 5
  8. 8. Hiring a Fiduciary December 2009 Exhibit 3: Key Areas for Risk Management Costs, expenses, and Plan sponsor must be compensation associated Main requirements careful to: with investments Investment & administration  •  Must conduct extensive due  •  Compare services and costs  fees diligence at which they are offered •  May pay reasonable fees  •  Compare the plan and its  from the plan’s assets investments to those of other  firms •  Avoid choosing a higher- priced offering when a  comparable lower-priced  offering is available •  Allocate expenses fairly •  Disclose costs, including  transaction costs and  revenue-sharing, to plan  participants Bundled services & revenue  Current litigation,  •  Act with an understanding  sharing Congressional legislation, and  that bundled 401(k)  DOL regulations are in the  administration is not “free” to  process of setting rules about  participants what information should be  •  Understand what costs and  disclosed and how payments are associated  with a share class, how they  compare with other share  classes, and who gets paid  what by whom Ongoing monitoring •  Monitor plan providers,  •  Create appropriate  investments and fiduciaries procedures •  Stay aware of timely issues  •  Maintain records showing  in investments that procedures are followed page 6
  9. 9. If you have questions about any of these issues, please contact Allan Henriques, AIF®, of Smart Investor at (916) 435-2100 or allan@smart-investor.cc. Allan Henriques, AIF®, AIFA®, J.D., is the founder and president of Smart  Investor, a Rocklin, California-based wealth management firm that also acts as  an independent investment fiduciary. Allan is an Accredited Investment Fiduciary  and former attorney with 15 years of legal experience and more than 20 years of  financial services experience. He enjoys freeing his retirement plan clients to focus  on managing their businesses profitably. Smart Investor specializes in working with  entrepreneurs and small business owners who don’t have the time to efficiently  manage their personal investment and tax planning. The firm also provides cost- efficient charitable trust administrative services for individual and institutional  clients. Smart Investor’s team of highly-skilled professionals provides extraordinary client service. In helping clients  achieve their personal objectives and have fun with life, the Smart Investor staff personifies the firm’s core  values of respect, integrity, and valuing and giving back to clients’ and employees’ communities. Smart Investor  employees are personally involved with local charities and Allan serves on the board of directors of the Boys  and Girls Club of Auburn (California). Smart Investor 5800 Stanford Ranch Road, Building 800 Rocklin, CA 95765 (916) 435-2100 www.smart-investor.cc Hiring a Fiduciary Can Reduce Company Owners’ Headaches and Improve Employees’ Retirement Prospects  By Allan Henriques, AIF®, AIFA® J.D. © Copyright 2009 Smart Investor. All rights reserved. No part of this publication may be produced or retransmitted in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, recording or any information storage retrieval system, without the prior written permission of the publisher. Unauthorized copying may subject violators to criminal penalties as well as liabilities for substantial monetary damages up to $100,000 per infringement, costs and attorneys fees. The information contained herein is accurate to the best of the publisher’s knowledge; however, the publisher can accept no responsibility for the accurateness or completeness of such information or for loss or damage caused by any use thereof. This information is not intended to be a substitute for specific individualized legal advice. page 7
  10. 10. 5800 Stanford Ranch Road, Building 800  9  Rocklin, CA 95765  9  (916) 435-2100  9  www.smart-investor.cc