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Fiduciary Responsibilities And Risks



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Fiduciary Responsibilities And Risks

  1. 1. Fiduciary Responsibilities and Risk<br />Mark D. Mensack, AIFA®<br />Piedmont Independent Fiduciaries<br />Joanne Szupka, CPA<br />Roland J. O’Brien, CPA<br />Robert A. Lavenberg, CPA, JD, LL.M<br />BDO USA, LLP<br />
  2. 2. AGENDA<br />Fiduciary Risks & Responsibilities<br />Challenges to fulfilling fiduciary obligations<br />Techniques to overcome these challenges<br />
  3. 3. Who is a Fiduciary?<br />“A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.” <br />Bristol & West Building Society v Mathew<br />A fiduciary is anyone “exercising any discretionary authority or control regarding the management or disposition of plan assets…” <br />ERISA §3(21)(A)<br />
  4. 4. Two General Types of Fiduciaries<br />Named Fiduciary- Someone specifically named in the plan document, or appointed by the plan sponsor.<br />Functional Fiduciary– Someone who acts in a fiduciary capacity based on their job duties or responsibilities with respect to a plan.<br />Individuals serving on investment committees, selecting service providers to a plan, and/or having influence or any discretionary authority over a plan are typically considered to be Functional Fiduciaries.<br />
  5. 5. Are you a Functional Fiduciary?<br />Do you exercise authority, control, or influence in managing the plan?<br />Who chose the salesperson?<br />Who chose the product or service provider?<br />Who chose the investment options in the plan?<br />Who selects, monitors, or replaces investment options?<br />Do you ever tell a participant how to invest their 401k?<br />Do you ever approve a broker’s recommendations?<br />
  6. 6. A Fiduciary<br />Fiduciary status is determined either:<br />intentionally by being specifically named or appointed; or unintentionally by the functions one performs<br />Functions whereby one exercises authority, control or influence over the plan are fiduciary functions:<br />Hiring or firing service providers<br />Selecting or changing investment options<br />Making decisions, including approval of recommendations<br />
  7. 7. The ORC/Infogroup Survey August 19-23, 2010 <br />60% of U.S. investors mistakenly think that “insurance agents” have a fiduciary duty to their clients.<br />66% of U.S. investors are incorrect in thinking that stockbrokers are held to a fiduciary duty.<br />76% of investors are wrong in believing that “financial advisors” – a term used by brokerage firms to describe their salespeople - are held to a fiduciary duty.<br />
  8. 8. Non-Fiduciary Service Providers<br />Record-keepers<br />Third-Party Administrators (TPA)<br />Auditors<br />CPA’s<br />Stock Brokers = “Financial Advisors/Consultants”<br />Insurance Agents<br />
  9. 9. Fiduciary Service Providers<br />Trust Company<br />Registered Investment Advisors<br />Necessarily assumes non-ERISA fiduciary status under the Investment Advisor’s Act of 1940<br />Independent Fiduciaries who by contract assume:<br />ERISA 3(21) Fiduciary Status<br />ERISA 3(38) Fiduciary Status<br />
  10. 10. Personal Liability I<br />A fiduciary is personally liable for any losses the plan incurs by reason of its breach. A fiduciary who has breached its duty is liable to restore to the plan any profits the fiduciary made through its use of plan assets and for any other equitable or remedial relief deemed appropriate by the court, including removal of the fiduciary. <br />ERISA § 409<br />The DOL can also access a civil penalty against a fiduciary who breached its duty or any person who knowingly participated in a breach in the amount of 20% of the amount recovered in a settlement with the DOL or awarded in a civil suit. <br />ERISA § 502(l)<br />
  11. 11. Personal Liability II<br />LaRue vs. DeWolfe – February 20th, 2008 the Supreme Court decided that individual employees can sue their employer for breach of fiduciary responsibility.<br />“The threat to employers from an explosion of suits is real…I think it's meaningful for employers because it will open up the flood gates with respect to litigation." <br />Ken Raskin, White & Case<br />The relative benefit to a participant is small but meaningful and the plaintiff attorney stands to reap a substantial pay day for his or her efforts especially with the courts poised to award reasonable attorney's fees and costs according to ERISA 502(g)(1) regardless of the size of the claim. <br /> Fred Barstein, CEO of 401kExchange, Inc.<br />
  12. 12. Newark Star-Ledger <br />August 28th, 2010<br />
  13. 13. A Breach of Fiduciary Responsibility could result in:<br />Extinction-level event for your firm<br />Negative impact on the retirement security of your employees<br />Financial ruin for you and other firm leadership<br />Criminal penalties including imprisonment:<br />ERISA Section 501 contains criminal fines of up to $5,000 with potential imprisonment of up to a year.<br />Sarbanes-Oxley increased these to a maximum of $100,000 with potential imprisonment of 10 years. <br />
  14. 14. Fiduciary Risk<br />Fiduciary responsibility carries personal liability.<br />There is no “corporate veil” for fiduciaries.<br />DOL Sanctions can be between 20%-50% of plan assets.<br />The 2008 LaRue decision permits individual participants to sue plan sponsors for fiduciary breaches.<br />The Plaintiff’s Bar sees over $3 trillion in US 401k assets.<br />There are potential criminal penalties including imprisonment<br />
  15. 15. What is Fiduciary Responsibility?<br />Act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;<br />Carry out your duties prudently;<br />Follow the plan documents (unless inconsistent with ERISA);<br />Diversify plan investments; and<br />Pay only reasonable plan expenses. <br /> Fiduciary obligations are among the “highest known to the law.” <br />Brussian v. RJR Nabisco, 5th Circuit Court, 2000<br />
  16. 16. ERISA Fiduciary Responsibility Overview<br />Duty of Prudence– A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries :<br /> -with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;<br />ERISA § 404 (a)(i)(b)<br />Duty of Exclusive Purpose - “A fiduciary shall discharge his duties . . for the exclusive purpose of:<br />(i) providing benefits to participants and their beneficiaries; and<br />(ii) defraying reasonable expenses of administering the plan. . . .” <br />ERISA §404(a)(1)(A)<br /> <br />
  17. 17. ERISA Fiduciary Responsibility Overview<br />Duty to Diversify – A fiduciary must diversify investments so as to minimize the risk of large losses. Where participants make the investment decisions, at least three diversified investment option with materially different potential risk and reward characteristics must be available. <br />ERISA § 404 (a)(1)(C)<br />Duty to follow plan documents unless contrary to ERISA - A fiduciary must discharge his/her “duties in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of Titles I and IV of ERISA.<br />ERISA §404(a)(1)(D)<br /> <br />
  18. 18. ERISA Fiduciary Responsibility Overview<br />Duty to avoid Prohibited Transactions <br />ERISA 406 (a)(1)(c) prohibits all transactions between a plan and a party in interest, and lists several specific transactions that constitute self-dealing or a conflict of interest. Existing ERISA 408(b)(2) provides exemptions to ERISA 406 (a)(1)(c) if three requirements are met:<br />The service must be necessary for the establishment or operation of the plan.<br />The service must be furnished under a contract that is reasonable.<br />No more than reasonable compensation may be paid for the service.<br />
  19. 19. Reasonable Fees & Compensation<br />“assure that the compensation paid directly or indirectly by [a plan to a service provider] is reasonable, taking into account the services provided to the plan as well as any other fees or compensation received by [the service provider] in connection with the investment of plan assets. The responsible plan fiduciaries therefore must obtain sufficient information regarding any fees or other compensation that [the service provider] receives with respect to the plans investments….to make an informed decision whether the [service providers] compensation for services is no more than reasonable.” <br />DOL - Frost (97-15A) and Aetna (97-16A)<br />“engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. . . such process should be designed to avoid self-dealing, conflicts of interest or other improper influence.”<br />DOL Field Assistance Bulletin 2002-3 (Nov. 5, 2002)<br />
  20. 20. Self-dealing, Conflicts of Interest or Other Improper Influence Affect Expenses<br />Plan Sponsor – “We aren’t changing our service provider; we’re with ABC Bank and we have our lending relationship there.”<br />Firm selling 401k products – We only provide our clients with 401k products that pay us for “shelf space.”<br />401k Product Provider – We only include mutual fund options on our platform that pay us for “shelf space.”<br />TPA – I recommend XYZ 401ks; once we have $25 million with them they pay us an additional 10 bps override<br />Salesperson – I recommend investment options that pay me a higher 12b-1 fee.<br />
  21. 21. Effect of Fees & Compensation<br />Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. <br />If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000.<br />The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.<br />A Look at 401(k) Plan Fees, DOL,<br /> Employee Benefits Security Administration<br />
  22. 22. Rule 408(b)(2) Interim Final Service Provider Disclosure<br />Service providers receiving at least $1,000 must:<br />Disclose all direct and indirect compensation it, or its affiliates or subcontractors, receives. <br />Provide a description of the services to be provided.<br />Disclose whether they are providing any fiduciary services.<br />Final regulation is effective as of July 16, 2011 <br />It also includes a class exemption from the prohibited transaction provisions for a fiduciary who enters into a contract without knowing that the service provider has failed to comply with its disclosure obligations.<br />
  23. 23. Form 5500 Schedule C<br />Applies to “large plans.” (100+ eligible Participants)<br />Compensation above $5000 is reportable<br />Compensation Types<br />Direct – Paid directly from the plan<br />Indirect – “Revenue Sharing,” investment management fees, finder’s fees, float revenue, brokerage commissions, securities lending revenue, etc.<br />See section on Moral Hazard/Fallacy of Disclosure<br />
  24. 24. Challenges to FulfillingFiduciary Obligations<br />Fiduciary Expectation<br />Moral Hazard / Fallacy of Disclosure<br />Revenue Sharing<br />
  25. 25. Fiduciary Expectation<br />Auditor says:<br /> There were no noteworthy issues found during our audit.<br />TPA says: <br />You’ve passed your ADP & ACP testing<br />Broker says: <br /> Morningstar gives all of the plan’s funds at least three stars<br />Employees say: <br /> We have no complaints about our 401k<br />Plan Sponsor hears: <br /> I am fiduciarily squared-away!<br />
  26. 26. Fiduciary Expectation<br /> Fiduciary Non-fiduciary<br />TPA<br />(service provider)<br />Plan Sponsor<br />Has all fiduciary responsibility and all potential liability.<br />Recordkeeper<br />(service provider)<br />CPA/Attorney<br />(service provider)<br />Consultant(s)<br />(service provider)<br />Custodian<br />(service provider)<br />
  27. 27. Moral Hazard<br /><ul><li>Many types of 401k sales people offer fiduciary education, advice or assistance, but then deny in writing fiduciary responsibility. </li></ul>For example:<br /><ul><li>ABC Firm and ABC Firm Financial Advisors do not provide tax or legal advice, are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, and this material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisor before establishing a retirement plan or to understand the tax, ERISA and related consequences of any investments made under such plan.
  28. 28. The fine print on the “Fiduciary Warranties” offered by many 401k sales people is similarly eviscerated, and provides little, if any, fiduciary protection.</li></li></ul><li>Moral Hazard QUIZ<br />How many documents must a plan sponsor review in order to read all of the available information before adopting a group annuity 401(k) plan? <br /> (Lets assume there is just one mutual fund in the plan!)<br />What are the total number of pages in all of these documents?<br />How many of these pages address fees, compensation or potential conflicts of interest?<br />a) 2 / 127 / 6 b) 7 / 542 /56 c) 34 / 827 / 99<br />
  29. 29. Moral Hazard Quiz Answer: B<br />Prospectus – 72 pgs<br />9 pgs reference fees, compensation or conflicts of interests<br />SAI– 285 pgs<br />17 pgs reference fees, compensation or COIs<br />Annual Report – 44 pgs<br />6 pgs reference fees, compensation or COIs<br />Semi-Annual Report – 36 pgs<br />8 pgs reference fees, compensation or COIs<br />Group Annuity Contract – 33 pgs<br />5 pgs reference fees, compensation or COIs<br />Plan Level Documents – 58 pgs<br />9 pgs reference fees, compensation or COIs<br />Adm Service Agreement – 11 pgs<br />2 pgs reference fees, compensation or COIs<br />7 Documents<br /> 542 Pages<br />
  30. 30. Moral Hazard<br />Found on one of 542 pages. Your plan assets spent on:  <br />Payments for placement of funds on a Financial Intermediary’s list of mutual funds available for purchase by its customers or for including funds within a group that receives special marketing focus or are placed on a “preferred list”;  <br />“Due diligence” payments for a Financial Intermediary’s examination of the funds and payments for providing extra employee training and information relating to the funds; <br />“Marketing support fees” for providing assistance in promoting the sale of fund shares;  <br />Sponsorships of sales contests and promotions where participants receive prizes such as travel awards, merchandise, cash or recognition; etc.<br />SAI Page 180 of 285<br />
  31. 31. Revenue Sharing I<br />Revenue Sharing generally refers to a compensation practice in which money is paid to plan service providers out of the 401(k) investments, or by their managers (and affiliates.) It can be straightforward, hard to find, or hidden. Here are just two types, the first of which is straightforward, and the second of which is sometimes harder to find: <br />12(b)(1) fees - Ongoing “trail” commission paid to sales company for distribution and service. Typically range between 0.25% - 1% and deducted from fund assets.<br />Sub-TA fees (Sub-Transfer Agency) – Asset-based fee and/or a per head fee and deducted from plan/fund assets. Intended to pay for administration performed by an intermediary; e.g. record keeper or TPA.  <br />
  32. 32. Revenue Sharing I <br />Mutual Fund Share Class<br />
  33. 33. Revenue Sharing I <br />$11,141.18 $3,941.08<br />
  34. 34. Revenue Sharing I <br />$7,726.30 Hard Dollar<br />$11,141.38 12(b)(1) fees<br />$3,941.08 Sub-TA fees<br />$22,808.76 Total (67.7% higher )<br />$15,082.46 Undisclosed by service provider <br />
  35. 35. Revenue Sharing IIGroup Annuity Separate Accounts<br />“Insurance-company charges sometimes range as high as two to four percentage points annually. Added to management fees of the underlying investments, typically mutual funds, "You can be looking at annual charges of 3% to 5.5%...”<br />Matthew D. Hutcheson<br />Keller Rohrback is investigating 401(k) and 403(b) variable annuity plans for charging excessive and unreasonable fees, and engaging in self-dealing through revenue sharing kickback schemes with the mutual funds providers selected for the plans.<br /><br />
  36. 36. Revenue Sharing II<br />
  37. 37. Revenue Sharing IIGroup Annuity Separate Accounts<br />Expense Ratio of underlying fund* 0.26<br />Administrative Maintenance Charge 0.50<br />Sales & Service Fee 0.25<br />= Expense Ratio of Separate Account 1.01<br />Base Charge 0.60<br />Participant Fee 1.00<br />Total Cost 2.61%<br />*Vanguard Value Index Fund, Investor Share<br />Info provided by: David Wade, 401k Direct. Uncovering Hidden Fees in Insurance Company 401ks<br />
  38. 38. Techniques to Overcome These Challenges<br />Prudent Process<br />Prudent Expert<br />Delegation – Fiduciary Line of Defense<br />Finding Fiduciaries<br />Benchmarking<br />Total Retirement Outsourcing<br />
  39. 39. Prudent ProcessInvestment Policy Statement<br />First step in Prudent Process<br />Most Fundamental Fiduciary Function<br />Supports the “paper trail.” <br />Keeps investment process intact during market volatility.<br />Provides working framework for fiduciaries<br />Sets guidelines for making investment decisions.<br />Negates “Monday morning quarterbacking.”<br />
  40. 40. Prudent Process - Monitoring<br />
  41. 41. Prudent Expert<br />“Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert.” <br />DOL Reg. § 2509.95-1(c)(6)<br />“…where the trustees lack the requisite knowledge, experience and expertise to make the necessary decisions with respect to investments, their fiduciary obligations require them to hire independent professional advisors.” <br />Liss v. Smith, 991 F.Supp. 278, 297 (S.D.N.Y. 1998)<br />
  42. 42. Prudent ExpertERISA 3(21)(A)(ii)<br />Plan Sponsor<br />Recordkeeper<br />(service provider)<br />CPA/Attorney<br />(service provider)<br />TPA<br />(service provider)<br /> Fiduciary Advisor<br />ERISA 3(21)(a)(ii)<br />Custodian<br />(service provider)<br />
  43. 43. Fiduciary Delegation<br />ERISA section 402(c) allows for a plan sponsor to delegate fiduciary responsibility. A prudently selected and appointed fiduciary can alleviate a plan sponsor from nearly all fiduciary liability. The one residual fiduciary responsibility is to monitor the performance of the appointed fiduciaries.<br />An Investment Manager under ERISA 3(38)<br />An Independent Fiduciary under ERISA 3(21)<br />
  44. 44. Fiduciary DelegationERISA 3(38)<br /> Plan Sponsor Fiduciary Line Non-Fiduciary<br />of Defense Service Providers<br />Plan Sponsor<br />Recordkeeper<br />(service provider)<br />CPA/Attorney<br />(service provider)<br />TPA<br />(service provider)<br />Formal Appointment<br />ERISA 3(38)<br />Investment Fiduciary <br />Custodian<br />(service provider)<br />
  45. 45. Fiduciary DelegationERISA 3(21) Full Scope<br />Plan Sponsor Fiduciary Line Non-Fiduciary <br />of Defense Service Providers<br />ERISA 3(21)<br />Full Scope<br />Fiduciary<br />Plan Sponsor<br />Recordkeeper<br />(service provider)<br />CPA/Attorney<br />(service provider)<br />Formal Appointment<br />TPA<br />(service provider)<br />Formal Appointment<br />ERISA 3(38)<br />Investment Manager<br />Custodian<br />(service provider)<br />
  46. 46. Fiduciary Resources<br /><br /><br /><br />
  47. 47. SUMMARY<br />Identify & educate plan fiduciaries<br />Confirm in writing fiduciary & non-fiduciary service providers<br />Maintain a “Prudent Process”<br />Discover & evaluate all fees & compensation<br />Retain a Prudent Expert<br />Delegate to an Independent ERISA 3(38) or 3(21) Fiduciary<br />Monitor & Document<br />Fulfilling one’s fiduciary duties enhances the probability of retirement income security for one’s participants<br />Failure in fulfilling one’s fiduciary duties could be an extinction-level event for one’s firm, and financial ruin for the fiduciary<br />
  48. 48. Mark D. Mensack, AIFA®<br />Mark is a Managing Director and the Chief Ethics Officer of Piedmont Independent Fiduciaries, a Fee-only SEC Registered Investment Advisory firm. With more than 15 years experience in financial services and a background in ethical philosophy, Mark focuses on the ethical imperative of fiduciary responsibility to educate plan sponsors and other fiduciaries on their fiduciary duties. As an independent fiduciary, Mark assumes ERISA 3(21)(a)(ii) and/or ERISA 3(38) status in order to protect and enhance the retirement income security of retirement plan participants. <br />Piedmont Independent Fiduciaries<br />Managing Director, <br /> Chief Ethics Officer<br />T: 856 528 9524<br />E:<br />
  49. 49. Joanne Szupka, CPA<br />Joanne Szupka has over 13 years of accounting experience with regional and national public accounting firms in areas of employee benefit plans. She has been responsible for all areas related to audits and reviews of single employer, multiemployer and multiple-employer sponsored plans, including defined benefit, defined contribution and health and welfare benefit plans.<br />BDO USA, LLP<br />Assurance Manager, <br /> Employee Benefit Plan Specialist<br />T: (215) 636 – 5591<br />E:<br />
  50. 50. Roland J. O’Brien, CPA<br />Roland O’Brien has over 25 years of accounting experience with local, regional and national public accounting firms. He has been responsible for all areas related to the audits and reviews of single employer, multiemployer and multiple-employer sponsored plans, including employee benefits, qualified retirement, health and welfare and fringe benefits plans. Roland has been responsible for creating and presenting technical training programs, as well as providing quality assurance services related to employee benefit plans. <br />BDO USA, LLP<br />Director, <br /> Employee Benefit Plan Practice<br />T: (215) 636-5778<br />E:<br />
  51. 51. Robert Lavenberg, CPA, JD, LL.M<br />Bob Lavenberg has more than 25 years of experience with the Employee Retirement Income Security Act of 1974 (ERISA) and related business advisory services. His expertise spans reporting, government compliance and assessment of tax implications for plans, including employee benefits, qualified retirement, health, welfare, and fringe benefits. Bob currently serves as the Chair of the AICPA Employee Benefit Plan Audit Quality Center Executive Committee and is a former member of the AICPA Employee Benefit Plan Audit Expert Panel. <br />BDO USA, LLP<br />National Partner in Charge of Employee Benefit Plan Audit Quality, Chair of AICPA’s 403(b) Plan Audit Task Force <br />T: (212) 885-8313<br />E:<br />

Editor's Notes

  • Slides 8-10 in response to “I’m not a fiduciary”
  • Slides 11-14 in response to “our broker handles all that stuff.”
  • Slides 15-18 in response to “What do you mean, personal liability?”I’ll talk through Sanctions and they are summarized on slide 14
  • With Bob’s entry begin overall presentation
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