Posted by: Professionals In Human Resources Association (PIHRA) | May 3, 2010

The Migrating Status of Fiduciary Care

By Brant Griffin, Founder and Partner
North Pier Fiduciary Management, LLC.

There is a sea change afoot that will forever transform how advisory work is provided for qualified retirement plans. Forces are converging to address change to increase transparency and accountability of organizations providing fiduciary services to retirement plans. If these influences are successful, it will provide much needed clarity of different advisory service models that exist so that plan sponsors can chose the right service and organization for their needs.

At issue is a regulatory environment that has not kept up with the changes in the marketplace. The current defining fiduciary standard was developed by the Department of Labor (DOL) in 1975 shortly after the passage of the Employee Retirement Income Security Act (ERISA). Since then, the retirement plan landscape and the needs of plan sponsors have changed meaningfully. 401(k) plans have emerged as America’s preeminent retirement funding vehicle and advisory services supporting this evolution have developed to respond to meet the needs of the market. Presently, the governing standard of conduct for those performing advisory services to ERISA plans is nothing short of chaotic. Different regulations apply acceptable standards of conduct depending on the type of organization providing those services.

Broker-dealers are subject to one set of regulations that hold them to a non-fiduciary “suitability standard” when providing ERISA services. This low threshold standard does not legally obligate broker-dealers to put the interests of their clients ahead of their own. Broker-dealers have long been accused of hiding behind the veil of their legal structure that allows them to cloak the advice or guidance they provide as incidental to the inherent, transactional nature of their business. As a result, most broker-dealers have avoided a fiduciary role with their clients and perform services that many believe fall short as a result. Furthermore, this loophole permits them to maintain practices that many would argue subordinate their client’s interests to their own.

Alternatively, Registered Investment Advisors (RIAs) are subject to an elevated standard of care inherent in their legal arrangement. RIAs, by definition, are fiduciaries and maintain a fundamental obligation to act in the best interest of their clients. Therefore, they are often seen as maintaining a competitive advantage over broker-dealers and thus better suited to provide ERISA services.

Among the concerns is that advisory services, provided by either broker-dealers or RIAs, are indistinguishable to most plan sponsors and participants. Slanted sales materials, industry jargon and legalese in advisory agreements simply bewilder plan sponsors who are merely seeking an understanding of the marketplace and accountability for the performance of services they are in search of. Due to this inability to differentiate among services models, plan sponsors often maintain a relationship with an organization without a complete understanding of their fiduciary standing.

Today, there is a growing movement underway to correct these misperceptions in hopes of offering clarity on different ERISA advisory service models. Among the initiatives introduced is H.R. 3817, the Investor Protection Act of 2009.  H.R. 3817, passed by the House Financial Services Committee in March (but not yet law), along with other financial reform legislation currently making its way through Congress, is striving to modernize America’s financial regulatory system. These efforts would serve to strengthen the SEC’s power to regulate advisory services to ERISA plans and empower them to establish one consistent universal fiduciary standard that applies to all investment advice. They would also attempt to harmonize the rules that govern both broker-dealer and RIA practices to ensure that all those providing plan advisory services are held to task equally.

The DOL has also announced its intent to expand the definition of fiduciary under ERISA. Phyllis Borzi, Assistant Secretary of Labor for the Employee Benefits Security Administration, said there was concern that current regulations may allow plan advisors “…from whom plans expect impartial advice, to evade fiduciary responsibility.” We believe that among the major goals of this effort to establish a new fiduciary standard will be the prohibition of self-dealing and other conflicted practices maintained by some consulting organizations. Specifically troubling is the tainted advice sponsors receive when their consultants accept payments from the same asset managers they recommend to them.

If successful, these initiatives will not only provide more clarity and accountability to sponsors, but also ensure they receive the impartial advice they intended to pay for. It should also serve to clean up many industry practices that have long been in conflict with a true fiduciary approach. Among these are sales practices and compensation arrangements that are not consistent with a fiduciary’s duty of loyalty. The duty of loyalty requires that those who are fiduciaries to function in the sole interest of and for the exclusive purpose of the plan and its participants (ERISA Section 404(a)(1)(A)) and put the interests of their client ahead of all others, including their own.

A requirement to disclose conflicts of interest may likely abolish many questionable practices of broker-dealers and allow their plan sponsor clients to receive more objective advice through the elevation of their service model. For other broker-dealers, they may simply choose to maintain their conflicted relationships, and sell plan services to their ERISA clients in a non-fiduciary manner. This type of brokered service sale screams caveat emptor!

However, some firms have chosen to advance their service models beyond what any new initiatives may require. Traditionally, serving as a fiduciary to an ERISA plan has, for the most part, been performed as a limited scope 3(21) fiduciary. This advisory role is often relegated to simply making investment recommendations to the plan sponsor, with the final decision, and the liability of that decision remaining with the sponsor.

Many consultants are recognizing that simply providing investment recommendations to plan sponsors may not sufficiently meet an organization’s needs. Select RIAs, which have the requisite resources, knowledge and expertise, stand ready to accept an elevated fiduciary role. The appointment of an ERISA 3(38) “Investment Manager” allows a plan sponsor to outsource their investment decision responsibilities to the Investment Manager. This appointment further mitigates an organization’s investment liability by transferring it to an independent consultant that will manage the plan with discretion and assume full responsibility and liability for its investment decisions. The sponsor will simply retain the obligation to prudently select and monitor the investment manager.

Due to this elevated responsibility inherent in an ERISA 3(38) arrangement, the requirement for advisory organizations serving in this capacity is similarly higher as well. Undertaking this responsibility requires a firm to maintain practices that are above reproach. The thorough examination of internal practices, carefully review compliance procedures and complete avoidance of potential conflicts of interest is paramount.

There is a heightened sensitivity surrounding the issues of a fiduciary status today. Wall Street brokerages houses and special interests are lining up in hopes of shaping future laws that will affect the advice that plan sponsors receive. North Pier applauds those attempting to protect the interests of plan sponsors and promoting the advancement of transparency and accountability in the ERISA advisory marketplace. We have always held the simple belief that every organization advising retirement sponsors, regardless of their organizational structure, must be held to a fiduciary standard if the sponsor is to receive the services they truly need. Further, that every sponsor has a right, and an obligation, to clearly understand the fiduciary standing of the organization it has hired to advise them.


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