Here's what you should know.
A number of readers of this column have, over the years, asked me how I would describe the ideal investment advisor to fiduciaries of retirement plans. This month's column is an extended explanation of what I tell them.
Prudence as Process
Prudence as process, as noted many times in this column, is the cornerstone of modern prudent investing for all bodies of fiduciary law including the Employee Retirement Income Security Act of 1974 (ERISA) as well as the Uniform Prudent Investor Act (UPIA) and the Restatement 3rd of Trusts (Prudent Investor Rule).
In the context of ERISA retirement plans, I believe that a prudent process should be one that's legally sound, academically rigorous, cost efficient and morally right. The ultimate goal of this process must be to provide plan participants with the best chance to efficiently (cost-wise and risk-wise) accumulate the greatest amount of retirement assets possible. Let's examine in detail what I mean by each aspect of this prudent process.
The Legally Sound Aspect of the Prudent Process
The process described here must (not should) begin with a focus on the law of ERISA. That focus, more specifically, is on ERISA section 404(a)(1) which describes the four primary duties of a plan fiduciary. These include the (1) duty of loyalty (which underlies all fiduciary duties), expressed as the "sole interest" and "exclusive purpose" rules of ERISA section 404(a)(1)(A), (2) the duty of prudence under ERISA section 404(a)(1)(B), (3) the duty of (broad) diversification under ERISA section 404(a)(1)(C) and (4) the duty to follow all plan documents under ERISA section 404(a)(1)(D), but only to the extent that the terms of such documents don't conflict with ERISA.
These four duties, of course, are not those of the investment advisor to a qualified retirement plan. But the ideal advisor will educate plan fiduciaries about these duties and their critical importance, and remind them that they have personal responsibility (and therefore personal liability) for the prudent management of plan assets.
There are two situations in which plan fiduciaries can shed themselves of responsibility (and liability) in the management of plan assets. In the first situation, plan fiduciaries can avoid responsibility (and liability) for any dumb investment mistakes that they themselves might make. They can achieve this when the ideal plan investment advisor offers to be an ERISA section 3(38)-defined "investment manager" via a written agreement with the fiduciaries. By doing so, the advisor becomes an ERISA section 405(d)(1)-defined "independent fiduciary." In this situation, plan fiduciaries delegate their personal responsibility for the selection and monitoring of a plan's menu of investment options to the advisor under section 3(38). (Note that even here, though, plan fiduciaries still retain the responsibility (and liability) for selecting, monitoring and replacing (if necessary) the investment manager periodically to ensure that the manager is handling the plan's menu of investment options prudently.)
Very few investment advisors assist plan fiduciaries by acknowledging such fiduciary status because they cannot do so legally (i.e., broker/dealers--although the RIA arm of a broker/dealer can do so if it so chooses) or because their business model ordinarily doesn't allow them to do so (i.e., insurance companies, banks and mutual fund companies). I can't count the advertisements I've seen in which broker/dealers, insurance companies and others offer to help plan fiduciaries be better fiduciaries if they would only buy their patent-pending "tools." Such offers never include the providers themselves becoming ERISA sections 3(38)/405(d)(1) fiduciaries which would allow them to bring real value to plan fiduciaries by removing from their shoulders "virtually all of the fiduciary responsibility." (Source: http://www.reish.com/publications/article_detail.cfm?ARTICLEID=544)
Some of these plan providers will, at best, offer to help plan fiduciaries by becoming a co-fiduciary. Be careful, though, this is one of those wolf in sheep's clothing situations. Although a plan provider offering to be a "co-fiduciary" must comply with the (previously noted) four duties under ERISA section 404(a)(1), such providers refuse to accept real transfer of responsibility (and liability) from plan fiduciaries to themselves because they refuse, by definition, to accept delegation of discretion. In other words, since there's no discretion, there's no real transfer of responsibility and therefore no mitigation of any potential liability.