Who Is Winning the 'Fiduciary' Definition Debate?

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The week before last, I received a phone call from a congressional staffer who invited me to testify at a subcommittee hearing July 26. "Why pick on me," I asked. Well, it seemed that my June Morningstar column had garnered some attention in Washington and at least some solons wanted to hear about it from the horse's--uh, mouth. Would I like to come to Washington and testify? Let me see now: leave my home north of San Diego where it was sunny and in the high 70s with no humidity to fly clear across the country to a city where the forecast was 116 degrees on the day of my testimony with the kind of humidity that would make that seem like 250 degrees. Having lived through two Washington summers, it took me less than two seconds to decline the invitation politely.

Among those who did testify before the House subcommittee on health, employment, labor and pensions at that July 26 hearing was Phyllis Borzi, the assistant secretary of labor for the Employee Benefits Security Administration. It's worthwhile to go through some of her written testimony to get a better handle on the great ongoing wrestling match over whether the definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 will, in fact, be changed.

The ERISA Fiduciary Structure and How It Bears on the Wrestling Match

Borzi (who, by the way, I believe is earnest in her efforts, unlike many others in this great wrestling match, to protect plan participants and their beneficiaries) notes at the outset of her testimony that ERISA "expressly provides that a person paid to provide investment advice with respect to assets of a private-sector employee benefit plan is a plan fiduciary."

Furthermore she states, "ERISA and the [Internal Revenue Code] prohibit . employee benefit plan . fiduciaries from engaging in a variety of transactions, including self-dealing--when a fiduciary puts his or her own financial interests first--unless the relevant transaction is authorized by an 'exemption' contained in law or issued administratively by the Department of Labor."

Borzi's testimony here reflects the underlying historical anomaly of ERISA's fiduciary structure: Unlike all other countries in the world, only the United States allows an employer/plan sponsor to be a fiduciary of a qualified retirement plan. In all other countries, only independent fiduciaries can run a plan. In Europe, for example, employers can't get involved with their retirement plans at all.

But America's employers made it clear during ERISA's drafting stage in the early 1970s that, whatever final form ERISA eventually took, they wanted to be actively involved in running their retirement plans. That made sense since the contributions made by employers on behalf of participants in defined benefit plans (no glimmer of a 401(k) plan was in anyone's eye in those days) was employer money--at least before it was plopped into the plan--so they wanted some control over it. But this stance created an obvious problem: allowing employers to run their own retirement plans would result in lots of conflicts of interest, many related to whether an employer was acting as a fiduciary to the participants (and their beneficiaries) in its plan or acting as a fiduciary to its shareholders. (For additional information on this subject, please see my interview with Jeffrey Mamorsky, one of the drafters of ERISA, in my October column.)

The solution to this problem was an agreement between the federal government and employers: In exchange for the government allowing employers to control their retirement plans, they would be required to be fiduciaries acting in the interests of the participants (and their beneficiaries) in those plans. This trade-off formed the backbone of ERISA as reflected in the basic fiduciary law of section 404(a)(1)(A) and its great "sole interest" and "exclusive purpose" rules which require employers to act not merely in the "best" interests of plan participants (and their beneficiaries) but much more crucially, act in their "sole" and "exclusive" interests.

The ERISA section 404(a) language concerning the necessity that fees be "reasonable" and the "diversification against large losses" requirement also form this backbone. Borzi reminds us of other fiduciary duties in ERISA section 404(a): "ERISA additionally subjects fiduciaries who advise private-sector employee benefit plans to certain [fiduciary] duties, including a duty of undivided loyalty to the interests of plan participants and a duty to act prudently when giving advice."

To me--just as to anyone who takes seriously their work in the retirement plan business--these essential provisions of section 404(a) are like the Declaration of Independence and the Constitution of qualified retirement plans because they help guide fiduciaries in prudently implementing the fundamental underlying objective of ERISA: providing plan participants with retirement income security.

ERISA also requires employers to follow prudent fiduciary rules to help ensure that they act solely and exclusively in the interests of plan participants (and their beneficiaries). With respect to the prohibited transaction rules (ERISA section 406 (Title I) and IRC section 4975 (Title II)), any transaction between a plan and a "party in interest" or a "disqualified person" will result in a "prohibited transaction," unless such transaction fits into a statutory exemption or a regulatory exemption (for example, a class exemption). Loans to participants in 401(k)s and investing in company stock are among the most common prohibited transactions; both activities have been granted class exemptions. In a sense, then, the way in which ERISA is structured deems many fiduciaries as well as fiduciary and nonfiduciary service providers involved in qualified retirement plans to be criminals until they can prove their innocence.