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Mother Always Said to Read the Fine Print

How financial-services firms can wiggle out of fiduciary responsibility.

W. Scott Simon, 03/03/2011

Have a comment, insight, or burning opinion on this article? Make your feelings known in the comments section at the end of the article.

Last month, I was notified out of the clear blue sky by an organization in the retirement plan marketplace that one of my Morningstar columns from 2005 would be reprinted in its quarterly publication. After posting the column on the organization's website for a planned 90-day members-only look--which was a week before the column was to appear in print--I was notified out of the clear blue sky that it had been yanked, forever barred from appearing under this organization's banner.

The offending column explained in detail how a well-known (but unnamed) plan service provider asserted that it was a fiduciary while the contract its attorneys had drafted signature-ready for plan sponsors negated that claim, for all practical purposes, with an exquisite legal scalpel. Given the circumstances surrounding the sudden cancellation of the reprint, it was apparent that some individual, company or special interest group had given someone their marching orders to bury the column because it touched a raw nerve. Readers can decide for themselves which nerve that might be.

The kind of legal sleight-of-hand employed by the plan service provider highlighted in the reprint is still, unfortunately, all too often present in the retirement plan marketplace today. Examples of this involve certain financial services firms which say one thing in their written marketing materials (and, no doubt, in the oral representations made by their salespeople) while their legally binding contracts say quite another thing. In such instances, we have sales puffery (and worse) on the one hand while on the other we have the law of the Employee Retirement Income Security Act of 1974.

Advisors to qualified retirement plans such as 401(k) plans should be made aware of this vast gulf between perception and reality to not only better understand the nature of their competition but to also help protect the plan sponsors they serve from falling for the fake fiduciary protections peddled by certain financial services firms that also, by the way, have (really, really) non-transparent cost structures.

One such financial-services firm offers fiduciary solutions to plan sponsors. Its marketing materials claim that the firm will "share" the plan sponsor's fiduciary responsibility with respect to the investment options recommended by the firm for the sponsor's plan. That's a pretty powerful statement and no doubt was included to impress plan sponsors and garner business form them. The only problem with it is that it's legally untrue. The reason why has to do with the duties of the sponsor of a retirement plan and those of a so-called "co-fiduciary."

An important cluster of fiduciary duties required of every sponsor of a qualified retirement plan is to select, monitor and replace the plan's investment options. While it's true that most litigation under ERISA alleges administrative and operational problems with plans, fiduciaries at plan sponsors are often sued for providing imprudent plan investment options--like retail-priced options in multibillion-dollar 401(k) plans. An ERISA section 3(38) Investment Manager is one legally viable way by which plan sponsor fiduciaries can off-load their duties and liabilities associated with providing prudent investment options for a plan--subject, of course, to the sponsor exercising prudence at both the initial decision point to off-load and then on an ongoing basis. A more comprehensive way by which plan sponsor fiduciaries can off-load even more duties and liabilities is for them to appoint a 3(21) Named Fiduciary that, in effect, runs the plan for a sponsor. Topping even that in the protection of plan sponsors is when a sponsor steers its plan into a multiple employer plan with robust fiduciary checks and balances and truly prudent investment options.

None of these appointed fiduciaries "share" the duties delegated to them by a plan sponsor. After all, that's why a sponsor bloody well delegates them in the first place: to get them off their plate. For example, an ERISA section 3(38) Investment Manager doesn't share a plan sponsor's fiduciary responsibility with respect to the prudence of plan investment options; instead, it has "sole" carefully defined legal responsibility and liability for them because the sponsor has delegated them to it.

Contrast the transfer from a plan sponsor of legally meaningful duties with the foregoing fiduciaries with the financial-services firm here that touts itself as an ERISA section 3(21)(A)(ii) "co-fiduciary," asserting that it "shares" a plan sponsor's fiduciary responsibility with respect to a plan's investment options. First, note ERISA's definition of a 3(21)(A)(ii) fiduciary: "[it] . . .  renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so." Note further that the "magic woid" (as Groucho Marx would say) of "discretion" doesn't appear here. That one word is the linchpin in this part of the ERISA statutory scheme: those fiduciaries such as the kinds just described that have discretion "make decisions," the consequences of which can subject them to real legal liability, while those that don't have discretion such as the financial-services firm in question "give advice," "make recommendations," etc. to a plan sponsor, the consequences of which do not subject them to real legal liability.

Second, note that the term "co-fiduciary" appears nowhere in the text of ERISA. This term is used only as informal short-hand in serious discussions concerning the liabilities between and among each of the different ERISA named fiduciaries in a plan such as the ERISA section 3(16) Plan Administrator, the ERISA section 403(a) Trustee and the ERISA section 3(21) Named Fiduciary (and when--rarely--present in a plan, an ERISA section 3(38) Investment Manager). The term, then, has no legal significance at all. As such, it has no applicability to actually providing legal protection to plan sponsors.

Some think that where 3(21)(A)(ii) fiduciaries are involved in a qualified retirement plan they have no importance. I thoroughly disagree. Many such fiduciaries can have a significantly favorable impact on the plan sponsors they advise by providing them with many practical suggestions and insights. But that kind of help clearly does not extend to providing any meaningful legal protection for a plan sponsor. The financial services firm in question that implies--nay, asserts baldly--in its marketing materials that it's a co-fiduciary sharing a plan sponsor's fiduciary responsibility with respect to the prudence of a plan's investment options just cannot--and does not--provide plan sponsors with any legal cover. To say otherwise is just plain wrong.

But don't believe me: just look at the contract provided by the financial-services firm here to plan sponsors. More 25% of the contract's language is devoted to spelling out in detail what the financial services firm is not responsible for (essentially, zilch) and what the plan sponsor remains responsible for: sole responsibility (and therefore sole liability) to select, monitor and replace plan investment options; so much for sharing with the plan sponsor. And just look at what happens when plan participant plaintiffs sue plan sponsors: in many instances, the financial-services firms such as the one here are not sued in the first place because of the kind of contracts just described and when they are sued, they simply pivot to their dear contracts, point out that it's all on the plan sponsors and are then usually readily dismissed from the lawsuit.

Contrary to its marketing materials, then, the firm in question here doesn't create any competitive advantage over other advisory firms in this part of the marketplace. This is particularly true given that the investment options it offers to plan participants include group variable annuities which are accompanied by the hidden (and therefore high) costs inherent in such insurance products. So such firms that offer "fiduciary solutions" also have the real problem of (really, really) non-transparent cost structures. One other point: from the looks of the contract that this financial-services firm has with an insurance company record-keeper, it appears that the firm is paid by the third party record-keeper in spite of the fact that the firm states in its own contract that it's an ERISA fiduciary. But that's a whole different subject that I may cover in a future column.

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W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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