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When Non-Fiduciaries Hold the Fiduciary Keys

Some end-of-summer observations on suboptimal fiduciary set-ups, the 'incidental' issue in the fiduciary wars, and reflections on Tibble v Edison.

W. Scott Simon, 09/03/2015

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award. 


In my daily reading I sometimes run across some golden nuggets such as the following question, which was posed recently in one of the many excellent blogs that cover the retirement plan marketplace.

Yay, I'm Not a Fiduciary!
"As an employee benefits manager for a large nonprofit hospital, I work with our plan consultants to put together investment recommendations for our Employee Retirement Income Security Act (ERISA) 403(b) plan to the plan's fiduciary committee. I am not a named fiduciary for the plan (the named fiduciary is the committee) and I am not a member of that committee. I do not make any decisions regarding plan investments (or any other decisions regarding the plan, for that matter), and it is not the intent of my employer that I serve as a fiduciary. However, I have read that the Department of Labor (DOL) is tinkering with a more expansive definition of fiduciary, so I am concerned about my fiduciary status. Can you please advise me?"

This enquiry--so innocent and reasonable-looking on its face--helps explain why so many retirement plans in this country are run in such a sub-optimal way and, as a result, harm so many plan participants and their beneficiaries.

The enquiring employee benefits manager "works" with the plan "consultant" to make investment recommendations for the hospital's ERISA 403(b) plan to the plan's fiduciary committee. This manager is 1) not a named fiduciary in the plan document, 2) not a member of the plan's fiduciary committee, 3) doesn't make any decisions regarding plan investments, and 4) doesn't serve as a fiduciary since her or his employer doesn't intend that she or he so serve.

Let's step back a moment to understand this situation and its implications. A non-fiduciary employee benefits manager works together with a non-fiduciary consultant to make investment recommendations to the fiduciary committee. That equation looks like this: a non-fiduciary + a non-fiduciary provides non-fiduciary inputs to --> the fiduciary committee that's required to generate fiduciary outputs.

In many cases, this kind of fiduciary committee (or plan sponsor) will simply accept--in toto--the investment menu recommended by both such non-fiduciaries: the employee benefits manager and consultant. There is no legal obligation, no financial motivation, for the non-fiduciaries here to act in the "sole interests" (the ERISA fiduciary standard) of plan participants and their beneficiaries by, among other things, ensuring that costs are reasonable (and no reason why costs cannot be kept reasonably low) and that model portfolio investment options are diversified broadly and deeply to reduce risk as much as possible so as to avoid large losses in accordance with section 404(a) of ERISA. Broad and deep diversification of portfolio risk can help limit the amounts of decreases in values suffered by many portfolios in market downturns.

It's unlikely that the non-fiduciary employee benefits manager has any understanding of these cost and risk issues, much less even knows that they exist. (Witness the embarrassing ignorance of such managers put in charge of running huge 401(k) plans at large companies with unlimited resources uncovered by class action lawsuits over the last decade or so.) In fact, the non-fiduciary benefits manager typically has little experience with investments--but she or he is still tasked with the non-fiduciary responsibility to make investment recommendations to the fiduciary committee.

Although the non-fiduciary consultant may have "experience" with investments, she or he has little interest in reducing the costs of a plan's investment options and is, at best, indifferent to doing so. In fact, she or he often is motivated to increase those costs because that enhances her or his compensation under the business model they follow. The consultant is busy ensuring that it's carrying out the fiduciary duties it owes to its employer and the employer's stockholders. There's nothing wrong with that model until it gets mixed in with ERISA retirement plans. Once that happens, plan sponsors forget (or much likelier never knew in the first place) that they're entering the caveat emptor zone where the only sole interests that a non-fiduciary service provider takes to heart are its very own.

In neither case will the fiduciary committee be helped, whether that's due to the ignorance of the non-fiduciary benefits manager or the perverse self-interest of the non-fiduciary consultant's business model. That's why, in both cases, the odds are higher that plan participants and their beneficiaries will be harmed significantly. The non-fiduciary inmates end up running the fiduciary asylum in either case.

There is a way (as well as others), however, to vastly improve this situation for plan participants and their beneficiaries. Congress describes the three kinds of fiduciaries that can deal with retirement plans in ERISA section 3(21): 3(21)(A)(i) discretionary investment fiduciaries, 3(21)(A)(ii) non-discretionary investment fiduciaries, and 3(21)(A)(iii) administrative fiduciaries.

Administrative fiduciaries, while critical to the prudent operation of a retirement plan, are not at issue here.

Although non-discretionary investment fiduciaries can be of help to plan sponsors, legally they cannot take on responsibility (and any associated liability) for selecting, monitoring, and (if necessary) replacing a retirement plan's investment options.

However, a discretionary investment fiduciary such as a bank, insurance company, or advisor registered under the Investment Advisers Act of 1940 ('40 Act) can take on such duties as a fiduciary investment manager in accordance with ERISA section 3(38), considerably lightening the fiduciary burdens of a plan sponsor.

Hey, What's the Beef?
There sure was a lot of high-priced legal talent in Washington, D.C., at the U.S. Department of Labor's (DOL) hearings last month. They appeared largely on behalf of large trade associations that represent those--brokers and insurance agents--that just don't want to be fiduciaries. If anyone knows the law pertaining to everything under the sun about the financial services industry as well as its practices, it's that group of legal beagles.

Which is why it's so surprising that one of the mantras they keep repeating--please don't let those meanies at the DOL take away the ability of investors to receive valuable investment advice from their brokers--is just plain false.

According to the U.S. Securities and Exchange Commission, a broker is "any person engaged in the business of effecting transactions in securities for the account of others." In contrast: "An investment advisor is defined as a person who receives compensation for providing advice about securities as part of a regular business." Although there is a "broker-dealer" exemption in the '40 Act, it's quite specific: "In general, a broker-dealer whose performance of advisory services is 'solely incidental' to the conduct of its business as a broker-dealer [that is, effecting securities transactions] and that receives no 'special compensation' is exempted from the definition of investment adviser."

Stated another way: The only kind of advice that brokers can give legally is if it's incidental to the sale of securities. If it's not incidental advice, then, ipso facto, it must be fiduciary advice under the '40 Act. So even under current law, brokers cannot provide substantive investment advice. But if they happen to do so, they must register as a registered investment advisor under the '40 Act and be held to a fiduciary standard.

So if such advice is fiduciary advice, what's the beef? To reiterate, there's nothing new about requiring anyone who provides substantive investment advice to become subject to a fiduciary standard. That has always been the law. Maybe someone should sue the SEC to require it to actually enforce the "solely incidental" provision of the '40 Act.

Perhaps those high-priced attorneys who testified at the DOL hearings and are members of the District of Columbia bar should be disciplined for intentionally misleading regulators and the public about the very real legal--and practical--difference between the advice that is incidental (defined by Webster's as something that happens "as a minor part or result of something else") to the sale of a security that's provided by a (non-fiduciary) broker under the Securities Exchange Act of 1934 and the substantive investment advice that's provided by a fiduciary advisor under the '40 Act. After all, members of the D.C. bar are officers of the court sworn to promote the furtherance of justice (as is any attorney at whatever level of legal jurisdiction in our country). Surely the promotion of justice doesn't include the telling of tall tales in order to create a false narrative.

The Tibble v. Edison International Decision
On May 18, 2015, in Tibble v. Edison International, the United States Supreme Court found unanimously that a plan fiduciary has an ongoing fiduciary duty under ERISA to monitor the investment options in a retirement plan--a duty that is distinct from, and in addition to, the fiduciary's duty to be prudent when making the initial selection of plan investment options.

The outcome reflected in the court's 10-page opinion seemed, to me, to be inevitable for the plan participant plaintiffs from the beginning--despite the fact that the trial court and the Ninth Circuit Court of Appeals ruled for defendant Edison. After all, was the court really going to buy into Edison's absurd contention that it could pick a bunch of ludicrous investment options and six years later escape all responsibility (and associated liability) for its initially foolish decision-making just because the statute of limitations had run? Yup, that's just what Edison thought.

It appeared that the Court tweaked the collective noses of the lower (district and Circuit) courts when it described the fundamental, underlying foundation of ERISA--the common law of trusts: "We have often noted that an ERISA fiduciary's duty is 'derived from the common law of trusts.' Central States, Southeast & Southwest Areas Pension Fund v. Central Transport, Inc., 472 U. S. 559, 570 (1985). In determining the contours of an ERISA fiduciary's duty, courts often must look to the law of trusts. We are aware of no reason why the Ninth Circuit should not do so here. Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee's duty to exercise prudence in selecting investments at the outset."

In support of this, the Court's opinion cited the Restatement (Third) of Trusts: "[A] trustee's duties apply not only in making investments but also in monitoring and reviewing investments, which is to be done in a manner that is reasonable and appropriate to the particular investments, courses of action, and strategies involved.' §90, Comment b, p. 295 (2007)." The Court also referenced the Uniform Prudent Investor Act, which "confirms that '[m]anaging embraces monitoring' and that a trustee has 'continuing responsibility for oversight of the suitability of the investments already made.'" (My book, The Prudent Investor Act: A Guide to Understanding, sheds a great deal of light on such issues.) The court even went so far as to cite two legal treatises--Bogert on Trusts and Scott on Trusts, which are familiar to virtually every law student over at least the last 80 years--to support the proposition that elementary principles of trust law underpin the case. It will be interesting to see how the lower courts apply the Court's reasoning, but henceforth, every ERISA plan sponsor has a continuing duty to monitor a plan's investment options; it doesn't receive a free pass just because six years go by. As if that was ever in doubt.

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 Understandingis 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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