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The Morals of the Marketplace

It appears that the DOL is on a mission to accommodate the business models of interest groups that just don't want to be fiduciaries, writes Scott Simon of Prudent Investor Advisors.

W. Scott Simon, 11/07/2013

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.


Many of the business entities for which investment advisors labor in the retirement plan marketplace affirmatively choose to refuse to assume fiduciary responsibility and liability under the Employee Retirement Income Security Act of 1974 (ERISA). In effect, then, they are governed, among other things, by the "the morals of the marketplace," the phrase immortalized by Benjamin N. Cardozo, Chief Judge of the New York Court of Appeals, in the case of Meinhard v. Salmon (249 N.Y. 458, 464, 164 N.E. 545, 547 (1928)). (Cardozo later became a Justice of the United States Supreme Court in 1932.) This phrase, as rendered in that legal opinion, is simply code for an ancient Roman phrase of commerce: caveat emptor (or "buyer beware").

But should caveat emptor (the buyers, of course, being plan sponsors and, indirectly, plan participants and their beneficiaries) really be the guiding light for certain advisors when dealing with ERISA plans? It sure seems so, at least from the perspective of the U.S. Department of Labor (DOL). Phyllis C. Borzi, assistant secretary of labor for the employee benefits security administration, is in charge of the thankless job of reworking the DOL's definition of a "fiduciary." Should caveat emptor really be the lodestar for the relationship between plan participants and some advisors whose status may be redefined under the fiduciary standard planning to be proposed by the DOL?

Borzi has been quoted as saying that it's possible the new fiduciary rule will allow "potentially problematic, conflicted" transactions but that any such transactions will be accompanied by appropriate disclosures that might produce a potentially positive benefit. Problematic (meaning, according to my Microsoft Word thesaurus, "difficult," "tricky," "challenging," "sticky," "awkward," "knotty") transactions, conflicted transactions (only "potentially," of course) being allowed in ERISA plans? Really? And what are "appropriate" disclosures, or "inappropriate" ones for that matter? If the disclosures are appropriate, how might they produce "a potentially positive benefit"?

Disclosures as Pure Pabulum
Disclosures are usually of little help to, for example, plan sponsors because any information that may be divulged in a disclosure is simply that: information. But information about ABC is not the same as knowledge about, or understanding of, ABC. For example, one large, well-known investment consulting firm (XX)--a federally regulated registered investment advisory firm--states in its Form ADV brochure: "Conflicts of interest--real or apparent--are inherent in many of XX's businesses. Some of those conflicts are inherent in any large, diversified financial services firm, while others stem from the nature of the services we offer to clients."

While the foregoing disclosure contains information, the typical plan sponsor (or any sentient being) would not be able to glean any knowledge or understanding from it other than its service provider is engaged in conflicts of interest. The disclosure doesn't even convey to a sponsor that the consultant is probably engaged in any conflicts with the sponsor itself, much less that such conflicts could be harmful to the sponsor and the participants (and their beneficiaries) in the sponsor's plan.

The information in a disclosure is rarely (never, more like) adequate in providing a plan sponsor with knowing understanding of a situation and the sometimes-myriad implications that can arise from that situation. A plan sponsor, as the recipient of information contained in a disclosure, often has no independent context, no requisite body of knowledge upon which to draw that would allow it to understand the disclosed information in order to be in a position to make an informed decision. That's why such disclosures are, by and large, pure pabulum.

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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