A Closer Look at a New Weapon in the Fiduciary Wars

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.

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I have written a number of columns over the last half-decade or so on the "fiduciary wars" that continue to this day. In order to avoid a long narrative, suffice it to say that on one side of this conflict stands Wall Street (which includes Big Mutual Fund Companies, Big Stockbrokerage Firms, Big Insurance Companies, Big Banks, Big Broker/Dealers, et al.), and on the other side stands the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Labor (DOL) as well as those asking for a level playing field in the fiduciary wars.

The two essential questions to be decided: whether those on Wall Street 1) that provide financial services to individual retail investors (pursuant to SEC jurisdiction) will be governed by the "best interest" fiduciary standard of the Investment Advisers Act of 1940 and 2) that provide financial services to participants in retirement plans (pursuant to DOL jurisdiction) will be governed by the "sole interest" fiduciary standard of the Employee Retirement Income Security Act of 1974 (ERISA).

To date, neither has the SEC proposed any rules in this area nor has the DOL re-proposed its fiduciary rules in this area that have been in existence since 1975, one year after passage of ERISA.

One of the newest weapons in these wars was brandished in mid-May by Davis & Harman LLP, a Washington, D.C., law firm that, based on a review of its website, appears to lobby heavily for Wall Street special interest groups. That weapon--a survey--was commissioned by the law firm, which, along with the U.S. Hispanic Chamber of Commerce, co-sponsored the survey. The marketing firm that conducted the survey is also headquartered in Washington, D.C., and, based on a review of its website, appears to specialize in representing clients in the financial services industry such as stockbrokers, insurance agents, et al.

The survey--"The Impact of the Upcoming Re-Proposed Department of Labor Fiduciary Regulation on Small Business Retirement Plan Coverage and Benefits"--is also referred to as a "report" and "study," involving "research" and a "methodology." It has received enormous media attention and, at least in some quarters, is seen as achieving canonical standing in the fiduciary wars debates.

Like most people, I suppose, I looked at the headlines and scanned the news stories about the survey but never actually read the survey itself. When I did, I was taken aback by the deceptive nature of some of the questions and the sleight-of-hand conclusions drawn from the "data" presented. Compounding that is the seemingly easy acceptance of such conclusions by the media.  

The first thing to note about surveys in the financial services marketplace (or any other for that matter) is that many of them just happen to reach the same findings and come to the same conclusions as those of the organization that commissions them. When was the last time that you read about a survey (or for that matter, read a white paper, article, etc.) that didn't advance the cause(s) of the organization that had sponsored it? You will never see, for example, a Big Insurance Company issue a white paper concluding that insurance products are not prudent investment options for retirement plans. This reminds us of the adage that you shouldn't always believe what you read.

Before going any further, it's useful to include and analyze Appendix 1 to the survey. As the survey explains: "Respondents were given a description of the new regulation (See Appendix 1) and asked for their reaction." Further, "…Appendix 1 [provides] a fuller description of the contemplated content of the re-proposed regulation, as provided to survey respondents."

Here is Appendix 1, interspersed with my notes, in brackets:

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APPENDIX 1 - Description of Proposed Regulation

Now I want to describe a proposal for a new government regulation. As a plan sponsor, your company currently has a fiduciary responsibility to act in the best interest of your employees when it comes to the investment choices that are available in the company retirement plan. [Note: the fiduciary responsibility standard here is stated incorrectly: it is not the "best" interest standard but the "sole" interest standard as clearly stated in ERISA section 404(a)(1)(A): 'a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose…' This is not splitting hairs: the best interest fiduciary standard applies to registered investment advisers under the Investment Advisers Act of 1940, while the higher sole interest fiduciary standard is found, as noted, in ERISA.] This includes using a prudent process to select a reasonable group of investment funds and monitoring fund performance. [Correct.] Companies have liability to the extent that they do not meet their fiduciary duties. [Correct--and having non-fiduciary advisors and record-keepers will not change that. By the way, thus far, none of the language in Appendix 1 is a "Description of Proposed Regulation;" it is simply a restatement of the current law of ERISA.]

Currently, many employers depend on their plan provider or advisor to provide assistance on the selection and monitoring of funds they offer employees. Such use of assistance is permissible under the fiduciary rules as long as it is prudent to do so. [Correct--but it's critical to understand that even when a plan sponsor receives "assistance," it's still solely legally responsible and liable for its selection/monitoring/replacing duties.] [Only from here on does Appendix 1 depart from a restatement of current ERISA law and begin to muse about its own idea of some DOL re-proposed fiduciary regulation that may never be issued.] The Department of Labor is considering prohibiting both retirement plan providers and the advisors who sell retirement plans to employers from assisting the employers in the selection and monitoring of the funds in the retirement plan. [Incorrect. It would be only non-fiduciary providers and advisors that would be barred.] Under possible new rules, the employer would have two options: (a) find an independent expert on investments to provide, for an additional fee, guidance on the selection and monitoring of investment options [incorrect; an independent expert such as an ERISA 3(38) investment manager wouldn't provide mere guidance but would actually provide a transfer of legal responsibility and liability from a plan sponsor to it, with some firms doing it at no additional cost], or (b) do the selection and monitoring themselves, subject to fiduciary liability if this selection is not done in a prudent manner by someone with sufficient expertise. [Plan sponsors are always subject to this liability when they secure assistance from non-fiduciary providers and advisors.] If 'a' is chosen, the plan sponsor would be subject to fiduciary liability if the expert is not chosen in a prudent manner." [Plan sponsors face fiduciary liability in picking a firm that would not do a good job whether or not the firm is a fiduciary.]

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Another item of note: It may be that the co-sponsors of the survey were (unpleasantly) surprised by its overall findings and therefore had to spin them in the most favorable light possible. So, they had to spin the finding (which became the headline as reported by the media) like this: 30% of U.S. small businesses say that it's at least somewhat likely they will eliminate their retirement plan if the DOL's re-proposed fiduciary regulation is implemented.

This headline is derived from the following question asked by the survey: "When asked how likely they would be to drop their plan if this new regulation was implemented, close to 30% claim that it would be very likely (10%) or somewhat likely (19%) that they would."

Not to put too fine a point on it, but the survey respondents that were "very likely" to drop their plan totaled only 10%. Mind you, the survey's respondents, by and large, are unknowledgeable about retirement plans but yet were asked detailed questions (in 12-minute phone interviews) about a fictional DOL regulation that was barely spelled out to them, and that may be re-proposed at some future unknown time in some future unknown fashion and that no one can even be sure will ever be issued.

The misleading nature of the preceding 30% headline is revealed when the flip side of that headline--actually, the real story of the survey--emerges: 67% of respondents said that it's very unlikely (42%) or somewhat unlikely (25%) that they would drop their plan if the DOL's re-proposed fiduciary regulation goes through.

These two 30%/67% paired headlines are akin to these two: "President Lincoln Enjoys First Two Acts of Play at Ford's Theater" and "President Lincoln Assassinated at Ford's Theater." Both headlines are true, but printing the first one instead of the second is absurd on its face. While we can all easily recognize that absurdity, the duplicitous nature of the headline about the survey is unknown to most of us. You really don't need to know anything more about the forces behind this survey to understand why they don't want to operate in a fiduciary environment.

This leads me to another observation about the deceptive nature of some of the survey's questions. For example: "In the area of selecting or helping to select investments, over 80% evaluate [advisors or record-keepers] as excellent (40%) or very good (42%). Another 13% rate [them] as good. Only 4% evaluate the job done by [advisors or record-keepers] as fair or poor. In the area of monitoring and, if necessary, changing the plan line-ups, 75% evaluate [advisors or record-keepers] as excellent (35%) or very good (40%). Another 17% rate [them] as good. Only 6% evaluate the job done by [advisors or record-keepers] as fair or poor."

This question is deceptive because it entirely misstates the law of ERISA. Under ERISA, a plan sponsor has the inherent duties to select, monitor, and replace (select, monitor, and change, as phrased in the question) a plan's investment options. These duties may be delegated to a fiduciary such as an ERISA section 3(38) investment manager or a discretionary trustee. In either case, though, the delegation must be to an entity that's a fiduciary--more particularly, a discretionary fiduciary. But none of the entities that paid for this survey are fiduciaries. Indeed, the whole point of the survey is seemingly to help ensure that such entities that just don't want to be fiduciaries never will be fiduciaries. So when the preceding question implies that "advisors or record-keepers"--non-fiduciaries all--can select/monitor/change a plan's investments, it ascribes legal duties to them that legally they cannot have and in fact they do not want.

Were there any doubt about that, it's laid to rest by perusing the contracts that such entities provide to plan sponsors. The contracts make it crystal- clear that it's the plan sponsor that has the sole fiduciary duty to select, monitor, and replace a retirement plan's investment options and that the (non- fiduciary) advisor or record-keeper has not a thing to do with it. So why include the preceding question that posits something that simply isn't true?

A final observation: the survey's sample was comprised of 505 plan sponsors, with a smaller number answering some questions. (For purposes of space, I have ignored the 102 wannabe plan sponsors with a smaller number answering some questions.) The survey's methodology doesn't state whether the sample was randomly chosen or whether the survey's respondents were, say, hand-picked in hopes of a specific outcome. The latter, if true, would be embarrassing given that the real headline of the survey likely was not what the forces behind it wanted to see! 

The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.