Plan Sponsors Take Note You Are a Fiduciary

In the financial services industry consumers rarely ask how much they’ll be charged for products and services. If they do, they are often told -” and believe -” that they don’t pay anything because the insurance or investment provider pays the financial professional.

This less-than-transparent fee collection process has allowed financial providers to earn significant revenues without consumers fully understanding how much they are paying in direct and indirect fees. In strong economic times, consumers are usually not concerned with fees as long as investments are growing. That is starting to change.

For years, public debate about financial products and services centered on commission versus fee business models. In my opinion, fees and commissions are both valid compensation methods. The emerging issue for plan sponsors is public realization that there are:

  • Two sets of rules, the Suitability Standard of Care and the Fiduciary Standard of Care, in the financial services marketplace, and
  • That full disclosure and transparency are not common industry practices.

Under the Suitability Standard, the financial professional acts in the best interests of the firm and adheres to guidelines and rules established by governmental and self-regulatory bodies.

Under the Suitability Standard, a financial professional makes recommendations that are often influenced by home office pressure to promote proprietary products, sales competitions, higher commission payouts so long as the recommendations are “suitable” under the guidelines.

The highest standard of care, the Fiduciary Standard, is not rules-based. Rather, the financial professional always acts in the best interests of the client -” period.

While the distinctions between these standards of care impact us at the individual level, the most significant issue is how they influence the delivery of services to retirement plans.

To understand this, we must understand who is a fiduciary and what his/her responsibilities are.

Loosely defined, a fiduciary is anyone who has responsibility for other people’s money. This means that you are a fiduciary (named or unnamed) if you:
1) Appoint or serve as a trustee.
2) Hire or retain service providers and/or “prudent experts.”
3) Make or influence decisions related to the plan.

Why is this important?

When people lose money, they look for someone to blame so they can recover their losses. A spike in securities lawsuits usually accompanies bear markets. In fact, the liability exposure for plan sponsors and trustees today is higher than ever for several reasons:

  1. Unlike past recessions (think 1970s and early 80s) when defined benefit plans dominated, most workers now see market volatility first hand in their 401(k) statements.
  2. This recession is largely being blamed on the financial industry and its pursuit of profits at the expense of the consumer.
  3. The spate of 401(k) fee related class action lawsuits and Congressional and Department of Labor hearings into 401(k) fees and investment advice raised public awareness and heightened interest in litigation opportunities.
  4. The February 2008 U.S. Supreme Court LaRue decision now gives individual plan participants legal standing to sue plan sponsors and trustees for losses from fiduciary breaches whether intentional or not.

Add to these the fact that many Plan Sponsors and Trustees have fallen prey to the “fallacy of delegation.” Under the laws governing corporate retirement plans, trustees are encouraged to delegate duties to third party experts -“ typically 401(k) service providers and representatives. However, what many overlook is that, while the law encourages delegation of responsibilities, it doesn’t permit delegation of fiduciary responsibilities.

Plan sponsors and trustees have the central responsibility to act in the plan participants’ best interests (provide a fiduciary standard of care). By contrast, the majority of 401(k) service providers operate under the lesser Suitability Standard. In fact, many service provider agreements state that they are not fiduciaries to the plan and financial firms (insurance companies, Wall Street firms, banks, etc.) often prohibit representatives from acting in a fiduciary capacity.

Clearly, problems can result when persons who are responsible for acting in a fiduciary capacity rely on third parties who explicitly do not do so. While this may have sufficed in the past, the increased attention being focused on fiduciary matters by the Bar, legislative and regulatory bodies and now the media, compels prudent plan sponsors to consider proactive steps to manage their inherent fiduciary liabilities.

These steps include, but are not limited to:

1) Making sure all service provider agreements (including the agent of record) are in writing and specifically document responsibilities.
2) Reviewing all service provider agreements and, if not so stated, demanding that providers acknowledge their fiduciary obligations in writing.
3) Adopting a policy of full fee disclosure and revenue transparency. This includes fees, commissions, revenue sharing, etc.
4) Periodically benchmarking total plan fees to determine if they are still appropriate.
5) Taking advantage of the safe harbors offered by the Pension Protection Act regarding investment advice to plan participants.
6) Developing an Investment Policy Statement and using its screening criteria to evaluate your plan on a quarterly basis against the universe of mutual funds, not just those made available by your 401(k) service provider.

Ultimately, fees and conflicts of interests are like mushrooms; they tend to grow in the shadows. By adopting a policy of full fee disclosure and transparency and requiring service providers to adhere to a Fiduciary Standard, plan sponsors and trustees will reduce both their risk and total plan expenses.

Brian Lakkides is an Accredited Investment Fiduciary and president of Corporate Plan Administrators in Waterford, Mich., a fiduciary consulting firm that specializes in helping plan sponsors manage risk while avoiding excessive fees in the context of existing and proposed ERISA regulation. He can be reached at [email protected].