Hiring a Fiduciary Can Reduce Company Owners’ Headaches

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Hiring a Fiduciary Can Reduce Company Owners’ Headaches and Improve Employees’ Retirement Prospects

By Allan Henriques, AIFA®, J.D.

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By Allan Henriques, AIFA®, J.D.

Smart Investor5800 Stanford Ranch Road, Building 800

Rocklin, CA 95765(916) 435-2100

www.smart-investor.cc

Hiring a FiduciaryDecember 2009

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Owners of small companies want their corporate retirement plans to serve their employees well.

Indeed, once employers adopt corporate retirement plans, they are legally required to do so. Putting employees’ interests first is part of their fiduciary duty under U.S. law.

Unfortunately, it is commonly recognized that many owners of companies with less than $50 million in retirement assets don’t really get what it means to be a fiduciary.

It can be a time-consuming responsibility, involving intensive analysis and ongoing monitoring of the retirement plan. Even when owners understand their duty, they typically don’t have the time or skills to fulfill every requirement.

Many owners muddle through, although their employees may struggle to save in substandard retirement plans, and executives may expose themselves to legal risks that imperil their personal savings.

Fortunately, there’s a cost-effective solution: delegating duties to an independent fiduciary.

Employers need to understand what they’re up against—and the solution for these challenges. To help them, this report discusses the following:

• Definition of a retirement plan fiduciary and employers’ duties as fiduciaries

• Risks of not acting as a fiduciary• Owner’s ability to delegate some fiduciary responsibility, thus strengthening risk management

What Is a Fiduciary?A retirement plan fiduciary is anyone who is named as a fiduciary in the retirement plan documents or who exercises control over the plan’s operation. This typically includes “the trustee, investment advisers, and all individuals exercising discretion in the

1 “Meeting Your Fiduciary Responsibilities,” U.S. Department of Labor, Employee Benefits Security Administration. 2 Michael S. Melbinger and Michael P. Roche, “Benefit Plan Sponsors Need to React to the Supreme Court’s Decision in the LaRue Case,” Winston & Strawn Lunch Briefings (March 19, 2008), p. 49. This presentation is helpful in understanding the employer’s perspective on fiduciary issues.3 “Meeting Your Fiduciary Responsibilities.”4 “Meeting Your Fiduciary Responsibilities.”

administration of the plan, all members of a plan’s administrative committee (if it has such a committee), and those who select committee officials… The key to determining whether an individual or entity is a fiduciary is whether they are exercising discretion or control over the plan,” according to the U.S. Department of Labor (DOL).1 The DOL administers the Employee Retirement Income Security Act of 1974 (ERISA), the most important law governing corporate retirement plans.

Some corporate employees may be surprised to learn that they are fiduciaries. For example, a human resources professional learned that he was considered a fiduciary simply because he handled questions about a participant’s benefit claim, according to a case cited by the law firm of Winston & Strawn.2 Moreover, the DOL says, “…Fiduciary status is based on the functions performed for the plan, not just a person’s title.”3 Thus, it’s important to be aware of the responsibilities and actions that fall under the fiduciary umbrella (see Exhibit 1).

The penalty for breaching any of these fiduciary responsibilities could be more than a metaphorical slap on the wrist. The DOL says, “Fiduciaries who do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.”4 Fiduciaries are also potentially liable for their co-fiduciaries’ failures. A lawsuit could result in fiduciaries

losing their personal — as well as retirement plan — assets. Moreover, legal fees for individuals could


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easily run into six figures or more. In November 2009, in Martin v. Caterpillar, the litigants filed a settlement proposal calling for a payment of $16.5 million where it was claimed that the fiduciaries had breached their duties by maintaining imprudent investment options and paying excessive fees. The settlement fund included $5.5 million in attorney’s fees.

Types of FiduciariesThe Foundation for Fiduciary Studies, a non-profit organization established in 2000 to develop and advance practice standards of care for investment

fiduciaries, states that there are generally three types of investment fiduciaries.

First is the Investment Standard — trustees, investment committee members and plan sponsors who usually have the least amount of investment training but are responsible for managing all of the fiduciary responsibilities regarding the investment portfolio.

The second type is the Investment Advisor — the prudent experts who give advice to a retirement plan.

Third are the Investment Managers — who make

Exhibit 1: Conditions and Responsibilities of a FiduciaryAn individual, committee, or company may be a fiduciary if it:

• Is named in plan documents as a fiduciary, though this is not necessary to be considered a fiduciary — these fiduciaries are called “named fiduciaries”

• Exercises control over the management or administration of the plan or its assets• Provides ongoing investment management or advice to the plan or to plan participants

• Selects or supervises other plan fiduciaries

The DOL says fiduciaries’ responsibilities include

1. “Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them” — Duty of Loyalty (also known as the Exclusive Benefit Rule)

2. “Carrying out their duties prudently” — Duty of Prudence (also known as the Prudent Expert Rule), described in more detail below

3. “Following the plan documents (unless inconsistent with ERISA)” — Duty to Follow Plan Documents

4. “Diversifying plan investments” so as to minimize the risk of large losses, unless under the circumstances, it is clearly prudent not to do so — Duty to Diversify (also known as Duty to Avoid Large Losses)

5. “Paying only reasonable plan expenses” — Duty to Pay Reasonable Plan Expenses Relative to Services Provided

Elaborating on #2, the Duty of Prudence, it is important to note that fiduciaries are held to the high standard of a Prudent Expert — not simply a Prudent Person. ERISA explains that this requires “acting with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in like capacity and familiar with such matters would use.” The familiarity clause elevates the requirement to the level of a Prudent Expert.

individual securities selections to implement the investment mandate.

Risks for Fiduciaries from Lawsuits and PoliticiansLawyers and politicians are paying more attention to fiduciaries — and most of the attention is negative. This happens as more people recognize that the shift from defined benefit to defined contribution plans has endangered Americans’ retirement security.

Under defined benefit plans the employer assumed all the risks and costs of providing the predetermined level of benefits upon the employees’ retirement. Accordingly, the details of costs, investment vehicles, and so on didn’t matter much to plan participants because the details wouldn’t affect the level of their benefits.

Today, defined contribution plans, such as 401(k) and profit sharing plans, outnumber defined benefit plans. In contrast to a defined benefit plan, the employer’s contribution to the plan is defined. Moreover, there are no guarantees of the benefit the employee ultimately receives, and the employee assumes all risks. In a defined contribution plan, excessive expenses, poor investment choices, and poor investment results subtract directly from the benefit the employee will receive in retirement.

National leaders are looking for someone to hold accountable for this crisis. They could zero in on employers. The bottom line for owners of small companies: there’s a rising likelihood of getting sued and becoming subject to more legislative control.

LaRue Case Raises the Stakes

The U.S. Supreme Court’s 2008 decision in the case of LaRue v. DeWolff, Boberg & Associates, Inc. changed the outlook for retirement plans and their fiduciaries. It established for the first time that lawsuits can be filed when only one plan participant — rather than an entire plan — is affected by the breach of fiduciary duty. This recognizes the shift from defined benefit to defined contribution plans. As Justice John Paul Stevens wrote, “For defined contribution plans, however, fiduciary misconduct

need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive.”

This has potentially huge implications for companies. “The likely result of this decision is an increase in ERISA litigation against benefit plan sponsors and other fiduciaries, including executive officers and board members, who are favorite targets of plaintiffs’ lawyers,” according to the law firm of Winston & Strawn.5 Now that individuals can file lawsuits, a company could get stung with many small, yet time-consuming, costly lawsuits.

The LaRue decision also reinforces the point that fiduciary duty is the “highest duty known to law.” This means that fiduciaries must exert themselves to understand and carry out their duties and to ensure that other fiduciaries are also doing so. In the event of a fiduciary breach, no excuses are accepted. A fiduciary can’t say, “I didn’t know.” The old saying, “The buck stops here” applies to all fiduciaries. This makes it more important than ever for companies to pay more attention to responsibilities in this arena and to hold all retirement plan advisors and vendors accountable.

Government Taking More Interest in Fiduciaries

The word “fiduciary” now pops up regularly in news stories about investments and retirement. Just a couple years ago, the term was restricted to articles aimed at a narrow group of professionals. This also raises the likelihood of retirement plan fiduciaries coming under fire.

For example, the SEC Investor Advisory Committee created in 2009 has expressed interest in discussing fiduciary duty. There’s a hot dispute among regulators, industry organizations, elected representatives, and corporations about how and when fiduciary duty should apply to brokerage firms’ registered representatives and registered investment advisors (RIAs). This discussion puts fiduciary duty in the spotlight. Under current regulations, registered reps are held to a lower standard than RIAs. As RIAs see it, registered reps can put the interests of

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5 Melbinger and Roche, p. 4.

themselves and their companies first, whereas RIAs have the duty of loyalty to clients, which dictates that clients’ interest must come first. Accordingly, some brokerage firms “have brokers recommend their own in-house mutual funds, which carry heavy expense loads,” according to financial commentator Bob Veres.6 When these funds appear in a 401(k) plan, it’s clear this conflict has implications for plan sponsors.

Costs and Fees Make a Difference — A Big DifferenceThe staff of the Joint Committee on Taxation prepared for the U.S. House of Representatives Ways and Means Committee on October 30, 2007, a report of background information relating to retirement plan fees in which it concluded that “the amount of fees charged against retirement plan assets has a significant impact on the amount of plan assets that are available for retirement benefits.”7 It provided the following illustration of the impact of fees on a hypothetical participant who contributed $5,000 annually for 20 years as summarized in Exhibit 2.

Costs can add up. For example, plans with costs and fees totaling 2% reduced the amount available

to this hypothetical participant who made the “right” investment decisions and earned a hypothetical average 8% return by $67,898 (27.48%).

Owners Can Delegate Most Fiduciary ResponsibilitiesSome company owners are confused about the extent to which they can delegate fiduciary duty. They’ve been scared into thinking there’s nothing they can do. Owners — and other company employees who serve as fiduciaries because they exercise some control over their plans’ operations — will always have the duty to monitor other plan fiduciaries. But they can delegate much of their fiduciary duty to carefully selected and monitored independent fiduciaries. In fact, one could argue that the company has a fiduciary duty under the Prudent Expert Rule to hire an independent fiduciary, if owners and employees lack extensive expertise in fiduciary matters.


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6 Bob Veres, “A Swiftly Tilting Planet,” Financial Planning (August 2009), pp. 23-24.7 “Present Law and Background Relating to Qualified Retirement Plan Fees,” Staff of the Joint Committee on Taxation, (October 30, 2007), p 11.

Exhibit 2: Costs Make A DifferenceTotal Annual Fees & Costs 1.00% 1.50% 2.00%Annual Gross Rate of Return = 6.00% Fixed Account Value at Retirement $173,596 $163,916 $154,846 Reduction in Final Value Due to Fees $ 21,367 $ 31,048 $ 40,118 Percentage Reduction in Final Value Due to Fees 12.31% 18.94% 25.91%Annual Gross Rate of Return = 8.00% Fixed Account Value at Retirement $219,326 $206,745 $194,964 Reduction in Final Value Due to Fees $ 27,789 $ 40,370 $ 52,151 Percentage Reduction in Final Value Due to Fees 12.67% 19.53% 26.75%Annual Gross Rate of Return = 10.00% Fixed Account Value at Retirement $278,823 $262,445 $247,115 Reduction in Final Value Due to Fees $ 36,190 $ 52,567 $ 67,898 Percentage Reduction in Final Value Due to Fees 12.98% 20.03% 27.48%

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The first step in delegating fiduciary duty is to figure out where it currently lies. All responsibility lies with the plan sponsor, at least initially, according to ERISA. However, it’s possible to spread some of that responsibility among the trustee, committees, named fiduciary, plan administrator, and investment manager, assuming that the proper procedures are followed.

It’s easy to get confused about which outsiders act as fiduciaries in the complete sense of the word. Brokers may be genuinely concerned about the plan’s interests, but, as discussed above, they’re not legally required to put client interests first. Some vendors may talk up their roles as “co-fiduciaries,” while limiting their actual responsibilities by adding technical legal language to their service agreements. Unlike a fiduciary, a co-fiduciary has to act only when another fiduciary breaches their duty or when they are required to pursuant to their service agreement. Also, contracts may favor the vendor at the company’s expense. For example, some registered reps working for brokerage firms call themselves “co-fiduciaries” but won’t acknowledge their fiduciary status in writing. These reps “may be only assisting the fiduciaries in choosing investment options” and don’t have the authority or ability to buy or sell plan assets. As a result, the company owners sponsoring the retirement plan — not the brokers — still bear full responsibility and liability for investment decisions.

Once a company sorts out the above-mentioned issues, it can select an independent fiduciary who will assume all day-to-day investment and administrative duties, including selecting the menu of investment options and hiring/firing providers. A special rule allows companies to appoint an independent and qualified investment manager who is granted discretion and authorized to buy and sell plan assets. This manager is defined by ERISA as a registered investment advisor, a bank or insurance company who acknowledges his or her fiduciary status in writing. The acknowledgement of fiduciary status by this person or firm is critical.

When plan sponsors wish to delegate some or most of the plan’s fiduciary responsibilities, they should seek firms that understand the meaning of “fiduciary” and that know how to measure risks. One measure

is certification. For example, “The Accredited Investment Fiduciary® (AIF®) designation represents a thorough knowledge of and ability to apply the Fiduciary Practices,” says fi360 a Bridgeville, Pa., company that offers training and the credential. The AIF® designation falls under the Centre for Fiduciary Excellence, an independent global assessment and certification organization. This ensures that standards are set high.

The Standards of Fiduciary Excellence from fi360 provide a detailed checklist of issues that a retirement plan trustee or independent fiduciary should review to minimize their exposure to fiduciary liability. Companies should seek an independent fiduciary that can assess their plan’s compliance with these standards and then fix things if the company falls short of satisfying the standards. This will minimize the risks associated with the plan.

The goal of risk management for fiduciaries is to optimize plan participants’ results, while minimizing personal liability exposure. To manage 401(k) plan risks effectively, companies need rigorous processes that they and their vendors follow carefully, while documenting their actions. Once the company has selected an independent fiduciary, it can delegate much of this to the fiduciary.

The independent fiduciary will manage risks (see Exhibit 3) — especially the risk that the fiduciaries may be sued for paying excessive fees or conducting insufficient due diligence — the two most frequent areas of claims against fiduciaries.

Hiring an independent fiduciary with the right experience and knowledge leaves the company owners with the need only for residual monitoring. That means owners can focus on running their companies instead of grappling with complex, technically demanding analysis and decisions.


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Exhibit 3: Key Areas for Risk Management

Costs, expenses, and compensation associated

with investmentsMain requirements Plan sponsor must be

careful to:

Investment & administration fees

• Must conduct extensive due diligence

• May pay reasonable fees from the plan’s assets

• Compare services and costs at which they are offered

• Compare the plan and its investments to those of other firms

• Avoid choosing a higher-priced offering when a comparable lower-priced offering is available

• Allocate expenses fairly• Disclose costs, including transaction costs and revenue-sharing, to plan participants

Bundled services & revenue sharing

Current litigation, Congressional legislation, and DOL regulations are in the process of setting rules about what information should be disclosed and how

• Act with an understanding that bundled 401(k) administration is not “free” to participants

• Understand what costs and payments are associated with a share class, how they compare with other share classes, and who gets paid what by whom

Ongoing monitoring • Monitor plan providers, investments and fiduciaries

• Stay aware of timely issues in investments

• Create appropriate procedures

• Maintain records showing that procedures are followed

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If you have questions about any of these issues, please contact Allan Henriques, AIF®, of Smart Investor at (916) 435-2100 or [email protected].

Allan Henriques, AIF®, AIFA®, J.D., is the founder and president of Smart Investor, a Rocklin, California-based wealth management firm that also acts as an independent investment fiduciary. Allan is an Accredited Investment Fiduciary and former attorney with 15 years of legal experience and more than 20 years of financial services experience. He enjoys freeing his retirement plan clients to focus on managing their businesses profitably. Smart Investor specializes in working with entrepreneurs and small business owners who don’t have the time to efficiently manage their personal investment and tax planning. The firm also provides cost-efficient charitable trust administrative services for individual and institutional clients.

Smart Investor’s team of highly-skilled professionals provides extraordinary client service. In helping clients achieve their personal objectives and have fun with life, the Smart Investor staff personifies the firm’s core values of respect, integrity, and valuing and giving back to clients’ and employees’ communities. Smart Investor employees are personally involved with local charities and Allan serves on the board of directors of the Boys and Girls Club of Auburn (California).

Smart Investor5800 Stanford Ranch Road, Building 800

Rocklin, CA 95765(916) 435-2100

www.smart-investor.cc

Hiring a Fiduciary Can Reduce Company Owners’ Headaches and Improve Employees’ Retirement Prospects By Allan Henriques, AIF®, AIFA® J.D.© Copyright 2009 Smart Investor. All rights reserved.

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