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| > Investing > Fiduciary Focus |
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| Fiduciary Focus: Non-Fiduciary Investment Consultants (Part 3) |
| by
W. Scott Simon
| 07-06-06 |
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"The battle of Waterloo was won on the playing fields of Eton." This line has been attributed to Arthur Wellesley, otherwise known to history as the Duke of Wellington, Conqueror of Napoleon. Lord Wellington linked one factor--the activities of children--to another, seemingly unrelated factor--the defeat of Napoleon.
In perhaps a more certain way, one factor--the amount of income a person can expect from his or her retirement plan upon retirement--can be linked to another, seemingly unrelated (yet very harmful) factor--obscure, yet crucial language found in contracts entered into by fiduciaries of retirement plans and the investment consultants to such plans.
In my two previous columns, I examined how a real-life contract, in effect, gutted the contract of all ERISA section 3(21)(A) fiduciary duties owed to the plan's participants. The contract was drafted by a broker-dealer investment consultant to a 401(k) plan (through its RIA arm) and entered into by the consultant and the fiduciaries of the plan. This contract enabled the consultant to avoid real responsibility (and, therefore, liability) for any such duties while allowing the consultant to continue posing as a "fiduciary."
In this month's column, I'd like to continue this examination with a look at how this contract allows the broker-dealer consultant to plunder (all legally, of course) the accounts of plan participants, significantly (and unconscionably) reducing the amount of income plan participants can expect upon retirement. I'm not sure if Lord Wellington would approve of such behavior, but Blackbeard, that plundering pirate of old, certainly would. Let's see why.
ERISA section 404(a)(1)(A)(ii) states: "A fiduciary shall discharge his duties solely in the interest of the participants and their beneficiaries.for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan."
The "fiduciary" referred to here is the fiduciary of a retirement plan that is responsible for knowing the nature and amount of the fees and expenses incurred by the plan. The "duties" referred to here make up a portion of "the core fiduciary law [of] ERISA [section] 404(a)(1) which propounds the foundational norms--the duties of loyalty and prudence--which underlie all trust fiduciary law," according to John H. Langbein, the Reporter for the Uniform Prudent Investor Act and Chancellor Kent Professor of Law and Legal History at Yale University law school.
Needless to say, then, fiduciaries of retirement plans such as 401(k) plans should have a very good idea about the costs incurred by the plans for which they are legally responsible. It's no secret, though, that precious few of them have any clue about the nature and amount of such costs. This is due in no small part to the fact that ERISA doesn't require a non-fiduciary investment consultant to disclose its fees to plan fiduciaries. Fred Reish and Bruce Ashton, in a white paper prepared by for the Principal Group in September, label this a "disconnect" under ERISA law:
[T]he plan sponsor and its key officers have a duty to know and understand the fees and expenses being paid by the plan. However, in most cases, there is no commensurate duty on a non-fiduciary financial professional to disclose his fees. That disconnect creates a potential conflict between the plan fiduciaries and the intermediary; if the professional does not fully inform the fiduciaries of its compensation, he probably has not violated ERISA, but may have caused the fiduciaries to breach their ERISA duties.
So there you have it: Plan fiduciaries must ask non-fiduciary consultants to account for their compensation so that the fiduciaries can fulfill their fiduciary duty under ERISA section 404(a)(1)(A)(ii). The consultant, however, has no duty to (and very rarely does) answer that question. Reish and Ashton really have nailed it when they refer to this as a "disconnect."
But does a fiduciary investment consultant have the duty to answer that question? It would sure seem so. In the real-life contract between the fiduciaries of a 401(k) plan and what I referred to in my previous column as a "phantom" fiduciary (i.e., the broker-dealer/RIA investment consultant to the plan that poses as a fiduciary), the consultant agrees that, with respect to providing certain services, it is an ERISA section 3(21) fiduciary.
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| 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 Understanding is 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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