confero A quarterly publication of Westminster Consulting
ISSUE NO. 4
WHAT ARE YOU WAITING FOR?
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confero A quarterly publication of Westminster Consulting
ISSUE NO. 4
WHAT ARE YOU WAITING FOR?
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Features Fall Issue 2013 • Issue no. 4
TIME TO MAKE TIME TO REVIEW YOUR 401K
PLAN SPONSOR MYTH VS.FACT
THE OSTRICH DEFENSE
It’s time we stop putting off our response to regulatory fee disclosures, 408(b)(2) and “make the donuts”.
It is a common assumption that if a hired investment consultant has fiduciary status, there is no conflict of interest and responsibility has shifted. This article works to dispel this myth.
Plan fiduciaries have already adopted a deep responsibility, whether they fully understand it or not.
www.conferomag.com | 1
Contents Fall Issue 2013 • Issue no. 4
ONE PAGE MAGAZINE
A brief overview of some recent events and notable discussions within the industry.
Liability-Driven Investing — A thoughtful overview on liability-driven investing and its application.
RES IPSA LOQUITOR
Don’t Wait Until It’s Too Late! — Why it’s important to have an IPS Statement.
IN EVERY ISSUE:
Common Plan Fiduciary Mistakes and Best Practices — Some common plan fiduciary mistakes and tips on how to adopt best practices.
Owe Your Tomorrow— Some thoughts to consider before borrowing from your 401k to pay for college.
2 | FALL 2013
2 PUBLISHERS LETTER 3 CONTRIBUTORS 4 UPCOMING EVENTS
2013 CALENDAR 1
CIOS 30 Australia 2013
CIOS Australia 2013: Factors for Portfolio Success October 30, 2013 The Westin • Melbourne
aiCIO’s CIO Summit Australia is in its third year and coming to Melbourne for the first time. Our mission: To help chief investment officers (CIOs) and their teams at superannuation and sovereign funds to innovate, optimize their portfolios and tackle the issues that face investors in Australia, New Zealand and Asia. www.ai-cio.com/event/CIOSAus2013/
aiCIO Industry Innovation Awards December 9, 2013 The New York Public Library 1
aiCIO 9 Industry Innovation Awards
For the fourth time in as many years, December brings aiCIO’s much-lauded Industry Innovation Awards. Held in New York City, these awards highlight the most innovative and positive work being done for, and at, the world’s largest pensions, endowments, foundations, and sovereign wealth funds. www.ai-cio.com/event/awardsny2013/
www.conferomag.com | 3
confero A quarterly publication by Westminster Consulting
A quarterly publication of fiduciary ideas by various contributors within the industry.
Publisher Westminster Consulting, LLC. Editor-In-Chief Gabriella Martinez Contributing Editors Sean Patton, AIF® Thomas Zamiara, AIFA® Creative Director
elcome to our fourth issue of Confero, an issue dedicated to action and determination. We’ve entitle this edition, What Are You Waiting For?
Larry Peters, CPA, EA discusses opportunities to de-risk pension plans and the various strategies available to plan sponsors. One particular strategy, Liability Driven Investing (LDI) has become a topic of much conversation among consultants and plan sponsor alike. Our last issue focused on the Tibble v. Larry outlines a number of necessary steps Edison decision and a number of viewpoints to be considered when implementing a LDI of this important case from our contributors. de-risking approach. The consistent take-away that seemed most prevalent was the unswerving application of Dave Bard, AIF®, challenges us to not the processes and procedures that fiduciaries to put off addressing many of the issues need to apply when making decisions. If imposed on plan sponsors when responding you missed this issue, please visit www. to the regulatory fee disclosures, commonly conferomag.com to view this and other coined, 408(b)(2). We are all very aware of past issues. the tugs and pulls that we are subjected to managing a business. 408(b)(2) has shed What Are You Waiting For?, comes on the bright light on the importance and effect heels of our Tibble edition as a call to action of fees on our participants accounts. Dave to investment fiduciaries to re-examine their highlights a number of constructive steps processes, committees, decision making plan sponsors along with their advisors can procedures, and overall fiduciary exposure take to assess fees and pass on savings to in light of today’s challenging environment. participants. Diana Powell, Esq. provides a succinct Enjoy this issue, we welcome your feedback, overview of ERISA 402(a) and the need and consider contributing to a future edition. to review the plan and other plan-related Thanks so much for your continued support. documents for accuracy and completeness. She thoughtfully overlays these requirements on the 2010 Tussey v. ABB, Inc. case and the lessons to be learned from it.
Tom & Sean
4 | FALL 2013
Gabriella Martinez Contributors Gabriel Potter, AIF® Diana K. Powell, Esq. Thomas Zamiara, AIFA® Gabriella Martinez Lawrence R. Peters, CPA, EA David Bard, CRPS®, AIF®
Questions or Comments? email us at firstname.lastname@example.org
The information contained in this on-line magazine is for general information purposes only. The information is provided by Westminster Consulting and while every effort is made to provide information which is both current and correct, Westminster Consulting makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the on-line magazine or the information, products, services, or related graphics contained within the on-line magazine for any purpose. Any reliance you place on such information is therefore strictly at your own risk. In no event will Westminster Consulting be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this on-line magazine.
Gabriella A. Martinez Editor
David Bard, CRPS ®, AIF ® Contributing Writer
Gabriella is a marketing professional with over seven years of experience. She currently holds a Bachelor of Science in Multidisciplinary Studies with concentrations in Marketing, Printing & Publishing, Photographic Arts & Sciences and Psychology from Rochester Institute of Technology. She has been a featured writer and editor in several publications including Rochester Woman Magazine and Pup Culture.
Diana K. Powell, Esq. is Senior Legal Advisor with over 20 years of experience. She was a sole practitioner who advised educational organizations, government bodies and private corporations. Diana is a graduate of the University of Rochester with a B.A. in Political Science and Albany Law School of Union University, J.D. She holds a Certificate of International Law from the University of Notre Dame, London Law Center and has studied negotiations, mediation and arbitration at the University of Cornell’s School of Industrial Labor Relations, as well as Statistics and International Studies, specializing in the Republic of China, and Educational Policy and Research Methods at the Warner School of Education at the University of Rochester.
Gabriel Potter, AIF ® Contributing Writer Gabriel is a Senior Investment Research Associate of Westminster Consulting where he designs strategic asset allocations and conducts proprietary market research. He earned a B.A. in Economics and a Certificate of Business Management from the University of Rochester and an M.B.A. with concentrations in Corporate Finance and Computers & Information Systems from the University of Rochester’s William E. Simon School of Business. He also holds an Accredited Investment Fiduciary Analyst (AIF®) designation and has been quoted in Human Resources Executive Magazine and his articles have been published through fi360 and AdvisorOne.
Lawrence R. Peters, CPA, EA Contributing Writer Larry is a seasoned Human Resources Professional with extensive experience developing and executing Human Resources and Benefit strategies designed to meet corporate objectives. Larry is currently a member of the American Academy of Actuaries (MAAA), American Institute of Certified Public Accountants, New Jersey Society of Certified Public Accountants and a Fellow for the American Society of Pension Actuaries (FSPA). He has also served on the Advisory Committee to the Joint Board for the Enrollment of Actuaries, as well as a member of the Education Committee and Board of Directors of the American Society of Pension Actuaries. Larry holds a BA in Economics from Upsala College and an M.B.A. in Accounting from Fairleigh Dickenson University and is both a Certified Public Accountant and an Enrolled Actuary.
Diana K. Powell, Esq. Contributing Writer Diana K. Powell, Esq. is Senior Legal Advisor with over 20 years of experience. She was a sole practitioner who advised educational organizations, government bodies and private corporations. Diana is a graduate of the University of Rochester with a B.A. in Political Science and Albany Law School of Union University, J.D. She holds a Certificate of International Law from the University of Notre Dame, London Law Center and has studied negotiations, mediation and arbitration at the University of Cornell’s School of Industrial Labor Relations, as well as Statistics and International Studies, specializing in the Republic of China, and Educational Policy and Research Methods at the Warner School of Education at the University of Rochester.
www.conferomag.com | 5
THE ONE PAGE MAGAZINE Defined Benefit Plans Hit All-Time Low
Funded Status of U.S. Corporate Pensions Falls
As of Jan. 23, 2013, the number of pension plans covered by the Pension Benefit Guaranty Corp.'s single-employer insurance program fell to an all-time low of 22,697. That's a drop of nearly 3,000 plans from Sept. 30, 2011, which was the end of the PBGC's 2011 fiscal year.
The funded status of typical U.S. corporate pension plans fell 0.1 percentage points to 88.1 percent in August, according to the BNY Mellon Investment Strategy & Solutions Group (ISSG). Corporate pension plans, public pension plans, and endowments and foundations in the U.S. all lost ground financially in August as rising interest rates led to lower values for most asset classes, ISSG said. —PRNewswire
Percentage Of Private Industry Employees Participating In Defined Benefit Pension Plans, Selected Years, 1990-2011 Years
Percent of Employees
1990-1991 1994-1995 2005 2011
35 28 21 18
* Bureau of Labor Statistics
401k Failing Most Workers 401(k)s were never designed to replace pensions for most workers. They serve primarily as a tax shelter for high earners,” said economist Monique Morrissey, the report’s coauthor, in a statement. “The 401(k) revolution has been a disaster, yet some policymakers are calling for cuts to Social Security, which will be the only significant source of retirement income for most Americans—if they are able to retire in the first place.”
The Change Of Calculating Pension Plan Contributions By Employers MAP-21, a highway bill contains a little-publicized provision that allows companies to set their pension plan contributions using a rate based on high-quality bond yields averaged over 25 years. Before MAP-21, the rule was two years using current rates. Employers have to put in more money into their pension plans when rates are low and, conversely, put in less when rates are higher. The 25 year average is expected to be at least 2-3 percentage points higher than rates today.
Health Care Costs Weighing On Employers Options Historically, businesses have chosen to pay a set percentage of an employee’s health plan, no matter what it cost. But the survey found that now, an overwhelming majority plan to shift to a system of paying a set dollar amount. The so-called “defined contribution” model uses a private health care exchange to offer employees a set amount to subsidize the purchase of one of several options with differing premium costs, deductibles and co-pays. The survey commissioned by Alegeus, a provider of healthcare and benefit payments solutions, found that 75 percent of employers said they planned to shift to defined contribution programs in 2014 and 2015, and 90 percent said they would be interested in making a switch in the next three years. —Julie Donnelly Boston Business Journal, 8/20/13
The report also found: •
Households earning in the top fifth accounted for 72 percent of total savings in retirement accounts in 2010 and were the only income group that had more than their annual income saved in these accounts. Participation in defined-benefit pensions by workers from 25 to 61 years old declined over the past decade, from 52 percent in 2000 to 45 percent in 2010. For single people, black and Hispanic households and those headed by someone without a college degree, the median household has no savings in retirement accounts. Households with a college degree have six times the amount saved in retirement accounts compared to those with only high school degrees.
Constantine Von Hoffman — CBS News.com, 9/4/13
6 | FALL 2013
Women Contributing Less Through Defined Contributions Plans On average, women contribute 6.9% of pay to defined contribution plans, such as 401(k) plans, sharply lower compared with men, who contribute an average of 7.6% of pay, according to the Aon Hewitt analysis released Wednesday. In addition, 31% of women contribute less than the amount needed to be eligible to receive a matching contribution from their employers, compared with 25% of men. The result: The average account balance for women is $59,300, sharply lower than men, whose defined contribution plan account balances averaged $100,000. —Jerry Geisel Business Insurance, 8/14/13
In Loving Memory of
Robert F. McCormick (1952 - 2013)
An amazing colleague and friend. You will be missed.
www.conferomag.com | 7
LIABILITY DRIVEN INVESTING Lawrence R. Peters, CPA, EA Plan sponsors and Retirement Committees have been examining their Pension Plans with the objective of “de-risking” the plans to manage future volatility in funding and expense. Eliminating volatility will allow for the systematic funding of the Plans and accelerate the timetable for the termination of the Plans. The methodology identified and commonly used for achieving “derisking” is Liability-Driven Investing (LDI).
18| FALL 8 | SUMMER 2013 2013
Liability-Driven Investing (LDI) in brief Traditionally, pension plan investing has focused on maximizing returns. LDI reorients this traditional approach, and instead aims at reducing the risk to funded status through investment strategy and asset allocation. Its rationale: if the goal of a pension plan is to meet liabilities, then the investing goal should be focused on that larger plan goal. There are no hard-and-fast rules on
what qualifies as LDI; in some respects, it is still evolving. Furthermore, LDI objectives may differ from sponsor to sponsor, depending on ownership and capital structure. But all LDI strategies seek to quantify and more closely match plan investment returns to changes in benefit obligations that is, liabilities. In doing so, all LDI strategies seek to limit the swings in funded status, changes in contribution requirements, and impact on the balance sheet.
Liability Driven Investing
Despite the advantages offered by an LDI approach in de-risking a plan, the implementation of such a strategy was frequently delayed due to the uncertainties of the bond rate environment, and the significant drop in rates that had occurred (lower rates meant an increase in plan liabilities, along with concerns that if assets were transferred to fixed income investments, subsequent increases in rates would erode asset values). Although liabilities would decrease at the same time, the concern was that an increase in rates was both inevitable and imminent. Many plan sponsors and committees made a decision to delay implementation until rates rose, in order to take advantage of the subsequent drop in liabilities and the possibility of better investment returns attributable to equity exposures. Rates have increased significantly during 2013 to approximately the same levels that were available early in 2011. Because of this increase, liabilities have fallen and many plans have achieved improved returns on pension assets invested in equities. It may now be appropriate to implement an LDI strategy. This would lock in the recent gains earned on equities and begin de-risking the plan as well. Implementation of an LDI Strategy
LDI can be phased in over time using a “glide path” (based on the funded ratio of the plan) to assist the committee in the timing of adding fixed income and reducing the equity exposure in the plan. This glide path would normally reflect the appropriate measure of liability (Projected Benefit Obligation, Accumulated Benefit Obligation, Funding Liability, etc.) and whether or not the plan has participants actively accruing benefits. A sample glide path is attached (see Fig. A). In order to implement the strategy, the following actions will be necessary: •
Measure the current funded status of the plan, using current discount rates and the current value of assets.
Adopt a glide path that directs the timing of adding to fixed income and reducing the equity exposure in the plan. The glide path should reflect the appropriate measure of liability and the future benefit accruals under the plan, if any.
Initiate the LDI strategy by moving the existing fixed income portfolio to longer duration bonds to more closely match the duration of
Sample Glide Path Allocation to Fixed Income (matched to liability duration) as a function of Funded Status Funded Status-based on Projected Benefit Obligation
85% 90% 100% 105%
Allocation to Long Duration Fixed Income
liabilities in the plan. •
In the equity allocation, reduce volatility by examining the asset allocation to achieve broader diversification. This will diversify the sources of return and risk.
Identify appropriate fixed income strategies will be identified to receive a transfer of assets in accordance with the duration of liabilities and changes in our funded status.
As funded status improves, reduce equity exposure and add to the fixed income allocation. The process provides for funded status thresholds which, when reached, will trigger strategic asset allocation changes to reduce program risk and help lock in improvements in funded status; and it considers the plan’s funded status and the interest rate environment as it implements specific LDI techniques
Conclusion So what are you waiting for? Like most plan sponsors you missed the opportunity to de-risk your plan before the fall in interest rates which happened when asset returns were poor. Rates have recently improved and returns have been outstanding. Maybe it is time to take risk off the table through an LDI strategy. n
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| FALL 2013 2012 14 10 | January-March
Time To Make Time
TIME TO MAKE TIME TO REVIEW YOUR 401K By David Bard, CRPS®, AIF®
e’ve all seen the 1980’s Dunkin’ Donuts commercial from the 1980’s where Fred the donut worker gets up early in the morning and says over and over: “Time to make the Donuts”. Fast forward and substitute Fred the baker for today’s harried retirement plan fiduciary and the new mantra is, “Time to Review Your 401(k)”. The world of 401(k) plans is complex and regulations have changed while the DOL has demanded even more from plan fiduciaries. Do you know what has changed? Do you know what is changing, what regulations have been proposed, and what you are responsible for? When was the last time you completed a thorough review of your retirement plan using an outside, independent expert? www.conferomag.com | 11
Plan fiduciaries often wear more than just one “hat” for their employer. They have various responsibilities and are often saddled with a myriad of roles besides being a “plan fiduciary.” They are usually also the CFO, HR execs, or VP’s of Finance and accounting, who often have the added pressure to increase sales, cut costs and improve profitability. In addition to their daily day-to-day roles and responsibilities, a plan fiduciary has decision making authority over the retirement plan(s) and is duty-bound to take non-conflicted, affirmative action(s) for the sole benefit of plan participants and their beneficiaries. You may not have any worries. You may not even be thinking about your retirement plan. Your firm’s current retirement plan may actually seem to be going well. Your employees might be participating in pretty good numbers. Everyone may seem happy. You haven’t heard of many complaints and you have a few meetings a year where you—and your committee—listen to service provider updates and investment data and your returns seem within appropriate ranges. All seems great, right? Not necessarily. Those donuts aren’t ‘fresh’! There is a lot more you need to be aware of and to be proactively doing to ensure you meet the standards of fiduciary responsibility. If you fail to act in the best interests of your plan participants, and fail to document that, you may be liable. It’s time to make the time to review your plan. As of the summer of 2012, the US DOL has required that service providers (recordkeepers, administrators, investment advisors, and others) to retirement plans disclose compensation and fee information to plan fiduciaries in writing. Then, in order to avoid penalties and possible civil actions under ERISA, the plan fiduciary has a legal responsibility to: 1. Identify all covered service providers. 2. Confirm receipt of all your services provider disclosures. 3. Review content of disclosures to confirm completeness. 4. Assess whether fees being charged to the plan are “reasonable”. Now, “It’s time to make the Donuts!” It’s time to engage with a firm that has the knowledge, experience, and skill to review your plan and assess the reasonableness of all fees
12 | FALL 2013
There is a lot more you need to be aware of and to be proactively doing to ensure you meet the standards of fiduciary responsibility. If you fail to act in the best interests of your plan participants, and fail to document that, you may be liable. It’s time to make the time to review your plan.” being charged versus services provided. 401k fees are often hidden, difficult to identify, and often unknown and/or buried into fund expenses. And you, as a named, plan fiduciary are responsible for what you should know, rather than what you actually know. As a retirement plan fiduciary, do you really know what services you are receiving? Do you know what services may be available on your current platform or available on another platform? Do you know how much you are currently paying for the services you are receiving? Do you know your recordkeeping costs broken out from your investment expenses and advisor cost? The lack of transparency from service providers, the lack of clarity from investment managers, and the obfuscation by investment advisors combined with the lack of time, knowledge, and expertise necessary to perform the analysis are all contributing factors that make review by the overwhelmed plan fiduciary very difficult if not impossible. We are empathetic to these factors which encumber a plan fiduciary from fulfilling their role. We understand a fiduciary isn’t always equipped to perform the analysis demanded by law and the DOL, given their time constraints and unfamiliarity with the nuances and language of retirement plans. In our experience, once the fiduciary makes the time to engage a specialized firm for assistance, best-practices dictate that they solicit vendors with an RFI asking for competitive
Time To Make Time
bids for services. You have a fiduciary responsibility to evaluate the plan’s needs and search for the most suitable service providers with the most reasonable cost. This RFI is a ‘live’, ‘go-to-market’ exercise designed to provide a plan sponsor and fiduciary with the most current pricing data while outlining new and improved services and tools for plan participants they may not be aware of. Not only does this allow plan sponsors to provide participants with a better plan, but should the DOL’s law-enforcement arm—the Employee Benefits Securities Administration, or EBSA—come calling, the plan and plan fiduciary has proof they are fulfilling their fee disclosure duties and have demonstrated a fiduciary process and fiduciary prudence. Just as importantly, the plan sponsor can use this process to negotiate with providers for better pricing. Fee disclosure is all well and good as long as plan fiduciaries take an active role and recognize the need for the extra step to actually examine and perform an analysis of the plan. By taking the time to hire an outside expert, a plan fiduciary has proactively made a decision to protect themselves from liability and fulfill their moral duty to create better plan outcomes for their participants. Thus far, we have focused on plan fees and the liability associated with NOT actively assessing them; just as importantly, a plan’s fiduciary governance structure and procedures should be reviewed and monitored as well. There must be time made for Fiduciary committees to enforce good and sound fiduciary processes. Plan fiduciaries and their committees are strongly recommended to hold regular meetings and keep accurate records of all matters discussed. When significant decisions are made, those decisions should be documented, and any alternatives considered should be described. Finally, all appointing fiduciaries should be reviewed as well. So while plan fiduciaries often get distracted, side tracked, and overwhelmed by the stacks of papers on their desks; while their inbox grows, time must be made to assure the plan’s needs are being met in a competent, efficient, and price conscious manner. The solution is to engage in outside, independent experts, who can assist and partner with a plan’s fiduciary to make the best, freshest, and most delicious “donuts”. n
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Res Ipsa Loquitor
LOQUITOR IPS STATEMENT: DON’T WAIT UNTIL IT’S TOO LATE!
“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence.” —John Adams
DIANA K. POWELL, ESQ. 14 | FALL 2013
deals, rights and responsibilities are codified and reduced to written documents to have legal significance. This is especially true when it comes to plan documents and company 401(k) plans. Ordinary citizens throughout the United States rely on documents such as the Bill of Rights and the United States Constitution every day for the rights and principles found within their texts. The importance of governance documents is easy to comprehend when viewed in this light. With regard to corporate governance and fiduciary responsibility, companies owe their employees a fiduciary duty to put their employee benefit plans, namely their 401(k) plans in writing. Under the regulations in ERISA 402(a) (1), employers are required to codify the employee benefit plan in writing, (specifically) contained in a
written document referred to as a Summary Plan Description (SPD). ERISA 402(a) (1) – Every employee benefit plan shall be established and maintained pursuant to a written instrument. However, there is no definitive regulation within ERISA that requires the Investment Policy Statement (IPS) be put in writing. How can this be when Investment Policy Statements can serve such an integral part of the employee benefit plans? Best practice asks: Why hasn’t the DOL responded in a definitive way and regulated that the IPS should be made into a written document akin to the SPD? Many in the field suggest it is time they did. According to DOL Bulletin 94-2, Investment Policy Statements “serve a legitimate purpose in many plans by helping to ensure that
IPS Statements: Don’t Wait Until It’s Too Late
investments are made in a rational manner and are designed to further the purposes of the plan and its funding policy … to provide general instructions or guidelines to be applied in all applicable … types of investments.” It is all but incontrovertible that an Investment Policy Statement is an integral part of a company’s employee benefit plan. Therefore, it is reasonable that employers be legally required to codify these IPSs as part of their documentation process, just as with SPDs. Short of making an official recording (as in spoken) stating what is contained within the IPS, a written account is more practical and more reasonable. It is hard for those of us from the world of ERISA and of defined benefit and defined contribution plans and fiduciary responsibility to understand when Plan Fiduciaries fail to comprehend the importance of governance documents. It is even harder to fathom their failure to appreciate the consequences when they fail to follow the terms of their governance documents. Furthermore, since Tussey v. ABB, Inc. (No. 2:06- CV-04305, 2010 U.S. Dist. LEXIS 45240 (W.D. Mo. Mar. 31, 2010)) ignorance is no longer bliss. If Plan Fiduciaries and participants did not think it was important to carefully and succinctly codify their governance documents before now, after Tussey v. ABB, Inc. they now know it is paramount. Keeping in line with Tussey they should then follow the principles they have set forth in their plan documents thereby fulfilling their duties as fiduciaries. Tussey v. ABB, Inc. was a case that involved plaintiffs who were both present and former employees of ABB, Inc., a manufacturer of power and automatic equipment, who brought suit alleging “that their ERISA covered 401 (k) plans were paying their vendors excessive compensation.” ABB, Inc. had two committees responsible for managing the 401(k) plans, Fidelity Management Trust Company and Fidelity Management and
Research Company. One of the plans was for collective bargained employees and one for non-collectively bargained employees. The Pension Review Committee was the named fiduciary of the plans and as such was responsible for selecting and monitoring the investment options. One of the key issues involved in Tussey was the Pension Review Committee’s failure to follow the terms of the Investment Policy Statement. In its decision, the Court found as a matter of fact that “the Pension Review Committee, which was responsible for selecting plan investments, failed to follow its own procedures.” Ultimately, the United States District Court, W. D. Missouri, Central Division ruled in favor of the plaintiffs, finding that the ABB defendants breached their fiduciary duties. Some pundits on this topic have suggested that, especially in the case of ABB, Inc. not having an Investment Policy Statement would have been better for the corporation than having the IPS and then failing to follow the terms of the Investment Policy Statement. While the facts of the case and the outcome certainly give merit to this argument—ABB, Inc. may not have been penalized as severely for failing in its fiduciary duties had it not unsuccessfully followed its own IPS document. The issue still remains with regard to ABB, Inc. and to any other corporation when it neglects to have an IPS or if it fails to follow the terms of its IPS is whether that corporation has failed in its fiduciary duties to its plan participants. One of the key issues is whether failing to have an Investment Policy Statement is a breach of a corporation’s fiduciary duty, remembering that the DOL does not yet legally require it. However, courts continue to look upon the use of IPS by plan committees favorably. It is an important issue to keep in mind. Case Law shows that Courts support the creation of written Investment Policy Statements. In Liss v. Smith, 991 F. Supp. 278 (S.D.N.Y. 1998) the court held that “ERISA
It is all but incontrovertible that an Investment Policy Statement is an integral part of a company’s employee benefit plan. Therefore, it is reasonable that employers be legally required to codify these IPSs as part of their documentation process, just as with SPDs.” does not have a specific requirement that a written investment policy be maintained by the trustee.” In this instance the court found that “such a policy is necessary to ensure that the plan investments are performing adequately and meeting the … needs of the Funds.” There are no clear explanations as to why the law hasn’t “caught up” with the best fiduciary practices suggested by the DOL and the Courts. However, best practices and Court rulings as well as comments from the DOL continue to indicate that there should be a requirement that Investment Policy Statements be put into a written document. An IPS which is reduced to a written document benefits the participants, both employers and employees. To meet the fiduciary responsibilities owed to clients, investment advisors should tell them, “Don’t wait until it’s too late.” n
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THE BIGGEST MYTH FOR INVESTMENT CONSULTANTS & FIDUCIARIES
By Gabriel Potter, AIF®
We apologize for the bad news ... Many of our readers are fiduciary trustees for large pools of money: pension funds, charitable foundations, employee welfare & retirement plans, and so on. You, the fiduciaries, should be applauded for adopting this burden, for it is often an underappreciated duty. As fiduciaries, you are responsible for a great deal and the scope of your responsibilities is ever increasing. At Westminster Consulting, we sometimes are bearers of bad news. It would be easier to tell investment committees all the ways that their attention wasn’t required and how much more leisure time everyone gets. In reality, we are obligated to explain where your fiduciary duties are. Here’s where the bad news come in. We have spoken with trustees working for a retirement plan or charity that have, in an effort to off-load fiduciary 16 | FALL SUMMER 2013 2013
responsibility, hired a fiduciary consultant to help manage their plan. Herein lays the Myth…
some consultants may claim to act as a fiduciary but still have major conflicts of interest.
THE MYTH: “Our trustees hired an investment consultant with fiduciary status. Our consultant has no conflict of interest because he is a fiduciary! So, our plan is totally covered and we, the trustees, we are no longer responsible for the plan.”
THE PERFECT EXAMPLE OF FAILURE
THE FACTS: This is wrong in two important ways. First, once you hire a consultant, even one that adopts a fiduciary standard, plan fiduciaries cannot completely off-load their fiduciary responsibility. They may share responsibility with a consultant, but they cannot off-load it completely. Second, and most importantly, the plan fiduciaries will always be responsible for overseeing the consultant. Why is this difficult? The sad reality is that
As a reminder, what’s the difference between a broker and a fiduciary? In summary, brokers are salesmen while fiduciaries are legally obliged to act in your interests alone, without conflict of interest or undivided loyalty. Let’s consider about the investment landscape for a moment. For decades, investment consultants and brokers working for wirehouses and large brokerage firms were subject to a lesser standard – the suitability standard – but now the fiduciary standard is expanding to become the new legal benchmark of behavior. The salesman can compete by expanding their business to include fiduciary lines of business, but it is not clear when they are acting in their own
The Biggest Myth
WATCH FOR THESE RED-FLAGS So, how do you know if you’re dealing with a conflicted broker or a loyal fiduciary? There are several red-flags to look for: 1. Get explicit documentation on your consultant’s total sources of revenue. This information should be included in the annual 408(b) (2) disclosure. If your consult accepts anything other than an explicit hard-dollar fee for services, then there may be a conflict of interest.
interest or for their clients. Take a moment and watch this video. It explains the difference between a broker and fiduciary quite well: www.youtube. com/watch?v=Dg5RRMAc1GY. In the video, brokers are compared to neighborhood butchers selling their wares, whereas fiduciary consultants are compared to dieticians, trying to make the best recommendations for your overall health. There’s nothing wrong with a knowledgeable butcher but – in the end – they are salesman. Your butcher will never recommend going next door to a competing fishmonger, or buying from the fruits and vegetable store instead. So, it’s a simple solution: just hire a fiduciary investment consultant and you are set, right? Not so fast! Business Insider ran an exposé of a fiduciary investment consultant. www.businessinsider.com/will-thereal-butchers-please-stand-up-2012-3
Business Insider discovered the fiduciary firm had a significant conflict of interest because they were affiliated with a broker-dealer. The firm had financial incentives to sell you their own products. Or, as Business Insider put it, “the dieticians own a butcher shop.” How can fiduciary firms get away with this obvious conflict of interest? The biggest reason is that brokers can dualregister as brokers and fiduciaries. In other words, these fiduciaries can easily revert to act like a salesman, subject only to a suitability standard, when selling their products. In reality, the biggest brokerage firms are filled with so-called fiduciary advisors who wear multiple hats, selling on-platform products with embedded fees whenever possible, despite the best interest of the client. In short, being a fiduciary won’t protect clients from conflicts of interest. n
2. Does your consultant prefer to have custody of assets? Do they use an investment platform with specially vetted mutual funds, separately managed accounts, or alternative investments? These products typically have special revenue and incentive arrangements, and there may be a conflict of interest. 3. If your consultant requires a Series 7 license to practice, they may be dual-registered with a broker/ dealer and there may be a conflict of interest. 4. How big is the disclosure? How complex? If the disclosure is filled with pages of small print and “Legalese”, it becomes easier for brokers to continue business as usual without taking your best interests in mind.
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During our discussions with clients, concerns are expressed by individuals responsible for the administration and governance of their companyâ€™s retirement plans. Retirement plan fiduciaries have been increasingly subject to litigation by plan participants, and are concerned about how to manage their risk.
COMMON PLAN FIDUCIARY
AND BEST PRACTICES Lawrence R. Peters, CPA, EA
Common Fiduciary Mistakes A good place to start is to identify the most common ERISA Fiduciary mistakes, and then adopt best practices to reduce the possibility of committing these mistakes. The mistakes that can potentially lead to the most significant problems are: 1. Failing to identify who your Plan Fiduciaries are. Fiduciaries may be named in the plan document, but also may become fiduciaries by virtue of their functions or actions. If an individual exercises discretionary authority or responsibility for the administration of the plan, or exercises any authority or control over the plan or disposition of the planâ€™s assets, they could be a fiduciary. 2. Individuals may not understand when they are acting in a fiduciary capacity. Many individuals who are members of a retirement committee perform both fiduciary and settler functions. Fiduciary duties include plan administration, implementation of amendments or termination of the plan, holding or investing plan assets, appointing a fiduciary, and communication with participants.
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Common Plan Fiduciar y Mistakes and Best Practices
Settler functions include plan design, plan amendment or termination, and employee communications about corporate issues.
provided. Failing to monitor fees for reasonableness and negotiate fees with service providers can expose fiduciaries to liability.
3. Failing to monitor appointed fiduciaries and service providers leaves the appointing fiduciary exposed to liability for actions of the appointed fiduciary. There is a duty to monitor the activities of persons or entities selected by the fiduciary to perform plan functions.
8. A fiduciary must use the level of care that a prudent person familiar with such matters would use in the same situation. If relying on experts, experts must be selected prudently, be fully informed of all relevant facts, and advice should be updated.
4. Failing to document reasons behind decisions made and actions taken creates unneeded risk.
Failing to follow advice of investment consultant could be considered as failing to use the level of care necessary. It should be carefully documented if the fiduciary decides on another course of action.
A fiduciary’s conduct is evaluated according to the result of a decision as well as the process used to make the decision. Procedural prudence means: •
Identifying factors relevant to decisionmaking process
Identify necessary fact-finding steps and background information
Identify required expertise; when necessary, consult with outside experts (e.g., accountant, actuary, legal counsel)
Plan Fiduciary Best Practices Despite these common failures, there are a number of fiduciary best practices that will reduce risk. These practices can be implemented and maintained with little additional effort by plan fiduciaries. These best practices are: 1. Know standards, laws, plan, and trust provisions 2. Establish a Committee Charter, detailing rules and obligations
Evaluate relevant criteria
3. Diversify assets to specific risk/return profile
Document the decision and the process
4. Prepare/review investment policy statement
If it isn’t documented, it didn’t happen! At least you can’t approve it. 5. Failing to Conduct Fiduciary Training isn’t acceptable. The Department of Labor has indicated that fiduciaries should take part in regular training to improve their skills, and the training should be documented. 6. Fiduciaries have a road map to follow in the form of a Plan’s Governing Documents, including its Investment Policy Statement. Failing to follow the terms of these documents is a clear violation of fiduciary duties. 7. Fees paid from plan assets directly reduce the benefits or security for plan participants. There probably have been more law suits regarding excessive fees in recent years than for any other reason. Section 408(b)(2) requires fees to be disclosed, and plan fiduciaries to determine if those fees are reasonable for the services
5. Use “prudent experts” and document due diligence 6. Control and account for plan/investment expenses 7. Monitor the activities of “prudent experts” 8. Avoid conflicts of interest and prohibited transactions 9. Hold regular Plan committee meetings 10. Engage in fiduciary education and training 11. Document, Document, Document! Take the time to review your current practices against these best practices. Begin by auditing your activities and documentation for compliance with these best practices. Then an action plan can be prepared that will result in a reduction of your potential liability. n
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THE OSTRICH DEFENSE
By Gabriel Potter, AIF®
recently got back from Africa. While watching Ostriches stride across the grasslands, our guide reminded us that the Ostrich does not actually stick its head in the ground when threatened; that’s just a myth. Actually, ostriches are fast enough to outrun most predators, and they have strong clawed legs to defend themselves. It simply makes no evolutionary sense for an animal to willfully ignore a problem and hope it goes away. Despite this common sense realization, the myth persists—at least for the animal kingdom— but humanity is better than that, right? As it turns out, humanity is not always as directly logical as our counterparts in the animal kingdom. In our litigious society, we will attribute the responsibility of our actions based on our information at the time. The argument goes, “we can’t be liable for information we don’t have.” In other words, by not understanding the dangers, we have avoided our responsibility for managing them. There have been several high profile court cases which featured defendants arguing their ignorance of the law, or the truth, as a way to lessen their responsibility. Wikipedia lists these cases under the subject “The Idiot Defense”, and highlights their outcomes here: www.en.wikipedia.org/wiki/ Idiot_defense. Pointedly, they remark “no major instances of the idiot defense being successful in criminal proceedings have been reported in American jurism to date.”
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One might think, given such a weak track record, the Ostrich Defense would lose all credibility. It doesn’t make sense in the animal kingdom. It hasn’t had success in practice. By contrast, acknowledging a threat and working directly to address it just makes common sense. By contrast, I remember a classroom discussion about the Martha Stewart insider trading scandal. One of my Finance professors tried to argue that the primary reason Martha Stewart went to prison was because she didn’t adequately assert her ignorance about the law. To review the incident, Martha Stewart was warned by her broker that one of her stocks (ImClone) was going to lose a lot of value after learning a key drug patent failed to get FDA approval. The information about the FDA disapproval was private information; acting upon material, non-public information is called insider trading, and it is illegal. So, when Martha Stewart made trades based upon insider information, she would have warranted, at minimum, a fine, or penalty, or an official reprimand of some sort. However, my professor’s argument was that Martha Stewart ultimately went to prison not because of the insider trading, but because she lied to the investigators about her actions. She was ultimately convicted on conspiracy and obstruction of justice for her attempts to conceal the crime. If she had simply plead ignorance of the law – something like, “My broker told me the company was going to go down and so I sold the stock.
The Ostrich Defense
Is this a problem, officer?”—she might have avoided jail time. However, because she tried to destroy evidence, she demonstrated an understanding that she broke the law and a willingness to lie to maintain her innocence, the legal system was obliged to give her a stronger penalty. So, for Martha Stewart, maintaining a position of willful ignorance might have saved her from some culpability. I’m not a legal expert and I certainly can’t go back to time to ask to Martha Stewart and get her to change her strategy, so I can’t test my professor’s theory. In the, admittedly hypothetical, scenario in which Martha fesses up to the insider trading immediately, why might she avoid some of guilt of her action? I might argue that a LOT of common law depends on the role assumed. In other words, what would a typical member of the community do, presuming an prudent standard of understanding and care. After all, who would have expected a domestic maven like Martha Stewart to know the intricacies of securities law? Certainly, Martha Stewart is less liable for these actions compared to her NASD registered stock-broker: securities professionals are supposed to know better. Martha Stewart never put herself
forward as an expert in legal or investment requirements. By contrast, if Martha Stewart started out patently horrendous recipes in her magazine, she would be subject to greater criticism than an amateur chefs, since she has put herself forward as an expert in the field. In other words, the role you adopt helps to determine your responsibility. If you have accept a role with greater responsibility, like a stock-broker, you must maintain the higher standard, act according to the law, and accept higher penalties for failures. Most importantly, once you’ve accepted a role with more responsibility, you can no longer maintain ignorance as a defense. Therefore, we have a final question: do your plan fiduciaries understand the responsibilities they accepted by adopting that role? Logically, once a fiduciary has accepted that title, they have a duty to understand what they are now responsible for. In other words, they can no longer stick your head in the sand and pretend that they are safe from responsibility by claiming ignorance. n
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You Owe Your Tomorrow Borrowing from Your 401(k) to Pay for College By Diana K. Powell, J.D.
“Let our advance worrying become advance thinking and planning.” —Winston Churchill
xperts continue to warn us that we are simply not saving enough for retirement. People on average are not taking advantage of their 401(k)’s and other savings options available to them at the workplace. We seem to live in a “YOLO” world (You only live once) when we should think in terms of “SITUP” (Save it to use, People!) Investopedia defines a 401(k) plan as “a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis.” (source: Investopedia)
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This is the retirement savings plan offered by most large and mid-size corporations to employees that create “automatic savings” for the future. (source: 401Kafe) Work today, plan for tomorrow in order to be able to support yourself when it is time to stop working and retire by putting money away in a 401(k). Unfortunately, life gets in the way when it comes to saving for retirement. One of the biggest obstacles to saving for retirement happens to be youth – “workers under the age of 35 have the lowest 401(k) participation of any age group.” (source: Center for Retirement Research) Younger workers simply don’t think about saving for the future. The cost of living is another huge detriment to saving for retirement—the biggest costs being higher education.
The cost of higher education has skyrocketed over the past 25 years. According to Cronin, Data shows that “the average price of a four-year college education has risen 440 percent—more than four times the rate of inflation.” This begs the question—where is the money coming from? Financial aid in the form of loans is the resounding answer. Loans typically come in one of two forms: (1) federal, low-interest Stafford loans and Pell Grants; or (2) higher interest, unregulated, private student loans. However, the private student loans come with a lot of risks and, the tactics employed by private colleges and banks have been compared to “those employed by the subprime lending market,” and students graduating from four year colleges and universities are coming out saddled with “debt that
You Owe Your Tomorrow
they can’t possibly repay.” (source: Roos) This has parents looking for alternative ways to fund their children’s college costs and some are considering borrowing from their 401(k)’s. Loans from 401(k)’s are allowed by law. The statutes governing plan loans usually do not place specific restrictions on the use of the loans, but do state the loans “must be reasonably available to all participants.” (source: 401khelpcenter) However, employers place use restrictions within their Summary Plan Documents on the acceptable reason for borrowing from a participant’s 401(k), of which to paying for education expenses for yourself, a spouse or a child is typically allowed. The only issue remaining is whether it is a good idea to borrow from you
401(k) to pay for college expenses. There are pros and cons, but in the end it will always come down to planning. If a person begins early enough to save for retirement, then presumably he or she will have enough saved to comfortably borrow from the 401(k) to help pay for the college expenses to offset the “cons” of borrowing from the retirement fund, such as the loss of interest on the amount borrowed, possible fees, other opportunity costs. Also, there is a limit of half of the balance or $50,000 maximum you can borrow from the account, so that will only go so far towards the cost of the college expenses.
in your 401(k). 401Khelpcenter lists these pros as: 1. There are usually no restrictions, 2. The interest you pay you are paying to yourself, 3. It is convenient, 4. The wait is not long to get the loan, and 5. You are choosing where the money is coming from. If you have planned ahead and saved prudently, then you can, if you choose to do so, borrow from your 401(k) to help pay for college expenses— if the pros outweigh the cons. Instead of risking your future and having a “YOLO” attitude about life and retirement you can successfully “SITUP!” n
However, there are many “pros” if you have started early enough and have built up a “comfortable” amount www.conferomag.com | 21
What Are You Waiting For?, comes on the heels of our Tibble edition as a call to action to investment fiduciaries to re-examine their proces...