Seven ERISA Precepts That Should be Observed

Investment News makes excellent points about the increasing risk of litigation from disgruntled plan participants due to the LaRue v. DeWolff decision. 

A warning light for fiduciaries

What you can do about the increasing risk of litigation from disgruntled investors

By Blaine F. Aikin


June 9, 2008

If there were a color-coded advisory system for fiduciaries, it now would stand at yellow, flashing “elevated risk.” Economic, regulatory and legal circumstances are converging to raise the likelihood of litigation. Investors are seeing financial goals fade into a more distant future. The economy is bad, the price of food and fuel is going up and the value of homes is going down. Meanwhile, the financial markets are as unpredictable and unsettling as at any time in recent memory. People are making lifestyle changes to spend less but aren’t able to save more. It only makes sense for them to focus greater scrutiny on the way fiduciaries are caring for their nest eggs. Regulatory scrutiny of fiduciaries is increasing. With changes to Internal Revenue Service Form 5500 for retirement plan reporting and proposed rules pertaining to the Employee Retirement Income Security Act Section of 1974, the Department of Labor is pressuring investment service providers to give better disclosures of compensation and conflicts of interest. These changes will make it easier for investors to identify fiduciary shortfalls. Finally, through its LaRue v. DeWolff decision, the Supreme Court has opened the door to fiduciary litigation all the way down to the level of individual participants in self-directed retirement plans.

All of these factors create the perfect litigation storm: investors in a bad mood over their financial well-being, regulations making it easier to discover fiduciary breaches, and more parties to pursue remedies for fiduciary transgressions through the courts. For fiduciaries, it boils down to an environment of greater accountability.

The way to mitigate the risks of legal or regulatory action is to reduce fiduciary risk — exposure created by engaging in practices that do not serve the investors’ best interests or by failing to perform duties that are expected of those acting in a fiduciary capacity. Everyone who manages money on behalf of others must take a good, hard look at the way they are doing their job — now.

Here are seven precepts drawn from ERISA and other major legislation governing fiduciary conduct which must be observed:

• Keep current on the laws, regulations, and plan and trust documents that govern portfolios you manage. For example, the Pension Protection Act of 2006 provides two safe harbors, the qualified default investment alternative and the fiduciary-adviser role, which should be considered by sponsors of, and advisers to, participant-directed retirement plans.

• Maintain proper portfolio diversification. Managing risk and return through effective asset allocation is at the top of the hierarchy of investment decisions to be made by investment fiduciaries. Virtually all participant-directed retirement plans should offer QDIAs to help ensure appropriate diversification for even the most uninformed and uninterested plan participant.

• Have, and conscientiously follow, a written investment policy statement to guide the management of each portfolio. The IPS is, in effect, the business plan for how the portfolio is going to achieve the investors’ objectives. It is the first line of defense to demonstrate procedural prudence, so long as the fiduciary’s actions are consistent with what it says.

• Select “prudent experts” such as investment advisers and investment managers through a well-designed due-diligence process. Fiduciary responsibilities safely can be shared, and some fiduciary risk mitigated, if these experts are chosen through sound due-diligence protocols.

• Monitor the “prudent experts” as well as other key service providers, such as record keepers, third party administrators and custodians, to make sure they are satisfactorily performing the roles for which they were hired. Document any deliberations held to consider retention or termination of service provider relationships.

• Control and account for expenses. To quote commentary to the Uniform Prudent Investment Act of 1994: “It is imprudent to waste money.” You must know who is getting paid, and how much, in order to make the critical determination that fees and expenses incurred are “fair and reasonable” for the services provided. “Fair and reasonable” is a relative standard that requires comparison with industry benchmarks or direct comparison conducted through competitive bidding.

• Avoid self-dealing and conflicts of interest. A fiduciary standard of care requires a loyalty that serves only the best interests of the investor. Disclosure of conflicts of interest will not suffice in most fiduciary situations.

The common theme among these is to focus on sound processes. Fiduciary excellence is achieved by consistently applying sound practices aligned with the best interests of investors. Excellence eliminates risk. Blaine F. Aikin is president and chief executive of Fiduciary 360 LP in Sewickley, Pa.

For archived columns, go to investmentnews.com/fiduciarycorner.

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