When I began this series I realized that it takes faith to write a multiple-part series. One always has to wonder if the key points you seek to make will still be relevant when the series is complete. This was especially true when I began this series in January. We had just completed the second-worst year of returns in the history of the stock market and the New Year was starting out with no glimmer of hope.

But I believed then, and still do, that these concepts are applicable for 401(k) plans in any economic environment.

And as 2009 has progressed each of these key points is not only still relevant, but their importance has only increased.

Point #1: A strong “do-it-for-me” solution
Now more than ever, participants realize they don’t want to manage their own assets and aren’t very good at it when forced to do so. Yet the highly publicized failings of many target-date funds during 2008 (many 2010 funds, believed to be defensive portfolios, lost even more than the broad market) has highlighted that not all “do-it-for-me” solutions are created equal. As a result, plan sponsors are now searching for, and participants are demanding, a truly strong solution.

Point #2: Fee transparency
This issue is certainly picking up steam as evidenced by the 401(k) Fair Disclosure and Pension Security Act of 2009 currently under consideration in the House of Representatives. This legislation would remove the onus for seeking fee transparency from plan sponsors and would mandate that plan providers clearly disclose all compensation they receive, which certainly seems like a common sense approach that should have been put in place long ago.

Point #3: Utilization of a fiduciary advisor
In another move toward common sense, the Obama administration has recently proposed that brokers be held to a fiduciary standard. And surprisingly, the brokerage world’s main lobbying group has voiced support for the idea. It now seems that everyone agrees that someone giving advice to a 401(k) participant should do so solely in that participant’s best interest. The as-yet-unresolved, but critical, question however is: “Will brokers step up to the current fiduciary standard, or will the fiduciary bar be lowered to accommodate brokers and others with inherent conflicts of interest?” For the sake of participants and plan sponsors let’s hope the bar will not be lowered.

So, it has been affirming that all three of these principles of fiduciary prudence have held up in the light of recent history.

The final fiduciary best practice is also, without a doubt, a timeless concept:

Point #4: Following a well-documented process
Here’s a deep question for you: If you follow a prudent process, but you don’t have the documentation to prove it, did it really happen? In the eyes of regulators and the court system, the answer may be “no.” A well-documented process is key.

Fiduciary best practices dictate that a well-documented process begins with an Investment Policy Statement (IPS). A well-written IPS serves as the strategic plan for the oversight of a 401(k) plan. It provides detail on the goals of the plan, the roles and responsibilities of all parties involved, and provides a framework for ongoing monitoring. Yet surprisingly, only about half of all plan sponsors currently have an IPS. And experience shows that those who do have not reviewed it in years. To truly follow best practices, a viable, active IPS is a must for plan sponsors.

The second component of following a well-documented process is to have a single repository for 401(k) documentation. You would be amazed (or perhaps not) at how many plan sponsors cannot locate a copy of their Adoption Agreement, or maybe a copy of the minutes from their last committee meeting, or the service agreements with providers.

The source of this confusion, and a clear hurdle for a well-documented process, is that different documents seem to be the responsibility of different parties and are kept in different offices by different people. By creating one, single repository (for example, we call the one we create for our clients the “Prudent Fiduciary Process Binder”), plan sponsors can ensure that they are not only following a prudent process, but that they have the documentation to prove it.

Conclusion
As I laid out back in January, ERISA requires that plan sponsors act “…with the care, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of and enterprise of a like character and with like aims.” (Section 404(a)(1)(B))

I believe that plan sponsors following each of the four steps I have mentioned in this series will surely exhibit the care, prudence and diligence required of a “prudent person” in a post-2008 environment. And not only will plan sponsors have fulfilled their fiduciary duty, but plan participants will experience a much more secure retirement.

As we consider fiduciary best practices in the wake of 2008, you may realize that the first two factors…

1. A strong “do-it-for-me” solution.
2. Fee transparency.

…are directly linked to legislative efforts to improve the retirement security of American workers. The Pension Protection Act of 2006 (PPA) directly endorsed “do-it-for-me” solutions as the best default investments, while Congressmen George Miller (D – CA) and Robert Andrews (D – NJ) are pursuing a bill in the House that would make full disclosure of 401(k) fees the law of the land.  

The third area plan sponsors should focus on in a post-2008 world is also tied to the PPA: Utilization of a fiduciary adviser. 

Recognizing that participants need help in making their asset allocation decisions and that plan sponsors are reluctant to offer advice for fear of the fiduciary liability, lawmakers sought to create a new safe harbor that would increase the availability of advice in 401(k) plans. But they also recognized that most plan providers have significant conflicts of interest and that their advice would be clouded by those conflicts.

So, in an effort to overcome the prohibited transaction rules, the “fiduciary adviser” under the PPA was created with certain limitations. Advice offered by a fiduciary adviser must:

·         Not impact the compensation received by the adviser (aka the “level comp” provision).

·         Be generated by an independently audited software program.

If these conditions are met, then a plan sponsor can offer advice to participants through a fiduciary adviser without liability for the resulting advice.

Interestingly, conflict-free advice has always been available from a second type of fiduciary adviser, the independent, fee-only Registered Investment Advisor (RIA). 

By engaging an RIA, plan sponsors have always been able to shield themselves from the liability associated with participant advice, as well as the fiduciary task of investment selection and monitoring.    

As we move forward from 2008, we can all acknowledge that participants need help. Fortunately, plan sponsors now have two options for providing that much-needed investment advice. Whether by using the services of a provider who meets the limitations set forth in the PPA or by engaging an independent, fee-only RIA, the utilization of a fiduciary adviser is definitely a prudent best practice that can make a difference for participants, while also protecting plan sponsors.

In my last entry, I began introducing the components of a prudent fiduciary process in the wake of the trauma the financial markets experienced in 2008.

Prior to 2008, many plan sponsors already knew that the majority of participants are ill-equipped to manage their own assets, but this past year crystallized that reality. Given that, I made the point in Part I that the first component every plan should provide is a strong “do-it-for-me” solution.

The second component relates to an issue that continues to garner a lot of attention, not only in the financial press, but also with lawmakers: fee disclosure.

Section 404(a)(1)(A) of ERISA states that fiduciaries should pay only fees that are “reasonable”. Asserting that many of the nation’s largest employers, and the individuals responsible for their 401(k) plans, have failed that fiduciary duty, the St. Louis law firm of Schlicter, Bogard and Denton filed class-action lawsuits in 2006 that continue to be heard in the judicial system today.

While acknowledging evidence that some of the defendants have been negligent in their processes and that some “may not have been behaving admirably”ⁱ, the courts are typically ruling in favor of the plan sponsors and the plan providers. The burden of proof has been difficult and revenue-sharing, the root cause of the lawsuits, continues on.

Recognizing the difficulties facing plan sponsors and that the courts appear to not be a source of clarification, the Department of Labor (DOL) is also weighing in on fee transparency with proposed regulation 408(b)(2). In short, the regulation would require that all forms of compensation received by service providers be fully disclosed. But as expected, many service providers are fighting 408(b)(2) aggressively and the regulation has still not been adopted.

So with no direction from the courts and delayed assistance from the DOL, what is a plan fiduciary to do when it comes to ensuring that the fees paid by a plan are “reasonable”?

There are two viable options:

1. If your service providers (investment advisor, consultant, TPA, Recordkeeper, etc.) receive any type of revenue-sharing, you should require each service provider to annually complete the DOL’s “401(k) Plan Fee Disclosure Form”ⁱⁱ. This seven-page form asks specific questions that seek to uncover a provider’s sources of revenue, even those “hidden” fees that are difficult to decipher within service agreements. (Note: Capital Directions has created a shorter, three-page version of this document to help plan sponsors obtain the most meaningful information from providers in a concise manner. Contact me if you would like a copy of this document.)

2. The fiduciary can choose to work only with service providers that do not receive revenue-sharing. Fee-only service providers are still the minority in the 401(k) world, but the inherent transparency is driving many plan sponsors to this model. The fee-for-service arrangement involves fees being invoiced directly, either to the plan or the plan sponsor, as opposed to being deducted from investment returns.

Once total expenses of the plan are determined, the judgment of their reasonableness is still a subjective process. Only a time and labor-intensive RFP process evaluating comparable service providers would ensure that fees and expenses were indeed reasonable. Fortunately for plan sponsors, an acceptable best practice is to benchmark a plan every three to five years, followed by annual documentation of the plan’s total expenses.

While it may be a challenge for fiduciaries to fulfill the responsibility of ensuring the reasonableness of plan expenses, the ERISA mandate is clear, and the focus on that mandate will only likely increase going forward. Demanding full transparency of fees and expenses will be an integral part of a prudent fiduciary process for the foreseeable future.
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 ⁱ Employee Benefits Institute of America, “Seventh Circuit: Non-Disclosure of Revenue Sharing Did Not Violate ERISA”, www.ebia.com, March 10, 2009.

ⁱⁱ United States Department of Labor, “Retirement Plans, Benefits & Savings: Fiduciary Responsibilities”, www.dol.gov/dol/topic/retirement/fiduciaryresp.htm, March 10, 2009.

As fiduciaries responsible for the investment of assets on behalf of others, I doubt that many of us will miss 2008. Being a fiduciary always carries with it a tremendous sense of responsibility, but the market environment of this past year made our roles that much more challenging.

Yet we have to remember that fiduciary prudence is not about results. It is about process. And process is about achieving long-term success in the face of occasional bumps (or craters, as the case may be) in the road.

ERISA requires that fiduciaries of qualified retirement plans act “…with the care, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of and enterprise of a like character and with like aims.” (Section 404(a)(1)(B))

So what care, prudence and diligence does a “prudent person” use in a post-2008 environment? Over the next several weeks, I will lay out what I believe to be the critical components of a prudent post-2008 process.

Component #1: Providing a strong “do-it-for-me” solution.

The vast majority of participants do not want to manage their own assets and most do a poor job when they are forced to do it. Prudent fiduciaries recognize this and in 2009 and beyond will include a strong “do-it-for-me” solution in their process.

The prolific growth of target-date and lifecycle funds is in direct response to this realization and most plans now offer some sort of “do-it-for-me” solution. But not all of these funds are created equal and fiduciaries should ensure that they can clearly answer the following questions:

1. Does the fund follow a logical glide path? Of course, fiduciaries must first ensure that they understand each fund’s glide path. Is there an equity-to-bond mix that is appropriate for participants at all risk levels and time horizons?
2. Do you fully understand the funds’ underlying holdings? In the wake of the Madoff scandal, transparency is paramount. Fiduciaries should have a clear understanding of where participant assets are ultimately invested.
3. Do you know the bottom-line expenses of each fund? Transparency of fees should include not only the funds’ expense ratios, but also the fees associated with the underlying holdings and any wrap fees or revenue-sharing.
4. Do participants truly understand how to use the funds? A target-date or lifecycle fund is intended to provide full diversification in a single-choice option. Yet many of the analyses we conduct for plan sponsors reveal participants holding multiple target-date funds in one portfolio, or holding a lifecycle fund alongside a number of individual funds, thus reducing the intended diversification benefit.

As we enter 2009, I think it’s safe to say that all prudent fiduciaries now offer some sort of “do-it-for-me” solution. But are your target-date or lifecycle options truly a strong offering? Do they meet the standard of what “…a prudent man acting in a like capacity…” would offer?

Participants would certainly be interested in the answer to that question.