Nature Abhors a Vacuum – and So Should Fiduciaries

Nature Abhors a Vacuum

Conflicting court opinions, dueling regulators and uncertain direction from the executive branch are making it harder for plan fiduciaries to do their jobs.

The recent decision by the U.S. Court of Appeals for the 5th Circuit to invalidate the DOL’s fiduciary rules creates further confusion in an area that had already suffered from an excess of …confusion. A few things to note in considering this state of affairs:

•      The 5th Circuit’s opinion goes to the core of key elements of the fiduciary rule – the DOL’s efforts to impose greater standards on financial professionals who provide advice regarding participants’ rollover decisions and to expand the definition of advice to a plan that triggers fiduciary status. The Court of Appeals opinion interprets ERISA in ways that essentially lock the DOL into continuing to use regulations issued in 1975. This opinion will allow brokers and insurance agents to continue to steer retirement plan participants out of employer-supervised funds (that are more likely to be lower-cost institutional shares) and into retail-priced funds and commission-bearing annuities.

So, as long as that opinion stays on the books, any effort by the DOL to expand fiduciary protections will be severely hamstrung. The DOL has been silent on how it will respond to the 5th Circuit decision, adding further uncertainty.

•      The SEC has indicated an intention to issue a fiduciary standard that would apply to all investment advisors and broker dealers. But note, the SEC has not actually taken action and any meaningful SEC proposal is also likely to create cries of anguish and more litigation. Also, the SEC’s jurisdiction extends only to “securities” – and this term does not include fixed annuities or most variable annuities.

•      As noted by The Consumer Federation of America, financial sales professionals use a broad range of terms to indicate that they are trusted advisers acting in consumers’ best interest. (Financial Advisor or Investment Salesperson? Brokers and Insurers Want to Have it Both Ways)

•      As the fiduciary lawsuits against major universities work their way through the courts, the judicial branch has added more uncertainty, reaching very different conclusions in cases with (essentially) identical complaints. For example, the claim against the University of Pennsylvania’s 403(b) plan with TIAA (alleging a breach of fiduciary responsibility, based on the fees charged to participants) was dismissed, while the case against Yale University was allowed to proceed.

In the midst of all of this, it is important for plan fiduciaries to drown out the noise and develop a fiduciary strategy for the times. Here is a framework for such a strategy:

•      Bottom line on top: the buck starts and stops with the fiduciary. Plan fiduciaries cannot rely on outside entities – even the Department of Labor – to protect a plan from excess fees, poor performance or providers with conflicted service structures. This responsibility rests with the plan fiduciaries. Period.

•      Use a process – a thoughtful and thorough process. Being a prudent fiduciary is about the process – such as reviewing all investment funds regularly, having a process for deselecting funds that fail to meet plan standards, or reviewing vendor compensation and fees on a regular basis. But, it must be a thoughtful and diligent process. Simply having a process where you check some boxes on a checklist won’t hack it.

•      Hire experts. A fiduciary must act “with the care, skill, 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 effect, as a prudent expert. And if you do not possess the expertise internally, hire it.

•      Tradition is nice – but not for a fiduciary. Continuing to do something because it is familiar or because a change would be disruptive represent a trap for a fiduciary. Don’t fall into it.

•      Look into the horizon. The fiduciary issues of tomorrow are already starting to emerge. Start looking out for them. For example, we know that data security and employees’ confidential financial information are coming under increasing scrutiny. Have you reviewed your providers’ policies and programs to protect that data? Does your provider agreement provide protections for the plan (including indemnification) if a provider is negligent with that data?

•      Look into the horizon (part 2). Many of the key items used by prudent fiduciaries now (such as the use of index funds and ETFs) have really grown in popularity over the past few years. What are the “prudent practices” of the future? Start looking for them now.

•      Focus on the plan – but look at the whole plan. For many years fiduciaries overlooked high plan costs because such amounts were paid by participants and not the employer. This mindset is now (fortunately) a thing of the past. But fiduciaries must remember that they are fiduciaries … to the plan. They must think (holistically) about the plan – how much is being paid to providers for plan services, both as direct and as indirect compensation. They must think about provider activities that undermine the plan both directly and indirectly (such as provider practices that may steer participants to higher cost proprietary products).

Fiduciary duties under ERISA “are the highest known to law.” Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir.), cert. denied, 459 U.S. 1069 (1982). The legal confusion surrounding certain fiduciary issues cannot obstruct fiduciaries’ execution of those duties.