The DOL Fiduciary Rule, Seller's Exception and Independent Fiduciaries

How does a service provider determine whether it is making a recommendation to "independent fiduciaries of plans and IRAs with financial expertise?" This is a key question that could determine whether an organization or individual is tagged as an ERISA fiduciary and subject to added liability as a result.

According to "Chart Illustrating Changes From Department of Labor's 2015 Conflict Of Interest Proposal To Final," one of several modifications includes the following: "Providing an expanded seller's exception for recommendations to independent fiduciaries of plans and IRAs with financial expertise and plan fiduciaries with at least $50 million in assets under management is not fiduciary advice."

As always with legal issues, I defer to knowledgeable attorneys to parse this language. However, given an implementation deadline, compliance professionals of firms that sell to ERISA plans and IRA owners no doubt want to clarify definitions and concepts such as "independence" and "financial expertise."

One attorney with whom I spoke suggested the intent is to lower the chance of a conflict such as when a fiduciary receives compensation for a vendor or product he helped put in place. Another attorney put forth the notion that fiduciaries of a "larger" plan (in this case, a trust with assets above $50 million) could be seen as more "sophisticated" and "informed." I'm not convinced that the ambiguity of the final language can be dispatched without addressing a series of questions, some of which are listed below.

  • Is a consulting firm that seeks an exception and wants to sell its delegated investment management or Outsourced Chief Investment Officer ("OCIO") services thereby prohibited from pitching any of its own proprietary products and using them if it wins a contract?
  • When a C-level executive such as a Chief Financial Officer sits on a plan investment committee, who will assess whether her decisions are made solely in the interest of plan participants and not to plump up a bonus tied to a particular decision or outcome?
  • Can a seller avoid fiduciary classification if the client is a plan or IRA with assets less than $50 million but managed by knowledgeable fiduciaries?
  • Might a seller fail to procure an exception if it is later shown that a plan or IRA with more than $50 million in assets is "large" but managed by fiduciaries who do not possess financial expertise?
  • How do sellers intend to determine whether "financial expertise" exists and can they do so without insulting potential buyers?
  • How will existing "know your customer" guidelines change to accommodate the notion of "financial expertise?"
  • How do regulators intend to determine whether "financial expertise" exists?
  • If there are multiple fiduciaries and some possess "financial expertise" but others do not, is the seller at risk for losing the exception or not obtaining it in the first place unless it can verify that all in-house fiduciaries are competent?
  • If a plan fiduciary or IRA owner or manager changes, does the seller need to assess "financial expertise" for the replacements? Does the U.S. Department of Labor need to do likewise? 
  • On what basis is the $50 million determined? At a point in time or as a rolling average? Are assets to be based on market value or book value or something else? Will regulators review Form 5500 numbers to determine if the $50 million test has been met?

If anyone knows of an article or webinar that addresses these issues, please kindly email contact@fiduciaryleadership.com. I would like to share resources about "independence" and "financial expertise" with readers of Pension Risk Matters.

Note: Interested persons can click to download "Pension risk, governance and CFO liability" by Dr. Susan Mangiero (Journal of Corporate Treasury Management). The phone number listed on the article is not current. 

Fiduciary Certification and Training

Last week, I had the pleasure of speaking to Dr. Anna Tilba with the Newcastle University Business School in the United Kingdom ("UK"). A mutual colleague had suggested we speak since we both work in the governance area. Dr. Tilba has studied the fiduciary practices of investment intermediaries. Her report fed into the UK's Law Commission publication about current fiduciary standards and areas for improvement.

One of the topics that arose during our conversation was the need for adequate fiduciary education and what she referred to as the professionalism of investment stewards. I agree that having experienced and knowledgeable individuals in place is critical. Even if the intent is to outsource certain services to others, investment committee members are tasked with making an informed decision about what to delegate and to whom.

Stateside, the U.S. Department of Labor ("DOL") continues its Fiduciary Education Campaign. Each seminar covers topics such as those listed below:

  • Comprehend the nature of each ERISA plan offered;
  • Apply rigor in selecting and monitoring service providers; and
  • Steering clear of prohibited transactions.

DOL website visitors can access something called the ERISA Fiduciary Advisor for information and answers to questions about duties. It's a tool that should help beginners although the DOL cautions that content is not "intended to be a substitute for the advice of a retirement plan professional."

So far, there is no uniform set of answers to questions such as the following:

  • How should in-house fiduciaries be selected?
  • How should in-house fiduciaries (individually and as a group) be assessed in terms of demonstrating procedural prudence?
  • Should in-house fiduciaries receive a bonus for achieving certain plan-specific goals?
  • Does everyone on an investment committee need to be equally proficient in a particular subject area or should someone serve as a Sarbanes-Oxley type of "financial expert?" 
  • Do in-house fiduciary term limits make sense?
  • How do variables such as plan design and characteristics of the workforce impact the kind of fiduciary education needed?
  • How should training differ for small to medium sized plans as addressed by the "Report of the Working Group on Fiduciary Education and Training?"

The good news is that data exists to benchmark myriad types of retirement plan decisions in terms of process and not just outcomes. Furthermore, there is a large array of training opportunities. Click here to download the "Retirement Plan Professional's Designation & Certification Guide" to learn about several dozen available offerings. Note that this document has a 401k focus. The bad news is that not all programs are created equal in terms of topic coverage. Even if they were sufficiently similar, facts and circumstances for a given retirement plan often dictate the need for specialized training not required elsewhere. 

Although fiduciary training is uneven across plans, sponsors and geographic location, I predict that lawmakers here and outside the United States will eventually impose universal certification requirements for retirement plan fiduciaries. I don't think a "one size fits all" approach to fiduciary training is ideal but political pressures will almost surely prevail. As the collective pension crisis worsens (and I acknowledge that lots of plans are in great shape), participants and taxpayers will want to know who was in charge of troubled schemes and how they made decisions. Proverbial heads tend to roll when voters' wallets shrink.

Hard to Value Assets, Hedge Funds and Investment Fiduciaries

As I have pointed out on multiple occasions, valuation is an integral part of investment risk management for several reasons. First, fees paid to asset managers are frequently linked to performance and performance calculations depend on reported values. If values are artificially inflated, returns are likely to be inflated as well. Second, imprecise values can skew asset allocation decisions, lead to hedges being too big (or too small) and possibly cause an investor to breach trading limits that are part of an Investment Policy Statement. It's no surprise then that valuation process questions about who does what, when and how continue to surface.

According to a May 9 Wall Street Journal article, the U.S. Securities and Exchange Commission ("SEC") is investigating "the way hedge funds value their thinly traded holdings and how they respond when investors ask for their money back." The SEC has been vocal about its concerns regarding asset valuations for awhile. In December 2012, Bruce Karpati, then Chief of the Asset Management Unit of the SEC Enforcement Division (and now in private industry), talked about a focus "on detecting fraudulent or weak valuation practices - including lax valuation committees and the use of side pockets to conceal losing illiquid positions - and the failure to follow a fund's stated valuation procedures." Click to read "Enforcement Priorities in the Alternative Space." (As an aside, some hedge funds buy and sell actively traded securities for which there is a ready market and full price transparency.)

The U.S. Department of Labor ("DOL") regularly broadcasts its concerns about "hard to value" assets, including financially engineered products that show up in certain defined benefit and defined contribution retirement plans. In September of 2008, I spoke before the ERISA Advisory Council, by invitation, to address valuation issues from the perspective of a trained appraiser and fiduciary best practices expert. Click to read "Testimonial Remarks Presented by Dr. Susan Mangiero." I talked at length about valuation questions to ask of service providers and procedural prudence considerations for institutional investors.

A few weeks ago, senior attorney Fred Reish addressed monitoring and uncertainty in his April 19, 2016 newsletter. He directed readers to Fiduciary Rule preamble text that urges an advisor and his financial institution to install an adequate monitoring process before recommending "investments that possess unusual complexity and risk, and that are likely to require further guidance to protect the investor's interests." Click to read "Interesting Angles on the DOL's Fiduciary Rule #1." It doesn't take a rocket scientist to conclude that a "complex" and "risky" investment could be hard to value and not particularly liquid. (I have purposely not defined the terms in quotes herein as they are often related to facts and circumstances for a particular investor.)

Expect to read more about this important topic of valuation, especially as applied to those investors in search of higher returns. In a "no free lunch" world, risk and return go hand in hand. It's not necessarily a bad thing to take on greater risk as long as there is an understanding at the outset as to what gives rise to uncertainty and how risks are being mitigated.

Fiduciary Rule and Small Businesses

Given the newness of the U.S. Department of Labor ("DOL") Fiduciary Rule, many still have questions about both content and implementation. One such inquiry arose during a workshop I was asked to create for members of the CT chapter of the National Institute of Pension Administrators ("NIPA"). During our discussion, an audience member wondered out loud if small businesses would be sufficiently overwhelmed that they decide to jettison plans to offer benefits to employees. The reasoning is that compliance costs could dwarf any perceived upside associated with creating retirement arrangements for workers.

As we celebrate National Small Business Week from May 1 through May 7, 2016, the issue of disproportionate impact is certainly relevant. As with any regulation, there are winners and losers. Critics have been vocal about what they see as flaws. Last June, the U.S. Chamber of Commerce released a report entitled "Locked Out of Retirement: The Threat to Small Business Retirement Savings" that predicted a fallout for small business owners who "provide roughly $472 billion in retirement savings for over 9 million U.S. households" via SEP and SIMPLE-type IRA plans. Its author, Drinker Biddle & Reath LLP attorney Bradford Campbell, wrote that "Main Street advisors will have to review how they do business, and likely will decrease services, increase costs, or both." As the U.S. Department of Labor Fact Sheet points out, the final rule covers IRAs, 401(k) plans and many other types of employee benefit plans, some of which were already regulated pursuant to the Employee Retirement Income Security Act of 1974.

Talk about deja vu. Investment News just published an article about the Fiduciary Rule effect on small broker-dealers as relates to documentation and other elements of compliance. The author, Attorney Ross David Carmel, worries that the DOL Fiduciary Rule could be catnip to the plaintiffs' bar because it is vague, "with no definition of best interest or reasonable compensation." He adds that increased costs will likely be passed along to consumers. Of course, buyers of any services have the right to decline or go elsewhere if competitors are willing to sell.

Only time will tell how things materialize for companies that rely on IRAs and will therefore be impacted by the Fiduciary Rule. In aggregate, economic consequences could be large if small business compliance hits the bottom line hard. Statistics from the U.S. Small Business Administration website show that 28 million small businesses contribute 54 percent of U.S. sales.

April is Financial Literacy Month

Every year, April brings spring showers and a celebration of Financial Literacy Month. Instead of balloons and party favors, the Council for Economic Education launched a video campaign of famous people who explain "what they've learned about the importance of financial literacy and saving." Given the dismal outlook of retirement readiness, any effort to get people thinking about putting money aside for the future is a good thing.

According to the 2016 Retirement Confidence Survey, roughly one of every five individuals expects to postpone retirement for monetary reasons. Insured Retirement Institute research suggests that "less than a quarter of baby boomers, 24 percent, are confident they will have enough savings to last throughout their retirement years."

The extent to which the recently released U.S. Department of Labor Fiduciary Rule will impact savings patterns is unknown at this time. Certainly the goal is to empower individuals to plan ahead.

National Institute of Pension Administrators Workshop About Fiduciary Issues

In a few weeks, on April 27, Dr. Susan Mangiero will address the Connecticut chapter of the National Institute of Pension Administrators ("NIPA"). The educational workshop entitled "Impact of Final DOL Fiduciary Regulation" will address topics such as service provider due diligence and plan participant communication from an economic perspective. Interested persons should email clawton@retirewelltpa.com with questions or to register.

According to the NIPA website:

"The National Institute of Pension Administrators (NIPA) is a national association representing the retirement and employee benefit plan administration profession. It was founded with the idea of bringing together professional benefit administrators and other interested parties to encourage greater dialogue, cooperation and educational opportunities. NIPA’s goal is to improve the quality and efficiency of plan administration.

From its beginning in 1983, the founding concepts and specific purpose of NIPA is to educate and train plan administrators. NIPA started as an outgrowth of an eight person work study group. It is now a 1000-member national organization. NIPA's educational forums include courses, workshops and seminars focusing on the various aspects of plan administration."

We hope to see you there. 

Pension Risk Matters Blog Turns Ten Years Old

A decade after its debut on March 23, 2006, Pension Risk Matters is still going strong with well over 1 million visitors and over 1, 000 commentaries. At the time of its inception, there weren't too many economic blogs devoted to topics such as pension governance and risk management. I'm not sure why. Then and now, these areas command attention. Nevertheless, I want to express my heartfelt thanks to readers, commenters and individuals who allowed me to interview them and also to Pensions & Investments for its recognition of Pension Risk Matters as a "best blog."

As I reflect on the last ten years of blogging, I decided to pen ten takeaways about my experiences. Here they are:

  1. Blogging can be enjoyable if you like to write (and I do). However, it does take time and not everyone has the inclination to research a topic, write about it and then edit their work. On average, I review each blog post for grammar, spelling and consistency two or three times before I hit the "publish" button. In addition, I test any embedded web or file links to make sure that they work.
  2. When it comes to blogging about a time-sensitive topic, not everyone can respond quickly. Many companies have social media policies that strictly prohibit an employee from posting to a blog or other platform without having content pre-approved by a compliance officer.
  3. A blogger should have a mission that makes it easy to return to the keyboard over and over. In my case, I have long been a believer in the importance of sharing information about industry trends and best practices. I strive for neutrality by writing in a way that hopefully educates and informs rather than taking an advocacy position about a particular investment or service provider.
  4. Identify a good technology vendor with whom you can collaborate. Originally, I created blog posts as part of a company website but soon found that approach wanting. As a result, I searched for a company that could provide added functionality. I ended up selecting Lex Blog to design Pension Risk Matters as a standalone blog destination. Later on, I asked Lex Blog to design a second blog - an investment compliance blog called Good Risk Governance Pays. Luckily I have not had too many reasons to contact customer support. When I have, they have responded quickly. Another advantage of working with a dedicated blog company is the ability to bounce ideas around about content delivery and enhancing traffic.
  5. Know the parameters of what is likely to work in terms of ease of use and access. Last year, I had Lex Blog migrate content on Good Risk Governance Pays to a responsive platform that allows readers to quickly view blog posts on a smart phone or tablet. I plan to do that soon with Pension Risk Matters.
  6. Add humor whenever possible. It's not easy to spin jokes about serious subjects such as due diligence or reasonableness of fees. What I do instead, when appropriate, is to choose colorful photos that stand out or begin a commentary with an attention-grabbing quote or anecdote. I'm always happy when readers tell me that they enjoyed reading a post because it was funny or at least memorable.
  7. If you use photos (and I recommend that you do), make sure that you have permission. I am a paid subscriber to several stock photo services, each of which has its own terms and conditions and rate schedule. Whenever someone contacts me with a request to use a photo, I suggest that they contact one of these photo services directly.
  8. Link back to earlier posts if it makes sense to do so. I mark each of my essays as belonging to one or more categories such as Fiduciary Education, Hedge Funds or Valuation. By doing so, life is simpler later on. I can click on any category link to refresh my memory about a preceding analysis that may have relevance to the topic du jour. For example, I just wrote about possible private equity obligations to a portfolio company with an underfunded pension plan(s). I did not remember the exact dates of an earlier set of posts I authored but clicked on Private Equity to quickly find four related posts. In a few minutes, I was able to retrieve and embed various links in my April 2, 2016 write-up.
  9. Be curious and stay abreast of industry happenings. This should be occurring anyhow, especially as the financial services industry continues to shake out from changing regulations, competitive pressures and market events. It's straightforward to set up Google alerts for various keywords and sign up for magazine newsletters. Make notes when attending conferences or webinars. Ask readers for suggestions about what they want to know. I never have a shortage of ideas. 
  10. Have fun. While true that numerous business bloggers commit time and money as part of an overall marketing and sales campaign, it is equally rewarding to be able to interact with professionals about how to stay current and seek to do the best job possible. If one of my blog posts is the springboard to such a discussion, so much the better.

Note to Readers: Many thanks again for your continued interest. If you want to guest blog about the financial services industry and are amenable to writing an educational essay, please email your topic idea and contact information.

Court Says Private Equity Funds Are Liable For Pension Liabilities of Portfolio Company

If you open a box and a dog pops out, your enthusiasm will be curbed if you were expecting something else. Surely this is how several private equity funds must feel now about one of their investments. According to "Private Equity Funds Liable to Union Pension Plan" by Jacklyn Wille (Pension & Benefits Daily, March 30, 2016), a federal judge recently ruled that several Sun Capital funds are "jointly liable for more than $4.5 million in withdrawal liability" that one of its portfolio companies, Scott Brass, "owed to a Teamsters pension fund." (You can visit Bloomberg Law to read the March 28, 2016 decision by clicking here.)

I will defer to attorneys to address the legal issues. So far, I found two commentaries on the heels of this 2016 legal decision. See "District Court Concludes Private Equity Fund Is Liable for Pension Obligations of the Portfolio Company" (Fried Frank Harris Shriver & Jacobson LLP, March 30, 2016) and "Private Equity Funds Held Liable for Pension Liabilities of a Portfolio Company" (Sullivan & Cromwell, March 31, 2016).

From my perspective as an economist, any surprise claim on future cash flows could be disastrous if it is large enough to jeopardize the ongoing viability of a business. Even if a business has sufficient resources to maintain itself as an ongoing concern, utilizing cash for something that was not planned for could lead to a lower growth rate than originally expected. Keep in mind that pension funds, endowments and foundations frequently allocate monies to private equity on the basis of expected returns for this asset class.

Projecting cash flows as part of due diligence is nothing new for many investors. That said, I am not convinced that all enterprise investigations fully address the impact of an underfunded defined benefit plan. I was recently contacted by a firm that was tasked to render a fairness opinion and wanted my views about pension math. The investment bankers were reviewing documents from bidders that radically differed with regard to the treatment of the target company's benefit plan burden. When I was asked to speak and also write about pensions and enterprise value, the invitation came from a senior valuation executive who felt that the topic was not being adequately addressed. See "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Dr. Susan Mangiero (Business Valuation Update, July 2013). Email me if you would like a copy of my 2013 slides about this topic.

In 2013, when this Sun Capital case originally made its way to the court, it struck me as an important issue. (I was not involved in this matter as an expert.) Several editors agreed and I ended up co-writing two articles with Groom Law Group partner David Levine. I've uploaded one of these articles to this pension blog. Click here to read "Private Equity Funds and Pension Plans: A Changing Dynamic" (CFA Institute Magazine, March/April 2014). At my request, Attorney Levine responded to this 2016 decision by emailing the following: "In short, while some private equity firms have already moved to evaluate and, in some cases, clarify their fund structures, this case is likely to lead to a second look at their structures and methods of involvement with their portfolio companies."

If certain limited partners are not already asking questions of their private equity fund general partners about the nature of portfolio company pension plans, controlling interest status and deal structure, their due diligence could quickly change in the aftermath of the 2016 Sun Capital litigation.

Interested persons can click on the links provided below to read earlier blog posts about this topic:

Fiduciary Rule: Instant Gratification or Panic

If you haven't viewed Tim Urban's TED Talk about procrastination, I urge you to do so when you have a short break. He spins a tale of prioritization woe by referencing different parts of our brain. There is the Instant Gratification Monkey who tries to lure the Rational Decision-Maker from productive endeavors. This playful little fella holds sway until deadlines force the appearance of the Panic Monster. Someone then responds by pulling an all-nighter or two until the next crisis. As this illustrator and Wait But Why blog site co-founder explains, it's not an enjoyable way to manage tasks and seldom generates good results. It is far better to prepare in advance and schedule "must do items" accordingly.

Occasionally, planning ahead is difficult. Other times, it is easy. As Mr. Urban illustrates during his fifteen minute "eat your peas" presentation, there are signposts that indicate when acceleration is required. In his case, it was the appearance of his photo and bio in a TED Talks program that gave a date certain he could not ignore. For investment professionals who anticipate the eventual passage of the U.S. Department of Labor Conflict of Interest Proposed Rule into law, it is clear that significant change is afoot. Even if the exact final language or timing is unknown today, fiduciaries (now and later) may not want to sit back and wait.

Already there is talk of increased delegation to organizations that are willing to serve as either an ERISA 3(21) or 3(38) fiduciary, acknowledging that nothing eliminates risk completely. As Pension Resource Institute CEO Jason Roberts opines in an Investment News interview, "...while these offerings can limit fiduciary responsibility for advisers at the plan level, advisers could still be exposed at the participant level."

Others advance the idea that the so-called fiduciary rule will catalyze creative problem-solving, especially in the technology area, and that smart money is on first movers. See "Fiduciary Rule May Spur Product Innovation" by Andrew Welsch (Financial Planning, March 16, 2016). If you missed my earlier posts on this topic, see "Retirement FinTech Gets Another Suitor - Goldman Sachs" and "Financial Technology and the Fiduciary Rule."

Whatever path is decided on will require a minimum amount of time for contracting and setting up operations. Starting late could be costly for everyone involved. Lest you figure out a way to be able to succumb to the Instant Gratification Monkey (unlikely in the case of regulations and rules that require sufficient compliance), now is a good time for procrastinators to address priorities. Expending time right away may not be fun but is nonetheless necessary.

Retirement Planning and Risk Management

Retirement planning is hard work and requires discipline and care. Few of us can rely on luck or the proverbial leprechaun's pot of gold at the end of the rainbow, Assessing uncertainty on an ongoing basis is as important as identifying goals. Sadly, I'm not convinced that the topic of risk management is being discussed as often as it should be with workers and retirees alike.

In the last month, I spent copious time reviewing educational materials produced by a handful of financial advisory firms. What I found confirmed my suspicion that coverage of the topic of risk does not often extend beyond an initial assessment of risk tolerance. A prospective client is asked to complete a questionnaire. The financial advisor then reviews the answers and makes a recommendation about what asset allocation mix seems right. When scenario modeling is used, an individual may be given several possible portfolios from which to choose. Ideally, as an individual's circumstances or goals change, the questionnaire should be completed anew and modifications made accordingly.

Outside of product boilerplate language and short paragraphs about diversification and dollar cost averaging, I did not uncover much information about specific risk management techniques that an individual investor can put to work. This is lamentable. Investment risk management is not just for corporations, financial service companies and governments.

There are lots of techniques that an individual can utilize, starting with the creation of an inventory of what protection is already in place, if any, and a risk map that specifies outcomes that an investor wants to avoid at all costs. In behavioral finance, the desire to avert losses is a well-known psychological bias and should not be ignored. It is important that an individual investor and his financial advisor acknowledge the "worst case" situation as part of setting objectives.

While gauging tolerance for risk is necessary, it is seldom sufficient for several reasons. First, a financial plan may focus only on investments and therefore exclude different kinds of insurance policies that are integral to capturing which risks are already hedged and which ones are not. Second, an investor may realize a target level of return but have a portfolio that is too small to generate sufficient cash flows. Bills are paid with cash, not returns. Third, if securities or funds are selected on the basis of expected return and standard deviation only, material quantitative and qualitative risk factors are likely excluded. As a result, an investor could be assuming "excessive" risk or not enough risk.

As famed author Mark Twain quipped "There are two times in a man's life when he should not speculate: when he can't afford it and when he can." One might say he was a risk manager ahead of his time.