Improving the RFP Process

A few months ago I was asked to complete a Request for Information ("RFI") by the sponsor of a large pension plan. Their goal was to hire an independent outside party to vet the investment management policies and procedures of its outsourced manager. I've long maintained that it is an excellent idea to have someone review operations and render a second opinion about how asset managers perform relative to a retirement plan's objectives, how much risk is being taken to generate returns, the extent to which the asset manager is mitigating risks and much more.

While this type of "kick the tires" engagement is not as common as many think it should be, that could change quickly. The Outsourced Chief Investment Officer ("OCIO") business model (sometimes referred to as the Delegated Investment Management or Fiduciary Management approach) is rapidly growing at the same time that recent mandates such as the U.S. Department of Labor's Fiduciary Rule, along with a flurry of lawsuits that allege breach, call more attention to how in-house plan fiduciaries hire and monitor their vendors.

Given the relative newness of this type of engagement and the fact that a review can mean different things to different people, I strongly recommend that the hiring party consider how much work they want done and what budget applies. In the case of the aforementioned invitation to submit a work plan and detailed budget, my colleagues and I were told by the plan sponsor they weren't really sure what should be done. Our suggestion was to carry out a preliminary review of existing policies, procedures and operations, report the findings to the trustees and then discuss what could be done as a subsequent and more granular assessment, if needed. This would get the ball rolling in terms of identifying urgent concerns and avoid having to write a big check. Even with an opportunity to ask questions of the hiring plan, there were still many unknowns. For example, would the plan sponsor be willing to pay for a complete investigation of items such as vendor's data security measures, adherence to its compliance manual, growth plans, risk management stance, employee personal trading safeguards, measures to avoid conflicts of interest, business strength, type of liability insurance in place and verification (if true) that back office cash management was separate from trading or instead have an examiner concentrate on a subset? When the plan sponsor said it wanted to have an outside reviewer look at historical investment performance numbers, was its goal to assess data frequently or over a longer period of time, relative to a selected benchmark, relative to an asset-liability management hurdle, based on risk per return units and so on?

Anyone who has reviewed bid documents from public and corporate plan sponsors will likely conclude that there is not much consistency, especially for due diligence and governance assignments. That's not ideal. Yes, it's true that facts and circumstances will differ but clarity in terms of what a hiring plan wants can be a plus for everyone. I think it would likewise be helpful for the bid document to state a budget number or "not to exceed" range and let the respondents suggest what work could be reasonably done for that fee. Both the buyer and seller would know at the outset whether it makes sense to proceed with discussions. Another way to go would have the plan sponsor hire someone to interview its in-house fiduciaries, identify and rank their major concerns and then use that information to create a structured Request for Information or Request for Proposal ("RFP") that would be distributed to potential review firms. This exercise would entail a short-run expense but could save money in the long-run by ensuring that the plan sponsor and the review team are in sync about expectations and deliverables.

The bidding process is often a tough one for both buyer and seller. In 2015, I interviewed the co-CEO of a company called InHub, Mr. Kent Costello. I have no economic connection with this company. I had asked for a demo after reading about the use of technology to help fiduciaries with their search and hiring of third parties. In answer to my question about the limitations of the existing RFP process for the buyer, Kent said "It can be difficult for investment committees to put together a list of questions that will help them to effectively compare firms and service offerings ... Poorly crafted, irrelevant, or repetitive questions will lead to a weak due diligence process and leave the committee confused and frustrated. Worse yet, it could mean the selection of an inadequate vendor." Just as important, he pointed out that sellers could be reluctant to take the time and money to prepare a detailed proposal, "given the low likelihood of winning the business..." Click to read "Electronic RFP Process and Fiduciary Duty."

Process improvement is always a plus, whether applied to crafting a bid document, responding with a proposal or implementing the work, once hired.

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 Management For Pension Plans

Besides being knowledgeable about medicine, nutrition and state-of-the-art health research, my doctor has a great sense of irony. He says things that make me laugh out loud. When I saw him recently, I mentioned how much I was enjoying reruns of some older television shows like Quincy, M.E. He replied, in typical clever fashion, "yea, but Sam did all the work and Quincy took the credit." It struck a chord because his statement is mostly true. In case you never watched the popular series about a coroner who helps the police solve crimes, veteran actor Jack Klugman (now deceased) applies Criminal Scene Investigation ("CSI") like smarts and tenacity in pursuit of justice. Sam Fujiyama (played wonderfully by actor Robert Ito) is likewise a medical doctor. He works alongside Dr. Quincy and is portrayed as an integral part of uncovering the truth.

In pension land, it is often the case that sponsors think they have hired someone to play the role of helpful Sam. The notion is that the advisor, consultant or fund of funds professional will be paid a fee to carry out a certain level of due diligence about action items such as setting up or revising an appropriate investment strategy, selecting or terminating an asset manager, redesigning a plan or evaluating pension transfer structures. Once the engagement letter is signed and a retainer fee is in place, the plan sponsor, like Dr. Quincy, can breathe a sigh of relief. Help is supposedly on the way - maybe. The safety net concept attached to bringing a third party on board, combined with what a colleague of mine describes as fiduciary fatigue, is reflected in the global growth of firms that describe themselves as fiduciary managers. While the retirement plan regulatory regime varies by country, the investment outsourcing model is gaining sway in the United States, the United Kingdom, the Netherlands and elsewhere. The undeniable trend to delegate merits discussion.

Before employers get too comfortable and think that their pension problems now belong to someone else, it is noteworthy to acknowledge that there are more than a few lawsuits that have been filed against third parties. Some of them allege breach on the basis of a failure to properly oversee and respond accordingly.

My observations come from firsthand experience. I have served as an economic analyst or testifying expert on disputes between an institutional investor such as a retirement plan, endowment, foundation or family trust. For other matters, I have provided due diligence training to fiduciaries and board members or reviewed the risk practices in place prior to a vendor being selected or as part of a later review of said vendor, once hired. As the founder of an educational start-up company a few years ago, I had a front row seat to the ongoing discussions between buyers and sellers of investment, risk and valuation services. Information in the form of repeated and in-depth surveys and numerous conversations about what pensions, endowments, foundations, family offices and other types of trust investors want and need from those who provide advice is telling. One issue that came up often from institutional investors was how to benchmark the quality of the work being provided by a delegate. This is a critical subject, especially for those outsourced professionals who are doing a terrific job and want their clients to be satisfied.

The topic of service provider due diligence is timely, important and the focus of my presentation on October 25, 2013 as part of the American Conference Institute's 6th Annual ERISA Litigation Conference. Interested readers are welcome to download my fiduciary due diligence slides.