Category Archives: prudent

Interesting Angles on the DOL’s Fiduciary Rule #2


BICE, DOL, prudent

This is my second article about the interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

The recommendation of investments and insurance products to plans, participants, and IRAs will be subject to the best interest standard of care. (The best interest standard is a combination of ERISA’s prudent man rule and duty of loyalty.)

The legal requirement that advisers make prudent recommendations and act with a duty of loyalty is well understood in the retirement plan world, but is new to IRAs.

Also, it’s commonly conceded that the prudent man rule is more demanding than the suitability standard. But that begs the question, what is required of the adviser?

The DOL answered that question in the context of fixed indexed annuities, and the answer may be surprising. (For other insurance products and investments, the DOL would likely say that a similarly rigorous approach is required.)

Here’s what the DOL said:

“Assessing the prudence of a particular indexed annuity requires an understanding of surrender terms and charges; interest rate caps; the particular market index or indexes to which the annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer’s authority to revise terms and charges over the life of the investment; and the specific methodology used to compute the index-linked interest rate and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-linked interest rate can be affected by participation rates; spread margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity’s period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity’s term (e.g., simple or compounded interest).”

Actually, there’s more than that. For example, based on ERISA precedence, an adviser would also need to evaluate the financial stability of the insurance company and its ability to make the annuity payments (e.g., 20 or 30 years from now).

 

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Interesting Angles on the DOL’s Fiduciary Rule #1


broker-dealers, DOL, fiduciary, prudent, registered investment advisers

While you have probably read articles that summarize the DOL’s final fiduciary rule and exemptions—and perhaps even articles that discuss specific aspects of the rules, there are a number of interesting observations “hidden” in the preambles to the regulation and exemptions.

In many cases, those comments are so focused on limited issues or complex that they are beyond the scope of the initial articles, speeches and webcasts. As a result, I will be writing several articles about those “nuggets.” This is the first of those articles.

In the preamble to the Best Interest Contract Exemption (BICE), the DOL noted that a fiduciary adviser and his or her financial institution (e.g., RIA firm or broker-dealer) could contractually limit the duty to monitor. But then the DOL went on to say:

“Further, when determining the extent of the monitoring to be provided, as disclosed in the contract pursuant to Section II(e) of the exemption, such Financial Institutions should carefully consider whether certain investments can be prudently recommended to the individual Retirement Investor, in the first place, without a mechanism in place for the ongoing monitoring of the investment. This is particularly a concern with respect to investments that possess unusual complexity and risk, and that are likely to require further guidance to protect the investor’s interests. Without an accompanying agreement to monitor certain recommended investments, or at least a recommendation that the Retirement Investor arrange for ongoing monitoring, the Adviser may be unable to satisfy the exemption’s Best Interest obligation with respect to such investments. Similarly, the added cost of monitoring such investments should be considered by the Adviser and Financial Institution in determining whether the recommended investments are in the Retirement Investor’s Best Interest.”

In other words, if an adviser isn’t going to have a duty to monitor the investments, don’t recommend investments that retirement investors lack the capacity to properly monitor.

It’s not clear where that line will ultimately be drawn – for example, does it refer to the particular investor or the average investor? As a result, some caution is warranted.

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Distribution and Rollover Education


DOL, plan sponsors, prohibited transaction, prudent

A reporter recently asked me to explain why people are saying that, under the DOL’s fiduciary proposal, an adviser should not recommend that a participant take a distribution and roll over to an IRA, but instead should provide distribution education. Here’s my answer:

There are two issues.

The first is that the recommendation to take a distribution must be in the best interest of the participant. That is, it must be a prudent recommendation and it must be done with a duty of loyalty to the participant.  In order to make a prudent recommendation, the adviser needs to investigate the relevant factors that a knowledgeable person would want to know to make that decision.  Some of those factors are:  the investment expenses in the plan as opposed to those in an IRA; the costs for advice in the plan versus those in an IRA; the range of investment options in the plan versus those in an IRA, and whether a larger range of investments is advantageous to the participant; the flexibility and costs of withdrawals from the plan as compared to an IRA.  That requires quite a bit of investigation and analysis, but does not prohibit a recommendation.

The second is that, if the adviser makes more in the IRA than in the plan, it is a prohibited transaction. For example, if the adviser doesn’t make anything from the plan (that is, he isn’t the adviser for the plan), but will receive 1% per year for advising the IRA, it is clearly in the best interest of the adviser to recommend a rollover, but is it right for the participant?  The DOL says that is a conflict, and financial conflicts are prohibited unless there is an exemption.  But, there isn’t an exemption specifically on point.  And, while people think that the Best Interest Contract Exemption (BICE) is intended to apply, it isn’t clear what BICE requires in this situation.  So, until the final BIC exemption is issued, it isn’t clear how advisers will be able to avoid prohibited transactions if they make distribution recommendations.

However, if an adviser provides non-biased and good quality distribution education, that’s not considered a recommendation. As a result, the prohibited transaction rules don’t apply.

Note: These rules will also apply to recommendations to withdraw or transfer money from IRAs. It is not just a plan issue.

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Navigating Retirement Risks: Creating Sustainable Retirement Income


prudent

This is the second article in our series on navigating retirement risks, based on our White Paper, Creating Sustainable Retirement Income in 401(k) Plans Using Managed Risk Funds (www.milliman.com/new401k).  The first article addressed how long a 401(k) participant will need his retirement money to last.  We also discussed how market fluctuations at the wrong time – what we called timing risk – impact the participant’s account.  In this article, we discuss the importance of investing retirement savings properly.  You can read the article here.

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Did you know …About the Fiduciary Requirements for Selecting an Insurance Guarantee for your Participants?


fiduciary, prudent

Insurance guarantees for retirement benefits — such as annuities, QLACs, and GMWBs—are increasing in popularity . . . because they guarantee that the money lasts for a lifetime. However, there is not much guidance about the fiduciary process for selecting a particular annuity or GMWB product to provide those guaranteed benefits. We have written a white paper about issues for selecting GMWB products for Lincoln Financial, which can be found at http://bit.ly/1rtMnFX. This article, found here: http://bit.ly/1yOnoS7, discusses key points from the white paper.

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Managing Defined Contribution Plan Investment Policy Statements


fiduciary, prudent

I recently wrote an article for JP Morgan about the fiduciary process for implementing investment policy statements . . . with particular emphasis on the monitoring of investments and investment managers in participant-directed plans. The article outlines a step-by-step approach for identifying investments to be placed on a watch list, the use of the watch list, and the process for determining whether to remove and replace the investment. I believe that the article is both a good outline of ERISA’s requirements for a prudent process and an educational piece for plan fiduciaries. It can be found under the publications section of my blog, here: http://fredreish.wpengine.com/publications/, or directly at http://bit.ly/1MayGaf.

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Navigating Retirement Risks


prudent

American workers are living longer. But a long life has its risks . . . especially the risk that retirement savings won’t last. Bruce Ashton and I have written an article about the sequence-of-returns risk created by market volatility (based on a white paper that Bruce Ashton and I wrote for Milliman). The article contains graphic examples of the impact of gains and losses in the years shortly before and after retirement. You can read the article here.

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Advisory Opinion 2013-03A


408(b)(2), DOL, fiduciary, prudent, recordkeeper, registered investment advisers

In Advisory Opinion 2013-03A, the Department of Labor said: “This letter also does not address any fiduciary issues that may arise from the allocation of revenue sharing among plan expenses or individual participant accounts . . .”

In effect, the DOL was saying that it has not issued any guidance—and is not prepared to issue guidance—concerning the allocation of revenue sharing. That is a reminder that there isn’t any explicit guidance on how to allocate revenue sharing. As a result, fiduciaries need to engage in a prudent process to make that decision.

In most cases, revenue sharing is used to pay the cost of recordkeeping. In effect, it is arguable that, when the recordkeeper keeps the money, it is a pro rata allocation among the participants’ accounts. That is because the most common way of allocating expenses (for example, recordkeeping or RIA charges) among participants’ accounts is the pro rata method. So, when a recordkeeper keeps the revenue sharing, participants benefit on a pro rata basis. (“Pro rata” means that amounts are allocated among the participant’s account balances in proportion to the value of the account balances.)

A consequence of the 408(b)(2) disclosures and the DOL’s guidance on revenue sharing is that fiduciaries need to pay more attention to revenue sharing. For example, do fiduciaries want the recordkeepers to keep the revenue sharing or do they want to allocate the revenue sharing to participants (along with the charges for recordkeeping)? Should part of the cost of recordkeeping be allocated to participants who are invested in individual brokerage accounts or who hold company stock . . . or should the participants who invest in mutual funds bear the full cost of the recordkeeping for the plan? Those are fiduciary decisions. In the past, most plan fiduciaries have simply accepted the method used by the recordkeeper. However, even then, that was a fiduciary decision. It’s just that the fiduciaries didn’t, in many cases, know that they were making it. Going forward, there undoubtedly will be greater accountability for these fiduciary “decisions”. . . since fiduciaries have been provided with information about revenue sharing as a part of the 408(b)(2) disclosures. Forewarned is forearmed.

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Investment Policy Statement: Friend or Enemy


fiduciary, plan sponsors, prudent

The ABB case has been thoroughly analyzed and widely discussed. Most of that analysis and discussion, though, has been about expenses and revenue sharing. This email focuses on the duty to follow the terms of investment policy statements (IPS). More technically, section 404(a)(1)(D) of ERISA requires that fiduciaries follow the terms of the documents governing the operation of the plan, unless it would be imprudent to do so. The IPS is one of the documents governing the operation of the plan.

As background, the trial court found that the ABB plan committee violated several of its fiduciary duties. One of those was the duty to follow the terms of the IPS. In the IPS, the committee was obligated to follow certain procedures concerning the removal and replacement of a fund, including placing a fund on the watch list before removing it. The court found that the committee failed to follow the procedures in its IPS and, as a result, breached its fiduciary duties. That was unfortunate, since the committee could have amended the IPS to change the procedure. However, it failed to do so… perhaps because the committee had forgotten the terms of the IPS or perhaps because it believed its exercise of discretion would override the terms of the IPS.

So, is the IPS a friend or an enemy of plan committees? The answer is, depending on how it is done, it can be either.

Unfortunately, we see too many IPS’ that contain absolute and/or unnecessarily restrictive provisions. Those provisions can mandate a certain number of meetings, require a specified investment removal process, insist on a particular series of steps for some decisions, and so on. None of that is required by law… nor, in my opinion, by good judgment. Instead, an IPS should be a set of guidelines, and the plan committee members should be expected to exercise discretion and good judgment for the benefit of the participants.

Is there an alternative to the IPS being an “enemy?” Yes, of course.

If an IPS is properly drafted, it can serve as an educational tool for the committee and as a set of non-binding guidelines. In that way, the focus can be kept on the real job of the committee… to exercise its discretion. But the nonbinding guidelines in the IPS will be a helpful “map” for consistent and thoughtful decisions.

The moral to this story is that, if an IPS is going to be rigidly drafted as a series of requirements, then the committee should review the IPS before it acts and amend the IPS, if need be. On the other hand, and a better solution, the IPS could be better drafted. My experience is that, while the investment community is good at determining the criteria and other information to be included in an IPS, the investment community does not have the same risk management skills as attorneys. It is probably best if each does its “day job,” and the investment consultants focus on IPS’ as an investment tool, while the lawyers view them as risk management documents.

IMPORTANT NOTE: This case was heavily disputed and there may be disagreement about the facts. This article uses the facts as laid out in the court’s opinion and, based on my experience in other cases, the actual facts can be different.

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