The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

Fiduciary Prudence in a Post-2008 World - Final in a Four Part Series

August 2009

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.

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.

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