The Prudent Fiduciary

Scott Pritchard | Principal

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

Who "Mad(e)-off" With My 401(k)?

December 2008

Its 10:30 pm…do you know where your 401(k) assets are? Unfortunately, the plan sponsors who had their assets invested with Bernard Madoff didn’t. And the resulting losses have been devastating to their unknowing participants.

Madoff’s operations lacked any sort of transparency. His clients, including a number of large 401(k) plans, simply didn’t know where their assets were or how they were invested.

If your plans, or the plans of your clients, utilize Collective Trusts, Collective Funds, Unit Investment Trusts, or other tools with similar names, you face a similar lack of transparency.

In recent years, we have seen these “trusts” (oh, the irony!) being marketed as a less expensive alternative to mutual funds. While collective trusts are certainly less expensive than the average retail mutual fund, these trusts lack the transparency of mutual funds, which are required to provide copious public detail. Any fiduciary utilizing these trusts is at the mercy of the provider for all information about the trust’s holdings, expenses and performance.

The victims of the Madoff scheme were in the same situation. They relied completely on Madoff’s firm for all information related to their investments. Without the ability to “verify”, all they could do was “trust”…and the rest is now front-page news.

We encountered this lack of transparency first-hand when we were engaged to conduct an analysis of the 401(k) plan of an Atlanta law firm. The plan had been set-up by a brokerage firm and relied almost exclusively on collective trusts. When we attempted to analyze the funds offered in the plan, we were stonewalled. There was no publicly available information on the trusts and the brokerage firm had no interest in providing us, even at the request of the plan sponsor, with any detail on the underlying funds. All we had to go by was the performance results, which as you might have guessed, came straight from the brokerage firm. An objective fiduciary analysis was impossible.

Fortunately, fiduciaries do not have to resort to using these trusts in order to lower plan expenses. Cost savings and transparency are both available by following two simple steps:

  1. Utilize the institutional share class of passively managed, asset-class mutual funds. These funds provide precise asset-class exposure at a low cost and are required by law to fully disclose holdings, expenses and performance.
  2. Have plan assets held by an independent, third-party custodian. Separating the money from the investment provider creates greater accountability and increases transparency.

As fiduciaries, we cannot fulfill our duties without full transparency. We’ve heard that all year as it relates to fee disclosure, but the Madoff fraud reminds us that we also have to apply that to the structure of the investments we offer to plan participants. Collective Trusts, Collective Funds, and Unit Investment Trusts simply don’t meet the transparency standard.

It’s fine to trust. Just make sure you can verify.

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