Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.
Effective December 27, 2011, the Department of
Labor's Employee Benefits Security Administration (EBSA) issued its final rule
regarding the provision of investment advice to participants in individual
account plans, such as 401(k) and 403(b) plans, and beneficiaries of individual
retirement accounts. The final rule affects plan sponsors, fiduciaries,
participants, and beneficiaries of participant-directed retirement plans. Essentially,
the rule enables providers of investment advice acting as fiduciary advisers to
offer investment guidance to participants provided certain conditions set forth
in the regulations are satisfied.
The Need for Advice
Recent studies have indicated that participants who
receive professional investment advice consistently outperform those who go it
alone. Constructing a proper asset allocation is key to the long-term success
of any retirement strategy and most participants are ill-equipped to make such a
potentially life-altering decision on their own. The DOL's new participant
investment advice regulation attempts to offer participants another means of
achieving their retirement goals.
Not all investment advice that has been provided in
the past has been impartial or in the participant’s best interest. Sometimes
there have been conflicts of interest unknown to the plan sponsor. In selecting
a fiduciary advisor the plan sponsor still retains fiduciary responsibility in
selecting the form of investment advice they offer to their participants.
Best Fit
There are numerous factors to consider when
selecting a fiduciary adviser to a plan. The last few years have seen dramatic
growth in the independent investment consulting industry and with the passage
of the new regulation, more solutions are sure to follow. The first step is to
determine what type of investment advisory service is the best fit for the plan
participants. Traditionally, plans have relied on an eligible investment advice
arrangement ("EIAA") through a fiduciary adviser to help employees
make informed investment decisions, but this is no longer the only available
option.
Third-Party Advice
Web-based investment guidance services and managed
accounts offered through an independent, third party are increasingly popular
options. These firms are unaffiliated with any of the plan’s fund providers or
managers. According to the new regulation, their methodology for building an
asset allocation must not be in any way impacted by the funds selected. In
other words, they must not have a vested interest in or receive any additional
financial benefit from using one fund over another. The methodology must be
fund and share class neutral. In order to determine the best option for their
participants, plan sponsors should conduct a thorough analysis based on their
company's demographics and plan objectives.
Identifying Fiduciaries
Another important factor which is often overlooked
in selecting a fiduciary adviser is determining exactly who can act as a
fiduciary adviser. Many brokers may offer investment advice to participants but
most are protected by regulations from taking on fiduciary liability. In many
cases, if the adviser is not receiving compensation directly from the act of
offering advice, they are not considered a fiduciary under the current law. Eligible
fiduciaries generally come in four categories: a registered investment adviser
(RIA), an advisor for a bank providing services through the trust department,
an insurance company representative and a representative of a registered
broker-dealer. Plan sponsors should check with the fiduciary adviser to confirm
their status as an eligible fiduciary to the plan and receive confirmation in
writing that they are acting as a fiduciary.
Establish Evaluation Criteria
The next step in selecting a fiduciary advisor is
for the plan sponsor to establish objective criteria for evaluating an adviser
that fits the needs of its participants. The retirement plan committee is
responsible for creating a documented checklist that can then be used to
evaluate fiduciary advisers. Some general criteria should focus on identifying
any potential conflicts of interest, fee and compensation arrangements that may
cause the adviser to pressure participants into less appropriate products. The
firm’s experience and depth of services in providing fiduciary advice and
specifically the qualifications of the professionals providing the advice are
important. Checking for any disciplinary actions against the fiduciary adviser
or the firm should be conducted at the onset and on an annual basis for any
potential change in status.
The fiduciary adviser’s professional credentials
and investment experience are critical. Many large firms may be impressive
marquee names yet the individuals providing the advice may be junior, less
skilled advisers than small boutique firms whose advisers may be highly
experienced professionals providing high caliber advice.
Ongoing Monitoring
Once a suitable fiduciary adviser has been
selected, it is important that the sponsor establish a process for ongoing
monitoring of the adviser. Best practices dictate that a plan sponsor review
their plan's fiduciary adviser at least once a year. There are a multitude of
factors to consider, but a prudent approach would include a deep dive of the
adviser and documenting their process. This would include confirming that all
required documentation and notifications were provided. Another factor to
consider would be determining whether the adviser is actually complying with
the new participant investment advice regulation.
Revisiting the relative cost of the investment
advice program in relation to participant adoption and utilization is a prudent
way to quantify the value added by the fiduciary adviser. If participant
adoption is relatively low compared to the cost, perhaps more education is
required or the plan sponsor may want to scale back on the services offered . A
thorough review should also include inquiring into and following up with
participant comments and feedback. Any participant complaints should be
addressed immediately. Participant feedback, whether positive or negative is a
good way to stay ahead of any potential fiduciary liability issues. Fine-tuning
the plan based on participant comments may lead to increased participation
rates, if done in a prudent way. Updating the firm’s and fiduciary adviser’s
status for any disciplinary actions should be part of the annual evaluation.
The most important fiduciary benefit of conducting
this due diligence review is documenting the decision making process and the
results. Comprehensive documentation of the information collected to render
decisions that impact the plan is the best way to protect the plan sponsor from
fiduciary liability. While investment returns may go up and down, a detailed
accounting of the due diligence process is the plan sponsors' greatest asset.
An annual review of the plan's fiduciary adviser will go a long way to
fulfilling a plan sponsor's fiduciary duty.
Conclusion
Most participants lack the skill, training or time
to construct a disciplined, asset allocated, long-term investment strategy.
Short-term trends often lead them to make mistakes and risk their long-term
success. Individual investors are driven by emotion, causing them to make the
same investment mistakes over and over. The DOL's new participant investment
advice regulation attempts to offer participants another means of achieving
their retirement goals. Plan fiduciaries are responsible for evaluating and
understanding the advice options they offer to their participants. Realizing
the plan sponsor's role in delivering this essential service is an important
fiduciary duty. Establishing a defined strategy for implementing participant
investment advice is key to fulfilling a plan sponsor's fiduciary obligations.
