Roland|Criss Blog

Caught in the Middle

 by Ronald E. Hagan
CEO -  Roland|Criss

The financial consulting industry is embroiled in an internal fight.  At issue is the national effort to make all investment advisors legally required to put their clients' interests first.  In other words, to make all financial consultants accountable as fiduciaries.

Insurance companies and securities brokerage firms oppose strongly the fiduciary requirement.  They argue that a fiduciary standard covering all insurance agents, mutual fund brokers, bond brokers, pension consultants, and the like would only increase their costs.  They imply that the costs would be passed on to retirement plans, foundations, and retail clients.

Under today's rules, investment consultants may receive both direct and indirect financial benefits from investment product sources like mutual fund companies and insurance annuity issuers.  These benefits influence consultants' recommendations.

If they were held to fiduciary accountability, financial consultants would not be able to factor their income into their recommendations.  The tendency to color advice based on which product sources pay advisors the most income is, however, pervasive.  Even consultants that are registered under the Investment Advisers Act of 1940, which imputes to them a fiduciary duty to their clients, are able to skirt that law and receive extra money rewards.

The widespread opposition among financial consultants to a universal fiduciary standard for all investment vendors tears the cover off the trusted advisor concept.  This is bad news for those caught in the middle such as retirement plan sponsors, endowments, foundations, and private trusts.  The fiduciary laws to which they are accountable provide no relief from the duty to put the interests of their retirement plans' participants, charitable donors, and beneficiaries first.  Given the extent to which duty bound fiduciaries rely on investment "professionals" for the tough decisions they face, it seems only right that advisors who enrich themselves at the expense of trusting clients should get in the middle, too!

Is the Fox Selling Chicken Wire to the Hen House?

Ronald E. Hagan
CEO, Roland|Criss

The overarching job of the board of directors of a company that sponsors a retirement plan is to ensure a safe environment for its employees' nest eggs.  Most executives that directly oversee such plans want help performing the duties defined by various laws, court cases, and industry best practices.  In the past, board members, financial executives, and human resource managers that serve as pension fiduciaries have looked to providers of investment products and advice as their “trusted advisor” for such help.

In truth, investment providers do not all deserve the same level of confident reliance as trusted advisors.  For example, insurance companies are not legally bound to comply with any defined fiduciary law.  The same is true of securities firms that sell stocks, bonds, and mutual funds.  Only investment providers that are licensed as Registered Investment Advisors bear any semblance of accountability to a fiduciary standard of care.

This is important; a Registered Investment Advisor’s inherent accountability is to a specific securities law, but not to any pension law.  Many executives who manage retirement plans are easily misled into thinking that a Registered Investment Advisor is a “co-fiduciary.”  Such thinking has caused thousands of primary fiduciaries to believe that they are relieved of their investment decision making risk just because an advisor claims co-fiduciary status, when nothing could be further from the truth.  Scores of court cases in this decade prove it.

Last week’s decision in the U.S. Senate to trash a proposed rule that would have placed all investment providers under a common fiduciary roof is bad news for retirement plan sponsors.  The rule would have imposed on insurance agents, stock brokers, and Registered Investment Advisors alike, a pension connected fiduciary standard.

The financial reform package introduced last week by Senate Banking Committee Chairman Christopher Dodd, a Democrat from Connecticut, dropped an earlier provision that would have imposed a fiduciary duty on anyone offering advice on investments, dealing a blow to boards of directors, financial officers, and human resource executives.  After studying the arguments that led to Senator Dodd’s decision, it is clear that misleading arguments put forth by the insurance industry caused him to back off.  What does this mean for you?

You need to evaluate the practices and influence that your plan’s investment provider exerts on your decision making.  The provider may be an insurance company, a Wall Street securities firm, a Registered Investment Advisor, or even a third party administrator.  The U.S. Senate just gave all of them a permanent license to keep making chicken wire for your hen house!

The holes in the chicken wire are easily identified by a firm that audits investment firms.  Just be sure you don’t employ an investment firm for the task.  The safety of the nest eggs you are responsible for is at stake.  Federal pension law puts your personal net worth on the line, too.

A Powerful Solution for Pension Trustee Risk Emerges

All public pension plans face risks that could result in situations where employees do not receive promised benefits. Frequently, this is unavoidable due to factors like securities market fluctuations, interest rate changes, liquidity demands, and inflation.

In addition, public pension boards have unique pressures due to the “hothouse” environment in which they operate. Political constituents like lawmakers, local politicians, the media, and citizen groups often try to influence pension policy which can create a lot of distracting noise. If not screened through a quality management system, board members can wind up chasing investment fads with chaos the result.

What may seem to be politically viable is many times downright foolish for pension boards from a risk management viewpoint. This can happen when:

• lawmakers vote to amend plans without following a defined process to evaluate the impact;
• benefit formulas increase obligations without considering demographic trends and available assets;
• rate of return assumptions are increased in order to reduce contributions but windup creating funding shortfalls.

Certain risks are preventable, serve no purpose, should, and can be avoided. A key risk that can be neutralized is governance risk. Governance risks occur when trustees invest plan assets in a way that needlessly under-performs expectations.

The 2000 study by the Association of Public Pension Fund Auditors, titled Public Pension Systems: Statements of Key Investment Risks and Common Practices to Address These Risks, stated “characteristics of poor governance may include incompetence, poorly or improperly defined roles, poor communications, failure to meet fiduciary responsibilities, lack of ethical standards and inconsistency.”

In 2003, this same organization issued its report titled Public Pension Systems-Operational Risk of Defined Benefit and Related Plans and Controls to Mitigate these Risks.  This study described other hazards that many trustees and executive staff of pension boards face. Hazards include:

• board members and executive staff are not adequately trained and qualified to perform their functions and fiduciary responsibilities;
• board members and executive staff do not have the expertise to promulgate policies or operate the public pension plan;
• one or more board members and/or executives may not be independent, thus possessing a conflict of interest, and may not be performing their duties solely for the benefit of retirees and beneficiaries;
• involvement in inconsequential projects, causing critical functions to suffer.

What’s more, all retirement plans, including public pension plans, rely on outside contractors. Pension board members and plan executives are often at the mercy of these contractors when:

• the scope and the object of the contracts are not sufficiently defined;
• due diligence is not performed on major investment vendors and service providers like recordkeepers;
• service providers are not certified to provide fiduciary support services;
• investment vendors, service providers, and/or recordkeepers have conflicts of interest with the plan; and
• trustees fail to monitor investment vendors, service providers, and recordkeepers as defined in fiduciary laws.

In order to combat the potential problems defined in the above mentioned studies, pension boards should ensure that they use a “structured and methodical evaluation process.”

Recently, the Global Fiduciary Standard of Excellence emerged for all pension plans. Substantiated by the Uniform Management of Public Employee Retirement System Act, case law, and industry best practices it is a defined Standard that can help public pension trustees perform safely their investment and fiduciary responsibilities. It defines a management system that ensures safety and quiets detractors.

Roland|Criss trains trustees on the new Standard.  Roland|Criss also developed a system that implements the Standard’s practices and helps avoid relapses.

The initiative to promote pension trustee excellence is governed by the Centre for Fiduciary Excellence (“CEFEX”).  It is a certifying body that provides independent recognition of pension boards that can prove their conformity to the conduct defined by the Standard.  Qualifying pension boards are evaluated based on a structured, methodical process and receive CEFEX’s mark of excellence.  CEFEX selected Roland|Criss to manage its certifications in the United States.

Roland|Criss can assist public pension plans in three ways:

1. deliver training in the practices for which trustees are legally accountable;
2. install a management system that prudently guides investment decisions; and
3. help certify public pension boards against CEFEX’s impeccable fiduciary standard of care.