Be a Prudent Fiduciary“How to Select, Monitor and Assure That Your

Providers Properly Exercise their Responsibilities and Assume Appropriate ERISA and Contractual Liability”

John H. McKendry, Jr.

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WHO IS A FIDUCIARY?

� Exercises authority or control - management or disposition of the plan’s assets

� Renders investment advice for a fee (advice regarding value or recommendations regarding investment in purchasing or selling, advice is primary basis of investment and is suited for particular needs of plan, investment policies or strategy, overall portfolio composition or diversification)

� Discretionary authority or responsibility -administration of the plan

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INVESTMENT FIDUCIARIES

�TWO TYPES

� 3(38) Investment Manager complete discretion over selection of assets (registered investment advisers)

� 3(21)(A)(ii) Investment Adviser for a Fee (Broker)

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THE FAUX FIDUCIARY – INVESTMENT ADVISERS ACT OF 1940 (SEC)

�Brokers/insurance Agents not regulated (suitability standard)

�No established standards of care (“best interests” vagary)

�Focus on individual not retirement plan advice

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THE FAUX FIDUCIARY – INVESTMENT ADVISERS ACT OF 1940 (SEC)

�Emphasis on self-regulation (due to lack of enforcement resources)

�Mandatory FINRA Arbitration (no expertise, panels stacked against investors)

�No Plan Remedies (only cease and desist and fines to SEC)

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EMPLOYER/FIDUCIARY DUTIES – U.S. DOL VIEWS

� DOL Field Assistance Bulletin (February 2, 2007). Employer retains following fiduciary duties as a prudent expert to select and monitor (evidenced by procedural due diligence) the following (and if not qualified to obtain expert advice)

� Investment Menu (including, if desired, a qualified default option)

� Investment Advisers.

� Qualified Fiduciary Adviser

� Reasonableness of Fees Charged

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EMPLOYER/FIDUCIARY DUTIES – U.S. DOL VIEWS

DOL/EBSA Publication (May, 2004) Understanding and evaluating plan fees and expenses associated with investments, investment options and services are an important part of a fiduciary’s responsibility. Requires an objective process to evaluate fees, detailing specific services, level of responsibility of service provider, and identical disclosure to prospective providers for a meaningful comparison. Sample fee disclosure forms are provided at www.dol.goveebsa.

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ERISA – FIDUCIARY STANDARDS

�Solely in Interest/Exclusive Purpose

�Prudent Expert – Care, Skill, Prudence and Diligence. Person familiar with such matters

�Per the Documents - Plan, Trust, Agreements

� Investments – Diversification, Liquidity, Funding, Risk Avoidance

�Avoid Prohibited Transactions

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SERVICE PROVIDER PATTERNS – BROKERAGE FIRMS

�Advise Menu, Investment Platform (Insurer, Fund, Managers)

�Compensation – Indirect – Loads, Trailer Fees, Commission/Fees from Platform Provider

�Recordkeeper – Third Party

� Investments – Non-Institutional Share Classes

�Education

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BROKERAGE ISSUES

�Steadfast Refusal to acknowledge fiduciary status (minor exceptions), conflicts maximize indirect revenue

�Opaque compensation Structures (particularly in selling platforms)

�Compensation buried in difference between fund fees and price of investment management

�Higher Costs diminish Investment Returns

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SERVICE PROVIDER PATTERNS –INVESTMENT MANAGERS

�Advise Fund Menu/Manager of Investment Types

�Compensation – Percentage of Assets

�Recordkeeper – Third Party

� Investments – Funds –?Institutional, Managers

�Education – ?

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INVESTMENT MANAGER ISSUES

�Fee Structures – 1% (100 bps) or more

�Platforms – website access for Employer and participant?

�Education Minimal?

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FINANCIAL SERVICES FIRMS

�Advice – Platform of Options

�Compensation – Indirect

�Recordkeeper – Internal or Relationship

� Investments – Noninstitutional/ Proprietary

�Education - ? Individual Advice

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FINANCIAL SERVICE ISSUES

�Reluctant Fiduciary

�Opaque Compensation – Bundled Arrangements

� Investments – Revenue Driven

�Education – Individualized?

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INSURER PLATFORMS

�Advice – Menu from Platform

�Compensation – Indirect from investments on menu plus overrides (contract, asset charges)

�Recordkeeping – Internal

� Investments – Funds (non-institutional) Proprietary

�Education – General

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INSURER ISSUES

�Refusal to accept fiduciary responsibility for menu, conflicts

�Compensation – Highest among providers, often Opaque

�Proprietary – Provider favorable documents

� Investments – Clone Funds (not the actually traded funds) proprietary options, stable value, target funds

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MUTUAL FUND FAMILY PLATFORMS

�Advice – Menu

�Compensation – Internal Fees (non-institutional)

�Recordkeeper – Mix, internal versus third party

� Investments – Funds

�Education - General

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MUTUAL FUND FAMILY - ISSUES

�Advice – Fiduciary Reluctance, Conflicts

�Compensation – Opaque

�Recordkeeper – Third Party

� Investments – Non-institutional proprietary products

�Education – Individualized?

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IDEAL

�Advice – Independent Adviser able to select best funds

�Compensation – Transparent, each element separately identified

�Recordkeeping – Third Party

� Investments – Institutional, Low Cost funds, Model Portfolios from menu

�Education – General materials plus individualized advice

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IDEAL STRUCTURE/ADVANTAGES

�Capped, Declining Asset-based fee for investment advice

�Fixed per participant, Capped/Declining Recordkeeping fee

�Pay only for investment management for funds

� Individual Advice shielded from Employer Liability at Fixed Price or Included in Investment Adviser fee

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EMPLOYER PROTECTION

� Objective, Prudent Process in selecting and Monitoring Providers

� Adviser Fiduciary Status without conflicts

� Compensation Transparent for each element of service

� Recordkeeper appropriate Standard of Care

� Investments 404(c) Compliance

� Education General Conforms to DOL IB 96-1, Individual per 408(g) principles

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REQUEST FOR PROPOSAL (RFP)

� Background. Employer (Industry, Size) Plan Design, Number of Participants, Amount and Description of Plan Assets

� Preconditions Investment Adviser –fiduciary acknowledgment, ERISA standards of care, Liability acceptance (no/reasonable indemnification)

� Expert Guidance –

� Competent Counsel

� Adviser without conflicts, fiduciary status

� Cooperation

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RFP – ADVISOR SELECTION

� Background/Credentials, Registration, Licenses, Reputation

� Conflict Disclosure

� Services

� Relevant Expertise

� Clients – Recommendations, Departures

� Fees – RFP, Investment Policy, Menu Selection/Monitoring – all disclosed

� Protection insurance

� Sample Agreement – Fiduciary Acknowledgment Services, Compensation

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RFP – RECORDKEEPER

� Background/Credentials, Registration, Licenses, Reputation

� Conflict Disclosure

� Services – Timing/Warranties

� Fees – Amount – Each element of service complete transparency

� Protection – Bonding, Insurance

� Sample Agreement – Standard of Care/Liability, Dispute – Law, Venue, Forum

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RFP – RECORDKEEPER SERVICES

�Remission/Investment Splits

�Testing – Identify each element

�Distributions – Processing, Reporting

�Loans – Processing, Reporting

�5500/SAR Preparation

�Fees Complete Transparency

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REQUEST FOR PROPOSALINVESTMENT MENU/PROVIDER SELECTION

� Investment Policy

�Objective, Systematic Measurement

�Performance/Benchmarks

�Risk

�QDIA Recommendation

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REQUEST FOR PROPOSALINVESTMENT MENU/PROVIDER SELECTION

� Internal Diligence Process

�Bonding, Insurance

�Conversion Services

�Custodial, Trustee Services

�Fees – Complete Transparency

� Internal - Offset before performance

� Additional charges

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REQUEST FOR PROPOSALPARTICIPANT EDUCATION

� Guidelines� General DOL Interpretive Bulleting 96-1� Individual 408(g)� 404(c) Disclosure

� Plan� General Elements, Sample� Individual Information Gathering

Model Portfolios� Schedule� Sample Agreement

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REQUEST FOR PROPOSAL408(g) COMPLIANCE

� Proposed Regulations

� Fiduciary Acknowledgment

� Absence of Conflict – Fee Neutral/Computer Model Portfolio

� Notice – Fees, Investment Performance

� Issue – Brokers, Varying Fees (Sales, Trailer Fees, commissions, other incentives) not permitted based on investments selected, conflict disclosure required

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RFP WRAP UP –READ THE CONTRACT

� Fiduciary acknowledgement

� Clear specification of duties and compensation

� ERISA standard of care

� Matches RFP responses

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AVOID DEFECTIVE CONTRACTS

� Cannot/does not rely on advice

� Advice not tailored to plan

� Indemnify errors unless negligence, gross negligence, willful misconduct

� FINRA arbitration

� Choice of Law and Venue

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ANNUAL MONITORING AND MEASUREMENT

�Adviser – IPS Adherence, Revision

� Investment Monitoring Objective, Systematic Process against identified Criteria

�Recordkeeper – Performance

�Participant Education – Review, feedback

�Plan – Design, Required Updates compliance review

�Agreements – Review/Update

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ANNUAL MONITORING –INTERNAL REVIEW

�Document Compliance – Interim Amendment, Restatement, SPD/SMM

�Contribution – Timing, Accuracy

�Notices – QDIA, Auto-enrollment, Safe Harbors

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ANNUAL MONITORING –INVESTMENT ADVISER

�Review/Update Investment Policy

� Investment – Due Diligence Reports

�Review/Update 404(c) Disclosure Statement

�Compliance with Agreement – Fiduciary Status

�Confirm/Renegotiate Fee Structure

�Update Bond/Liability Protection

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ANNUAL MONITORING –RECORDKEEPER

�Audit Contribution, Investment, Split, Distribution, Loan Accuracy

�Review/Affirm Compliance Testing

�Confirm Benefit Statements

�Confirm/Renegotiate Fee Structure

�Update Bon/Liability Protection

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ANNUAL MONITORING –PARTICIPANT EDUCATION

�Develop Participant/Administrative Feedback Mechanism

�Confirm Compliance/Update Education Plan

�Confirm/Renegotiate Fee Agreement

�Legal Compliance – IB 96-1(general) 408(g) for Participants, Agreement (for Employer, Fiduciary Status)

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REWARD – DIMINISHED RISK

�Prudence – Clear Established Processes

�Expertise – Documented in Selection and review

�Documents – Established (IPS, 404(c), Agreements allocating Liability)

� Investment – Objective Process satisfies criteria

�Compliance Review

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PROOF OF REWARD –FEE LITIGATION RESULTS

�Hecker v Deere No requirement to disclose revenue sharing, 404(c) Disclosure and Compliance

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PROOF OF REWARD – FEE LITIGATION RESULTS

Kanawi v Bechtel No Duty to disclose revenue sharing

Taylor v United Technologies Proper monitoring, objective selection of mutual funds, recordkeeping fees reasonable against market

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DANGER – DEFECTIVE PROCESS

�Braden v Walmart Court looked behind process at retail mutual fund pricing result – failure of effort and competence, breach of duty of loyalty solely to Participants

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FORECAST – PROPOSED LEGISLATIONFAIR DISCLOSURE FOR RETIREMENT SECURITY

ACT OF 2009

� Written Agreements detailing Services, Discounted Services, and Revenue Sharing

� Disclosure Aggregate Fees applied against Participant’s Accounts

� Disclose Four categories of Fees

• Administrative • Investment Management

• Transaction • Other

� Offer One Low Index Fund

� Advice – Not based on Advisers Interest, Independence

� Disclose Share Class Comparisons

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PROPOSED LEGISLATIONINVESTMENT DISCLOSURES

�Charges for Each Option

� Investment Objective

�Risk Level

�Diversification

�Active v Passive Management

� Investment information

�All disclosures permitted by electronic media

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OUTSIDE, OBJECTIVE, EXPERT ASSISTANCE

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