Fiduciary Risk Management for Plan Sponsors and Advisers
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- Gabriella Henderson
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1 june 2012 perspectives Fiduciary Risk Management for Plan Sponsors and Advisers The recent recession and market volatility have changed the playing field for investors and for the financial institutions that manage defined contribution plans. While 401(k) participants watched their account balances lose value, many fled their equity portfolios for the safer ground of Treasury bond funds and money market funds. Others stayed the course and witnessed a remarkable recovery in the U.S. equity markets. Regardless of their experience, most investors account balances were impacted by the crisis in the financial markets and as a result, investors gained a newly acquired appreciation for market volatility. Challenges for fiduciaries For plan fiduciaries, the recent volatility in the markets has provided an unexpected number of challenges. Among the concerns that face them are: Increased scrutiny of retirement plans, and of targetdate funds in particular Demographic changes that may lead to increased risks of litigation Lawsuits relating to excessive fees and revenue-sharing that have led to greater transparency requirements for plan sponsors 1. Target-date funds increased congressional and regulatory scrutiny Target-date funds are now under increasing congressional and regulatory scrutiny for exposing investors and plan participants to the market downturn. Many 401(k) participants have looked at target-date funds as a set it and forget it safe alternative to having to manage market risk themselves. Once the crisis in the market hit, however, investors found that funds with the same target retirement date had investments that differed significantly, and many thought that their assets were protected by more conservative investment strategies. Such differences in target-date funds, and associated differences in recent investment performance, have prompted questions about whether plan fiduciaries and investors have an adequate understanding of target-date funds, and of their benefits, risks and costs. 2. Demographic change may lead to increased litigation There is a demographic change taking place in the United States that may affect litigation concerns for fiduciaries every eight seconds, someone turns 60. Baby boomers as a group have not prepared well for retirement. They have not saved enough, and many may have lost a substantial portion of their retirement portfolios due to the recent market volatility, even if they were properly diversified. When members of the baby boom generation retire and find that they may not have accumulated enough assets to provide for their retirement, what will happen? Will they seek to blame the company for a failure to properly inform them and disclose the dangers that they faced? When faced with inadequate retirement savings, participants normally have these options: Save more and have less disposable income today Retire later than they anticipated and work longer than they wanted Retire to a more modest lifestyle than they are currently enjoying Increase risk in an effort to increase their return FOR FINANCIAL PROFESSIONAL AND PLAN SPONSOR USE ONLY. NOT FOR USE WITH THE PUBLIC.
2 Participants now have discovered that they have an additional option they can sue the plan sponsor and other fiduciaries. How baby boomers will respond to the looming social and financial crisis of outliving their assets remains to be seen, but trends in litigation have plan sponsors and fiduciaries concerned about the future. 3. Excessive fees and revenue-sharing lawsuits will force greater transparency Recently, several class action lawsuits seeking damages for alleged losses incurred as a result of excessive 401(k) plan fees have been brought against some of the top corporations in America. In addition, the Department of Labor (DOL) has issued fee disclosure rules for plan service providers, including advisers. The fiduciary standard for fees paid by the plan is one of reasonableness. Participant class action Employee Retirement Income Security Act (ERISA) lawsuits generally claimed that the companies breached their fiduciary duty to monitor excessive costs and alleged that the plan sponsor and other fiduciaries: Failed to exercise the care, skill and diligence of a prudent person acting in like capacity and familiar with such matters. Failed to monitor expenses. Failed to implement procedures to properly determine if fees were reasonable. Failed to disclose conflicts of interest in a timely manner. Failed to provide sufficient information to make informed investment decisions under ERISA Section 404(c). Entered into misleading revenue-sharing arrangements. The lawsuits further alleged that the plan sponsor and other fiduciaries allowed investment management firms and service providers to charge unreasonable and excessive fees. This was alleged to have violated the fiduciaries duty of loyalty to act solely in the interest of plan participants and beneficiaries and to use plan assets for the exclusive purpose of providing benefits to participants and beneficiaries, as well as to defray reasonable expenses of the plan. Participants alleged that fiduciaries failed to disclose fees and that fiduciaries had a conflict of interest when acting in dual roles. The economic crisis and the concerns about losses have led to new regulations about transparency, fees and disclosure with regard to retirement plans, and target-date funds in particular. This regulatory scrutiny, coupled with a demographic change that could pose additional litigation risks, have left fiduciaries asking the question: How do we put in place a comprehensive combination of fiduciary processes and procedures that will reliably protect plan participants, plan fiduciaries and employer sponsors? Know the rules of being a Fiduciary to limit plan sponsor liability Part of an adviser s value proposition should be to alert plan sponsors that they need to successfully orchestrate a thorough fiduciary process to limit plan sponsor liability. Some advisers may wish to provide complete services in directing plan fiduciaries through a prudent due diligence process. A review of fiduciary rules and duties may be in order. Under ERISA, plan fiduciaries are not liable for plan losses merely because an investment lost money, but rather because they acted imprudently in selecting and monitoring the investment. Accordingly, when investigators review the selection of investments, they will generally focus on the procedures used by a plan fiduciary, rather than the ultimate performance of the assets. ERISA protects participants and beneficiaries by holding plan fiduciaries accountable for judiciously selecting service providers and plan investments. In carrying out this responsibility, plan fiduciaries must follow a prudent process, taking into account relevant information relating to the plan and the investments available under it. The DOL has mounted a new enforcement program to audit plans. The DOL enforcement effort that is focused on ERISA s fiduciary issues requires both plan sponsors and advisers to implement a much tighter fiduciary process. The DOL identified potential areas of investigation related to a number of investment issues. These range from the appropriateness of investments, to the improper receipt or payment of fees relating to plan assets, to self-dealing or conflicts of interest. For example, when investigating the selection of investments, a DOL investigation would focus on whether the plan fiduciary 2 FOR FINANCIAL PROFESSIONAL AND PLAN SPONSOR USE ONLY. NOT FOR USE WITH THE PUBLIC.
3 June 2012 performed proper due diligence in selecting an investment for the plan and followed a prudent process. Definition of a fiduciary One is considered a fiduciary to the extent that one: exercises discretionary authority or discretionary control over the management of the plan or the disposition of its assets; renders investment advice for a fee with respect to plan assets; or has any discretionary authority or responsibility in the administration of the plan. Plan fiduciaries (discretionary; de facto/functional) might include: trustees investment committee members board of directors corporate officers human resource managers investment advisers the plan s designated administrator persons responsible for appointing fiduciaries Here is a list of statutory fiduciary responsibilities under ERISA, Sections 404 and 406. Duty of loyalty To act solely in the interest of plan participants and beneficiaries and to use plan assets for the exclusive purpose of providing benefits to participants and beneficiaries while defraying reasonable expenses of the plan. Duty of prudence Sometimes referred to as the prudent person rule to act with the care, skill and diligence that a responsible person would use under the prevailing circumstances. Duty to refrain from engaging in prohibited transactions To refrain from transactions with parties of interest, self-dealing and other conflicts of interest. PRUDENCE IS PROCESS What the courts have said In one case called Whitfield v. Cohen, the court found that a fiduciary s lack of experience is not an excuse. The standard is that of a prudent fiduciary with experience or that of a prudent expert. Fiduciaries have a duty to seek independent advice if they lack experience. Courts focus on conduct in investigating, evaluating and making an investment. There is a continuing duty to monitor investments, and fiduciaries can be found personally liable for losses and lost opportunity costs. The Labor Department s Enron Amicus Brief stated that ERISA is unambiguous in what it requires of fiduciaries: They must act to protect the interests of plan participants and beneficiaries. Such actions may include: disclosing vitally needed information to participants; investigating suspicious circumstances surrounding plans; or freezing further investment in stocks that might be heavily overvalued. It is a prudent process that protects a plan fiduciary. That process might include: providing a clear investment policy statement initial and ongoing due diligence careful selection of investment options diversification ongoing performance monitoring Duty to diversify plan assets To minimize the risk of large losses while taking advantage of the opportunity for gain. Duty to follow the plan and other documents To follow the plan and documents governing the plan to the extent that they are consistent with ERISA. This would include an investment policy statement. FOR FINANCIAL PROFESSIONAL AND PLAN SPONSOR USE ONLY. NOT FOR USE WITH THE PUBLIC. Perspectives 3
4 SUMMARY CREATE A PRUDENT DUE diligence PROCESS Advisers can help fiduciaries follow a prudent due diligence process. For example, they can play an important role in helping to establish and run investment committees. They have an ongoing duty to educate new and existing fiduciaries about their roles and responsibilities. Advisers need to ensure that the retirement plan has an excellent investment policy statement to provide the necessary blueprint for the investment committee members to monitor and act upon. Most importantly, advisers need to ensure that plans have a combination of both process and procedures to protect the plan sponsor and other plan fiduciaries in the event of a DOL audit. Included in this process should be an investment policy statement, regular committee meetings, committee meeting minutes, prudent investment selection, initial and ongoing due diligence, performance monitoring and reporting, an investment watch list process and procedures, timely fund replacement and document retention. Checklists for retirement plan fiduciaries Documents on File Process Review Plan Fee Process Review Updates Plan and trust document Summary plan description (SPD) Last three years of Form 5500 filings Most recent plan audit (larger plans) Investment policy statement (IPS) Investment committee or trustee meeting minutes Service provider contracts Additional information and resources Annual review of fiduciary appointments Periodic training of all fiduciaries and benefits committees Annual review of written investment policy Annual review of plan costs and revenues (reasonableness test) Quarterly review of investment performance (by outside consultant) Quarterly investment committee meetings Independent fiduciary oversight for company stock Documentation of all processes Formal Section 404(c) compliance review Expand investment policy statement to address expense factors and revenue sharing Identify the total cost of plan services (sponsor/participant) Obtain fee disclosure (provider) Ensure that fees are reasonable in light of services provided Document hard-dollar costs and asset-based costs Compare costs against a peer group (benchmarking) Repatriate excess fees as plan revenue for specific plan needs Department of Labor provides information on Employee Benefits Security Administration (EBSA) and ERISA regulations: and Profit Sharing/401k Council of America (PSCA) provides a model Investment Policy Statement: American Society of Pension Professionals & Actuaries (ASPPA) a non-profit national organization for career retirement plan professionals: 4 FOR FINANCIAL PROFESSIONAL AND PLAN SPONSOR USE ONLY. NOT FOR USE WITH THE PUBLIC.
5 For the experienced adviser, client education and the subsequent implementation of prudent process and procedures will create a clear value proposition with the client and/or prospect. It demonstrates expertise, builds trust and sets up the opportunity for an ongoing consulting role. Information in this publication was prepared by Robert J. Rafter, J.D., President of RJR Consulting. This information is general in nature and is not intended to constitute legal or other expert advice on any particular matter. John Hancock Funds, LLC does not warrant and is not responsible for errors or omissions in the content of this material. Robert J. Rafter, J.D., and John Hancock are not affiliated and neither is responsible for the liabilities of the other. This commentary is subject to change as market and other conditions warrant. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not endorsement of any security, mutual fund, sector or index. This material does not constitute tax, legal or accounting advice, and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written to be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisers. John Hancock Funds, LLC Member FINRA SIPC 601 Congress Street n Boston, MA n Not FDIC insured. May lose value. no bank guarantee. not insured by any government agency. FOR FINANCIAL PROFESSIONAL AND PLAN SPONSOR USE ONLY. NOT FOR USE WITH THE PUBLIC. IOFRTP 8/12
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