Fiduciary Advisor Standards Do Not Have To Be So Confusing!

The search for a skilled investment professional to manage 401k plan assets is one of the most important tasks an employer can undertake, according to Ann Terranova, CFP of Union Financial Partners. Inevitably, you will bump up against the F-Word: Fiduciary. If you are going to hire the right advisor, you need to understand the implications of the word Fiduciary.

Laws governing fiduciary behaviors and responsibilities with respect to investment advice for a 401k plan are generally contained in the Department of Labors ERISA law. However, there are other significant and overarching laws that govern individuals working in the financial services industry as advisors that also have a bearing on 401k advisors. The behavior of Registered Investment Advisers RIAs- is described in the Invest Advisers Act of 1940 and regulated by the SEC. The ethical duties and responsibilities of Brokers are found in the 1938 Maloney Act that created the NASD (now FINRA). The responsibilities of Trustees are articulated in the Restatement of Trusts or Prudent Man Rule of the Uniform Principal and Income Act (UPIA). Ann Terranova says, The confusion comes when Brokers, who are exempt from RIA Registration when they are acting as securities salespeople, call themselves Investment Advisors.

An RIA under the 1940 Act is held to a fiduciary standard. The fiduciary is held to the highest standard and requires that the advisor put the needs of the client first at all times. A Broker, licensed by FINRA to sell securities, is held to a lower standard generally referred to as Suitability or Disclosure. The suitability standard is a condition that the security for sale must be suitable to the overall financial circumstances of the buyer. The disclosure standard is a set of rules telling the broker to disclose their compensation along with the attendant conflicts of interest. At the crux of the significant confusion surrounding fiduciary status in the business of offering financial advice is the insistence of Brokers to use the title financial advisor or investment advisor, titles previously reserved for Registered Investment Advisors.

Brokers are specifically exempt from registration under the 1940 Act with the understanding that the primary business of a broker is to offer securities for sale to the public and the actual rendering of financial advice remains incidental to that profession. If a broker does offer advice more than incidental to the business of selling securities, and wants to use the title financial advisor then that individual should be required to meet the fiduciary standard of a Registered Investment Advisor. But can a broker be a fiduciary and put the needs of the client first when their compensation comes directly from the sale or representation of securities and financial products? Can a broker at Merrill Lynchs retail office objectively recommend AT & T stock to a client when AT & T may be one of Merrill Lynchs large investment banking clients? Ann Terranova asserts that One ought not to be able to claim exemption from registration (if investment advice is incidental) and also hold oneself out to the public as an Investment Adviser (if selling securities). Yet the industry remains unchallenged in this regard and the distinction in the eyes of the public is virtually nonexistent.

In the ERISA realm, the difference between a Section 3(38) advisor and Section 3(21) (limited scope) advisor is similarly confused. ERISA provides that a plan sponsor can delegate the significant responsibility (and therefore significant liability) for the investment management functions of the plan to a Section 3(38) Fiduciary. An ERISA 3(38) fiduciary has discretion that makes it a decision-maker. An ERISA 3(38) fiduciary decides what investment options such as stand-alone mutual funds or model portfolios should be placed on a plans menu, whether to remove them from the menu, and, if it does remove them, what investment options will replace them. This is appropriate since the investment advisor usually has more knowledge and experience in the securities market than the individual at the company charged with managing the 401k plan. While the investment decision-making process will be explained to the plan sponsor, the ultimate responsibility for the decision rests with the investment advisor. If the advisor has the discretion to make the decision, the advisor is responsible for the decision, not the person who appointed the advisor. This gives the plan sponsor significantly reduced exposure to fiduciary risk.

By contrast, the Section 3(21) fiduciary is not actually a fiduciary at allmore confusion! An advisor, even if named as a fiduciary in an investment advisory agreement between the plan sponsor and the advisor, may not actually be a fiduciary. In determining fiduciary responsibility, ERISA looks at actions not words. An ERISA 3(21) advisor who is responsible for recommending, assisting, helping, or advising, the sponsor as the sponsor makes the discretionary decision to offer or replace various investments, is most conveniently able to hide behind their role when fiduciary blame starts flying. An ERISA Section 3(21) fiduciary makes recommendations, not decisions. Thus, the plan sponsor is not relieved of fiduciary risk. In this case, Ann Terranova says, the decision -making responsibility rests with an officer of the company, a professional who is generally not an expert in the investment field.

Since the financial crisis of 2008-9, much political fallout has centered around the semantics and substance of who and what is an investment fiduciary. Many people have been pushing for a universal standard of fiduciary duty because investors are generally unaware that investment advisors and brokers (calling themselves investment advisors) currently operate under different standards. Others wish to continue with a vague ongoing type of two-tiered system. The Dodd-Frank Financial Reform bill, Section 913(g) mandates that the SEC promulgate rules to provide the The standard of conduct for all brokers, dealers and investment advisers, when providing personalized investment advice about securities to retail customers, shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, or investment adviser providing the advice. The Dodd-Frank law states, however, that charging a commission and selling proprietary products are not necessarily violations of fiduciary duty. It also says that brokers would not have a continuing obligation of care after selling a financial product. That does not seem consistent with a fiduciary standard for all advisors.

Meanwhile, the DOL is working with the SEC to harmonize both agencies statues regarding who is a fiduciary when giving investment advice. But the SEC is unlikely to resolve its own lack of harmony among regulations that currently govern RIAs and brokers.

One impact of the new regulations, changes to ERISA Section 408(b)(2), will require service providers to spell out to plan sponsors their fiduciary status, detail the services that they provide, and disclose compensation. The planned effective date for this law is January 1, 2012. Brokers will have a hard time with this as they have established many complex and varying compensation arrangements. Though the law wont specifically require brokers to state that they are not acting as fiduciaries, many of them have already inserted clauses in their contracts spelling it out to protect themselves in the event of litigation.

While government and industry slug it out over new laws, regulations and the implementation of any enacted changes, plan sponsors must continue working to offer exceptional 401k plans to their employees. In my opinion, Ann Terranova says, the questions that should be asked of any investment adviser or prospective investment adviser to a plan is: Are you a Registered Investment Advisor under the 1940 Act? Are you going to state in writing that you are an ERISA 3(38) fiduciary? If the answer is no, move on to someone who answers yes.



*or 3(21) full scope also a fiduciary
**limited scope not an actual fiduciary