0

Emphasize Quality Over Quantity

Retirement plan fiduciaries are hiring independent fiduciaries with greater frequency.  Structured properly, the plan fiduciaries and senior management, should be insulated from liability for the actions of the Independent Fiduciary, provided that the process of selecting and hiring the Independent Fiduciary is prudent.

The process need not be tedious or cumbersome.  Furthermore, it should not be delegated to junior professionals with a mere rubber stamp approval provided by senior management.   A robust process, conducted with integrity, serves as an important foundation for fiduciary decision-making.

1.  Meet and interview the Independent Fiduciary candidate.

There is nothing more important than meeting with the potential Independent Fiduciary.   Most advisors, I suspect, would say that compiling data through an RFP process is the most important part of the process.  I disagree.

Data is important, but it does not take the place of a face to face meeting. Serving in a fiduciary capacity is a position of trust.   While technical skills can be assessed through an RFP response, trust can not.   Trust should be determine through a face to face meeting in which the hiring fiduciary attempts to gauge the way in which the Independent Fiduciary will analyze problems and execute fiduciary decisions.

2.  Assess the Fiduciary’s Independence.

The best laid plans of fiduciary protection will fail if the fiduciary is not independent.

The industry serving the retirement plans is vast and interconnected, a veritable spider web of relationships.  Hiring fiduciaries must be assured that the Independent Fiduciary does not have any relationships with the plans that could give rise to a prohibited transaction.  Focus on the receipt and payment of fees among the plans sponsor, the plan, the Independent Fiduciary and any affiliates of the above.

3. Review the Independent Fiduciary’s Procedures.

Every fiduciary should have a set of written procedures that it follows for a fiduciary engagement.  Request a copy of these procedures and evaluate them.  Ask the candidate whether they certify that the Procedures were followed.  Be assured that the  procedures are specifically tailored to the particular engagement and that they are not simply boiler-plate lists of tasks.

4. Inquire about Fiduciary Litigation.

Explore the candidate’s litigation experience.   The plaintiff’s bar is very active.  Qualified fiduciary candidates may have both been sued for breach of fiduciary duty and have won the case based on the facts; that is, a finding of the court that the fiduciary acted prudently.   Specifically, question whether the fiduciary’s procedures withstood the scrutiny of litigation.

5.  Is the Fiduciary an Expert?

Fiduciaries must be prudent experts.  Under take the requisite due diligence to determine that the fiduciary is both an expert with respect to the specific engagement and with respect to ERISA principles.   Investment/financial skills as well as fiduciary expertise are critical.  Compilation of data through an RFP can be helpful in this process.

Most importantly maintain a detailed written record of the selection and hiring process.  This documentation could be valuable if the process ever needs to be defended.

 

Continue Reading

0

An Independent Fiduciary Protects All Parties

With rising interest rates and CEO’s tired of pension-related balance sheet surprises, the volume and size of annuity transactions is bound to explode.

Experience teaches that exuberance in financial markets and products can lead to some very painful losses.  The Department of Labor is concerned.  It has seen this movie more than once.

Multiple factors go into the corporate decision to “de-risk” the balance sheet by purchasing annuity contracts.  Months of work go into this decision.  One key factor is the cost of the annuity, as well as the cost of executing the transaction.  While these transactions can be expensive to execute, senior corporate managers are also incentivized, and have a duty of loyalty to the company, to minimize these expenses.  Lower expenses enhance earnings.

However, annuity pricing is efficiently correlated to the credit quality of the issuer of the annuity.   In other words, lower credit-quality issuers charge less for their products.  The corollary is also true; higher credit-quality annuities are more expensive.

Left to their own devices, corporate managers are incentivized to purchase the cheapest annuity available even if it reduces the credit quality of the issuer.  This pressure is very strong.

Plan fiduciaries and participants, however, have a different view.  They are interested in the strongest credit quality issuer available, price be damned.  Remember, prior to the annuity purchase, the pension plan is funded by a diversified pool of assets, thereby mitigating investment risk.

An annuity purchase,however, substitutes a single issuer for this diversified pool.   The pensions of thousands of plan participants are dependent on this single issuer.  The issuer goes bankrupt, the pensions are lost… forever.

The conflicts for senior managers (some of whom are plan fiduciaries) in executing these transactions are real.  Should they pay up for higher credit quality; or, should they sacrifice credit to enhance earnings.

ERISA provides a single answer.  Fiduciaries must act in the interests of participants.

In the early 1990’s the bankruptcy of Executive Life Insurance Co. provided a huge wake-up call.   Many plans were invested in Exec Life products and they absorbed huge losses.

In response,  the DOL issued guidelines in IB 95-1 setting forth numerous requirements regarding the purchase of annuity contracts.  Post-Executive Life,  the DOL requires that a plan purchases the “safest available annuity”.   In reaching this determination, the DOL requires that 6 six factors be analyzed, price of the annuity is not one of the factors.

Recognizing the potential conflicts of interest and the competing pressures of corporate managers, these IB 95-1 suggests that an independent fiduciary be hired to make the the “safest available annuity” determination.

Unfortunately, plan sponsors don’t like hiring Independent Fiduciaries. They don’t like paying the fees and they don’t like a second set of eyes reviewing their judgments.  If corporate managers want to purchase an annuity from XYZ Insurance Co, they don’t want a third party telling them that they should purchase the annuity from DEF Insurance Co.  And, they really don’t like that an Independent Fiduciary will retain its own lawyers and advisors for the transaction.

Ironically,  the intensity of the resistance by senior managers to hiring an Independent Fiduciary actually illustrates and proves the very conflicts of interest outlined above.

Corporate managers who forgo an Independent Fiduciary might one day be in the position of having to prove to the Department of Labor that they transcended these conflicts and acted in the interests of plan participants.  In the context of large losses (possibly $ billions) That will be a hard argument to make.  The DOL will be very suspicious.  Remember, there is personal liability for breaches of fiduciary duty.

In the end, an Independent Fiduciary will make decisions in the interest of the plan participants.  However, the corporate managers can take great comfort from knowing that the conflict of interest is significantly mitigated by the hiring of the Independent Fiduciary.  Whether they understand it or not, the Independent Fiduciary provider significant protections to the corporate managers.

Corporate managers should focus on executing their corporate strategies.  Let the Independent Fiduciaries wrestle with the complexities of purchasing annuity contracts.

 

 

 

 

 

 

Continue Reading