Good Risk Governance Pays

Good Risk Governance Pays

Investment Best Practices | Risk Management | Valuation

SEC and Asset Manager Disclosures About Use of Derivatives

Posted in Derivatives, Disclosure and Transparency, Investment Management, Liquidity, Regulation, Valuation

National Vanilla Pudding Day_Small

Notice anything odd about this announcement? Are we to celebrate this creamy dessert on May 21, 22, 23, 24 and 25? If so, why is the event referred to as a “day” celebration? A quick search on the internet informs that National Vanilla Pudding Day is in fact May 22, 2015 and does not span nearly a week of joyous spoons in cups. Unfortunately, we would never know the truth by reading the sign.

One wonders if this type of ambiguity and confusion is a motivator for the U.S. Securities and Exchange Commission (“SEC”) in its quest for further disclosures by the $60+ trillion investment industry. According to “SEC Proposes Rules to Modernize and Enhance Information Reported by Investment Companies and Investment Advisers” (May 20, 2015), certain registered funds such as mutual funds and exchange-traded funds (“ETFs”) would have to complete a Form N-PORT each month. If finalized, reporting entities would need to share details about the (a) use of derivatives (b) pricing of securities  (c) information about securities lending, repurchase agreements and counterparty trades as well as (d) “[d]iscrete portfolio level and position level risk measures to better understand fund exposure to changes in market conditions.”

As with any initiative for enhanced transparency, the nature of how information is to be presented will be critical. For example, will derivative transactions that are used to hedge be reported as a separate category and distinguished from any derivative transactions that are used to synthesize asset or sector exposures in anticipation of certain price movements? Will derivative exposures be reported on a net or gross basis? If a derivative transaction has matured prior to month-end, will it be excluded? Will SEC reporting be compatible with Generally Accepted Accounting Principles (“GAAP”) reporting? Regarding valuation, is the goal to share insights with the public about the process used by a registered fund or rather a collection of numbers or both?

Andrew Ackerman with Dow Jones Business Wire explains that worries about a systemic meltdown are driving efforts to reform the capital markets. He adds that investors and asset managers should expect an SEC sequel that mirrors the kinds of stress tests and liquidity assessments that banks are being asked to perform in the aftermath of the 2008 credit crisis. See “SEC Votes to Propose New Mutual Fund Reporting Rules — 2nd Update” (May 20, 2015).

Notable is the implication for retirement plans and the fiduciaries who monitor investment selections for benefit offerings such as 401(k) plans. According to the 2015 Investment Company Fact Book, mutual funds represent $7.3 trillion of Individual Retirement Account (“IRA”) and defined contribution plan assets. That’s a large number. No doubt, both individuals and institutional fiduciaries will welcome any statements that can shed extra light on the risk-return profile of an existing or contemplated investment.

Electronic RFP Process and Fiduciary Duty

Posted in Compliance, Fiduciary Liability, Financial Expert, Investment Management, Pension

Kent Costello

As I have mentioned on other occasions, my work as a forensic economist (and sometimes testifying expert witness) has frequently focused on how service providers were selected and then monitored. Always interested in knowing about industry innovations as they occur, I was intrigued to recently learn about a firm called InHub. Founded in 2014 by two investment advisors, the company’s mission is to apply the power of technology to the Request for Proposal (“RFP”) process and thereby hopefully make it easier for institutional investors to form an educated decision about what advisor, consultant or asset manager to select. Just as important, the goal is to facilitate a centralized repository for documents and communications that could be helpful in demonstrating procedural prudence. After reviewing the website at and requesting a demo, I then asked Mr. Kent Costello (one of the two co-founders) to answer a few questions. The text below is the result of that Question and Answer session.

Q: In your experience, how do institutional investors such as foundations and pension plans currently search for service providers such as consultants and advisors? What are some of the pitfalls associated with these methods?

A: The approach taken by institutional investors to search for consultants varies and often depends on the size of an asset portfolio. Larger organizations with a billion dollars or more typically make their searches public and allow a given amount of time for consultants, managers, and other service providers to indicate interest and/or submit a proposal. In this way, they are essentially crowdsourcing the proposal process and may find firms through this method. A downside of this approach is that respondents are not necessarily pre-qualified. Some vendors are already known to investment committee members and may be referred to their peers. A disadvantage of selecting a vendor on the basis of referrals is that personal relationships may take precedence over the qualifications of a particular firm. It is not uncommon for a consultant to be a friend of a business owner or board member, especially for smaller firms. An advantage of the referral approach, when appropriate, is that it matches an institution in need with a trusted source.

Q: Besides launching a formal public search or connecting with a vendor as the result of a referral, are there other ways that an investment committee or board can identify service providers and then review their qualifications thereafter?

A: Yes. General meetings and website searches come to mind. Many times the committee (or board) will collect and maintain information from consultants who have called on them in the past or whom they have met at a seminar or conference. The obvious pitfall here is that a strong sales team or large marketing budget does not automatically guarantee that a particular vendor is qualified and can deliver services on a cost-effective basis. Critics can argue that firms that are sales-focused are not spending as much time as they should on servicing their existing clients or that a firm that is doing a good job does not need an active sales force because its organic growth is the result of a solid reputation. That said, I think the offering of an educational seminar to both clients and prospects by an advisory firm is a positive sign that the vendor is willing to take time to share new ideas and find ways to add value to their clients. With respect to a Google search, this could be a good first start although there is no way for an investment committee to know if it is missing experienced vendors by relying on the internet alone as a way to decide what firms to interview.

Q: Describe some of the limitations of the existing RFP process for the buyer.

A: As just discussed, investment committees searching for consultants and even consultants conducting manager searches should pre-qualify candidates based on initial criteria. This can be challenging in the absence of some sort of screening process. It can be difficult for investment committees to put together a list of questions that will help them to effectively compare firms and service offerings, especially for small and mid-sized committees. Poorly crafted, irrelevant, or repetitive questions will lead to a weak due diligence process and leave the committee confused and frustrated. Worse yet, it could mean the selection of an inadequate vendor. Then there is the issue of having to sort through mountains of data. RFP submissions are frequently submitted in hard copy form. The nature of the replies could preclude making an “apples to apples” comparison of each vendor’s capabilities. In sum, differences in the way replies are proffered and the sheer volume of submitted pages make it hard for multiple decision-makers to review information, let alone comment and ask questions in an interactive manner.

Q: Describe some of the limitations of the existing RFP process for the seller.

A: Given the proliferation of independent advisory firms, it can be challenging for even the largest and most established of companies to achieve industry-wide recognition and thereby ensure that they are considered for opportunities for which they would be a strong candidate. Firms responding to RFPs struggle to weigh the benefits, given the low likelihood of winning the business, against the significant amount of time and resources that are required to deliver a quality proposal. While there are often similarities among RFP questionnaires written by buyers, the differences can be significant enough that a vendor frequently has to spend time and money to modify its answers (i.e. reinvent the wheel) so that each proposal qualifies for further review.

Q: Are some RFPs easier to carry out than others? If so, please explain your answer.

A: Yes, some RFPs are easier to complete. As stated earlier, RFP consistencies do not always exist throughout the entire, and often lengthy, questionnaire. Then there is the issue of the number of people who are tasked with selecting an advisor, consultant, asset manager or other type of service provider. Where you may see three to seven committee members involved in an RFP for a corporate 401(k) plan, you may see north of twenty people involved in the review process of a large non-profit organization or other institution that is governed by a board. This creates challenges in a number of areas. Organizing communications with the would-be buyer, agreeing on the scope of services, addressing conflicts and negotiating a final contract are a few challenges that immediately come to mind. Sometimes a board or committee may hold a strong view and seek to sway others from voting in favor of a given vendor. Public organizations must adhere to certain rules such as “pay to play” prohibitions. Bureaucracy can extend the timetable before a decision to hire a firm is made. An advantage that larger institutions and public organizations can have over smaller investors is the ability to rely on staff members (if they exist) who are knowledgeable about investment management. This is especially important when conducting an RFP for a specific investment strategy that requires the ability to comprehend technical language. However, even bigger institutional investors can be confronted with information that is less than transparent. For example, some vendors may bundle services and charge accordingly. Others break down services (and related fees). It is critical for the buyer to understand exactly what services they need, what they will likely receive and how much things will cost in “true” economic terms.

Q: What do you believe are the characteristics associated with using an electronic platform for RFP initiation and completion?

A: As a co-founder of an electronic RFP platform, I obviously believe that there are significant advantages of harnessing technology when selecting vendors via an RFP. These include, but are not limited to, the following: (a) speed of preparation (b) ease of collection and reviewing of the proposals (c) centralized communication with committee and candidates and (d) proper documentation of the decision. Preparing a traditional paper RFP can be overwhelming for an average investment committee. If they have never issued an RFP in the past, they often do not know what type of information they should be providing as background, what services they should be requesting and what information they should be providing on their account in the form of a description and addendum documents. In a quality electronic RFP, the system will be laid out in a way that guides the committee through the key steps and even suggests ideas for content or questions to ask, allowing for a much more intuitive process. Instead of sorting through piles of papers, an electronic RFP allows for all proposals to be submitted to one online portal where committee members can log-in and view proposals side-by-side in the same format. When there is more than one decision-maker (which is normally the situation), an electronic RFP platform facilitates ongoing communication among committee members and/or board members. The communications are centralized and create a paper trail for outsiders to examine as needed. That paper trail likewise allows investment fiduciaries to demonstrate that they have individually and collectively adhered to a prudent due diligence process (if indeed they have). Finally, an electronic RFP process will automatically generate a document that includes relevant information associated with the RFP process such as (a) the purpose of the RFP (b) scope of services requested (c) key questions asked (d) committee members involved (e) all firms invited and (f) the voting process.

Q: Are there particular areas of an RFP such as compliance, fees or risk management that institutional investors are including more now than in the past?

A: Yes. Institutional investors are focusing on fiduciary obligations, fee disclosures and operational transparency. I expect to see more of this emphasis as the fiduciary outsourcing business grows. For example, when a consulting firm is engaged as an Outsourced Chief Investment Officer (“OCIO”), one would expect that function to be clearly addressed in the RFP. As fiduciaries can be personally held liable, enlightened committee members know that they must do a good job of selecting a service provider. Regarding fee disclosures, it is safe to say that new regulations are forcing institutional investors and their advisors to focus on fee compensation arrangements and transparency about buyer-seller relationships. More and more institutional investors are asking pointed questions regarding fee transparency and potential conflicts of interests. They are also expecting the consultants to provide services that help them understand the reasonableness of the fees of both other service providers and their own. This has led to a far bigger number of consultants that now employ a direct bill model (either as a flat fee or percentage of assets). Requests for fee benchmarking services and help with the RFP process have increased.

Q: How do you think the RFP process will change as the fiduciary outsourcing business model grows?

A: I do not think that the RFP process will necessarily change with the increase of fiduciary outsourcing but rather will become even more standard in the sense that questions and answers should reflect proper due diligence. Whenever one party seeks to shift responsibility and some liability to another, the act of deciding who will hold the burden of responsibility is an urgent and scrutinized decision. While fiduciaries can never fully abdicate their responsibilities, by outsourcing to a third party, they are seeking to mitigate their liability by granting discretion on key decisions to parties such as advisors, consultants and asset managers. In the event that something were to go wrong, one of the first things that an examiner would inspect is how the third party was vetted by the institutional investor.

Note: Interested readers can check out “Request for Proposal (RFP) Checklist for Retirement Plans” by Sarah E. Downie, Hughes Hubbard & Reed LLP, Practical Law Employee Benefits & Executive Compensation. Other educational resources include “Creating an effective RFP process” (Vanguard, 2014) and “Model RFP” templates (CFA Institute).

FINRA and Financial Fraud Sanctions

Posted in FINRA, Fraud

Crossed fingers

In its just-released “Sanctions Guidelines,” the Financial Industry Regulatory Authority (“FINRA”) makes no secret of its goal to design disciplinary actions “that are meaningful and significant enough to prevent and discourage future misconduct.” Repeat offenders are unlikely to get away with a mere slap of the wrist, particularly if their actions demonstrate “a reckless disregard for regulatory requirements, investor protection, or market integrity.”

As a forensic economist and someone who has calculated and testified about investment losses, FINRA’s comments about damages are noteworthy. Besides disgorgement, this industry watchdog group warns that “restitution may exceed the amount of the respondent’s ill-gotten gain.” For those seeking recompense, don’t jump for joy too soon. FINRA adds that a respondent’s inability to pay must be considered “with the imposition, reduction or waiver of a fine or restitution.” This could be a serious matter. Even if a victim proves his or her case, a fraudster may have already spent so much money that there is nothing left to distribute. In situations where assets exist, aggrieved investors will benefit from sanctions that are grossed up for inflation.

That said, the monetary sanctions for offenses, listed according to categories and sub-categories, in “Sanctions Guidelines” seem relatively low to me. For example, on page 34 of this new document, “Settling Customer Complaints Away From the Firm” shows a monetary sanction of $2,500 to $73,000. However, a suspension “in any or all capacities for up to two years” or an outright bar in “egregious cases” would seem to have a far more deleterious impact on the bottom line of the perpetrator (if he or she is found appropriately guilty). In today’s environment, the inability to keep relationships warm with constant contact likely makes it impossible to generate investment-related revenue.

With annual fraud-related losses between $40 to $50 billion, deterrence is being hailed as a cornerstone of effective regulatory response. Interested readers can download “Scams, Schemes & Swindles: A Review of Consumer Financial Fraud Research” (Financial Fraud Research Center, 2012) for insights about wrong-doers and characteristics of victims. If the authors are correct that fraud is on the rise, CNBC’s “American Greed” will continue to flourish. Click here to watch full episodes.

Non-Profit Compliance and Size

Posted in Compliance, Non-Profits

Little feet in big shoes

I sometimes hear individuals expressing the view that larger tax-exempt organizations are better managed. The thinking is that more resources allow for the payment of bigger salaries, presumably to attract otherwise unattainable talent. The acquisition of expensive technology systems that can track cash flows and any financial limit violations is another cost that smaller entities may not deem affordable.

Does size matter and if so, how? Do smaller organizations gravitate towards less risk-taking as a cautionary measure to offset fewer compliance resources? Are donors asking sufficient questions about important topics such as internal and external controls, adherence to mission, administrative budget and financial integrity?

The topic of size is referenced in a recent comment by Ms. Maura Pally, acting CEO of the Bill, Hillary & Chelsea Clinton Foundation (with more than $350 million in assets as of year-end 2013). In her April 26, 2015 blog post, she wrote “So yes, we made mistakes, as many organizations of our size do, but we are acting quickly to remedy them, and have taken steps to ensure they don’t happen in the future.” What exactly does she mean?

Regulators and industry associations seldom differentiate by size when it comes to fiduciary duties and adherence to existing statutes.

In “Nonprofits Face Up to More Compliance” (Wall Street Journal, May 17, 2013), Ben Dipietro quotes one executive as acknowledging that smaller organizations do not get a free pass to ignore rules. In “Recommended Best Practices in Managing Foundation Investments” (March 2010), the Council on Foundations makes no size distinction and instead focuses on federal and state fiduciary laws that prohibit self-dealing, investments that “jeopardize the existence of a foundation” and mixing for-profit purposes with charitable goals, inter alia. As part of “A Compliance Checklist for Private Foundations” (Council on Foundations, 2010), its author, Attorney Jane C. Nober, provides a road map for items such as public disclosure responsibilities, the maintenance of board meeting minutes and proper insurance coverage. Size gets a specific mention in the form of guidance about compliance with laws such as what happens when a gift exceeds $250. In “Principles for Good Governance and Ethical Practice” (Independent Sector, 2015), the large or small scale of a non-profit is discussed at the operational level. For example, how many people should serve on the board for optimal effectiveness? What kind of annual audit or review of financial statements should be carried out “in a manner appropriate to the organization’s size and scale of operations[?]”

The take-away is that size should not lessen the need for risk mitigation by any non-profit. Taxpayers and donors subsidize the work of foundations, endowments and charities. They want to know that safeguards are in place and that any problems that do occur are hastily fixed.

Excessive Fee Litigation and Public Pension Plans

Posted in Disclosure and Transparency, Fees, Investment Management, Pension, Private Equity, Susan Mangiero

where does all money go?

Having just returned from a two-day ERISA litigation conference in Chicago, the topic of fee benchmarking is top of mind. During a rousing session about excessive fee allegations, plaintiffs’ counsel Greg Porter (partner with Bailey Glasser LLP) and defense counsel Eric S. Mattson (parter with Sidley Austin LLP) discussed fiduciary litigation, the Exclusive Benefit Rule, the concept of “reasonableness,” revenue sharing and much more. What is clear is that this type of dispute between plan participants and sponsors (and their service providers) is likely to show up with increased frequency and extend to other types of employers such as cities and states that provide retirement benefits to their workers. Although municipal plans have not yet squared off in the courtroom against unhappy employees who assert that they are paying too much in fees, recent headlines portend change.

Claims in an April 9, 2015 press release from New York City Comptroller Scott M. Stringer document a concern about the adverse impact of “high fees and failures to hit performance objectives” that “have cost the pension system some $2.5 billion in lost value over the past decade.” According to “The Impact of Management Fees on Pension Fund Value,” a ten-year “healthy” gross rate of return of 6.5 percent is actually smaller by $2.5 billion when vendor compensation is taken into account. Based on the data considered, private equity has been the largest drag on performance with total value subtracted in the amount of nearly $2 billion.

In Pennsylvania, Governor Tom Wolf is bent on closing a $50 billion pension deficit by taking actions such as lowering costs. A renegotiation of $662 million in fees paid to investment managers by its biggest state retirement systems, the Pennsylvania School Employees’ Retirement System and the Pennsylvania State Employees Retirement System, could save money and put the plans on more of an equal footing with the national average of fee levels. See “Gov. Wolf thinks pension funds paying too much in fees” by Len Boselovic (Pittsburgh Post-Gazette, April 12, 2015). Others point to an anemic contribution rate as the culprit. In “The Annual Required Contribution Experience of State Retirement Plans” (March 2015), National Association of State Retirement Administrators (“NASRA”) researchers Keith Brainard and Alex Brown categorize New Jersey and Pennsylvania as outliers due to their “notably” low Annual Required Contribution (“ARC”).

Although a few years old, a database at presents state-specific information about change in dollar assets and management fees. Refer to “Are State Pension Funds Paying Wall Street Too Much?” by Mike Maciag (Governing, August 15, 2012). A report by the Maryland Public Policy Institute examines its experience relative to that of other state retirement plans with a specific focus on whether Wall Street advisors should charge less by eschewing actively managed strategies and adopting a passive approach instead. Click to read “Wall Street Fees, Investment Returns, Maryland and 49 Other State Pension Funds” by Jeff Hooke and John J. Walters (July 2, 2013).

Disclosure of said fees is another component of the ERISA litigation world and will surely be part of municipal lawsuits as well. In its February 18, 2015 no-action letter, the U.S. Securities and Exchange Commission (“SEC”) informed non-ERISA plan sponsors about its reporting obligations in order to avoid compliance mishaps relating to Rule 482 of the Securities Act. Each investment vendor to a reporting entity such as governmental and other non-ERISA sponsors of 457(b) deferred compensation plans, 403(b) plans and church 401(a) plans must agree in writing that it will “provide the DOL required investment information on each investment option it offers under the particular non-ERISA plan, as well as the respective fee and expense information…” on a regular basis. Click to read the SEC letter to the American Retirement Association.

Having worked as an economic expert on fee cases for plaintiffs’ counsel as well as defense counsel (depending on the matter at hand) and having carried out various research projects as a fiduciary consultant, my take is that these cases are seldom simple. Fee arrangements can reflect bundled services that must be thoroughly understood as part of the benchmarking exercise. An asset manager’s fee may be higher than another fund that generates a similar historical return because that investment company has implemented robust risk management technology or otherwise put in place protective mechanisms that are meant to protect institutional investors (and by extension, their beneficiaries). The key to unlocking fee “truth” is to examine a variety of facts and circumstances and then seek to compare vendor compensation levels against those of real peers.

In anticipation of further “excessive fee” cases that allege bad practices on the part of ERISA and non-ERISA plans, the industry will no doubt spend considerable time on what levels make sense and why.

New York City Comptroller Urges New Fiduciary Rules

Posted in Broker Dealers, Compliance, Fiduciary Liability, Investment Management


In a March 25, 2015 press release, Mr. Scott M. Stringer laid bare the details of his plan to “enact a state law requiring that financial advisors disclose whether they put their own financial interests above those of their clients.” In support of his desire for an expanded fiduciary standard to be implemented across the United States, he released a study that (a) chronicles the history of fiduciary responsibilities (b) discusses the downside of relying on the suitability standard and (c) summarizes how reform should occur.

According to “Safeguarding Our Savings: Protecting New Yorkers Through the Fiduciary Standard” (March 2015), fine print communications are insufficient and must be replaced with understandable disclosure language “so that prospective clients know of potential conflicts of interest and to what party the advisers hold their ultimate allegiance.” The concept of suitability is debunked. Authors of the study add that the status quo could result in a bigger price tag for investors. Advisors may direct clients to funds that have higher fees than comparable offerings or encourage rollovers that entail transaction costs. Even when a more costly choice makes sense, the return to an investor will be impacted accordingly.

Time will tell if New York City and other states succeed in implementing an expanded fiduciary standard, ahead of federal regulators. Certainly this announcement gives financial advisory firms further fodder for expanding compliance teams.

Homework and Investment Compliance Liability

Posted in Compliance, Investment Management

Have You Done Your Homework Concept

I almost fell off my chair the other day when the newscaster announced that homework would be banned for at least one New York city school. It seems that I am not alone. According to “Parents outraged after Manhattan school principal dumps homework for more playtime” (New York Daily News, March 6, 2015), critics decry this decision. One father asserts the importance of homework as a way to instill discipline for his daughter. A mother of two children at P.S. 116 asks that assignments be given to her daughters so that they don’t spend any free time in front of the television. Citing “lack of time for other activities and family time and, sadly for many, loss of interest in learning,” the principal of this pre-K through fifth grade public school is said to have ordered teachers to stop giving out math problems and requiring essays.

No doubt this debate will continue, with parents, researchers and policy-makers weighing in about the pros and cons of doing work that (gasp) is going to be graded or otherwise assessed. Notwithstanding the controversy about whether home makes sense, how much and at what age, my fear is that young people will simply not have the requisite skills to earn a decent living and compete with others around the world for work that increasingly requires complex problem-solving abilities. Having taught economics and finance at the university level for nearly a decade, I know firsthand that legions of students are ill-equipped for college. Basic skills such as writing and doing simple math without a calculator are out of bounds for too many people. Results of a November 2014 survey conducted by Achieve, Inc. and entitled “Rising to the Challenge: Are High School Graduates Prepared for College and Work?” cast a shadow over prospects for a widespread creation of a well-educated and employment-ready workforce. If true that students graduate with big gaps between what they know versus what they should know, companies and governments will have to pick up the slack by paying for remedial training. More specifically, shareholders and taxpayers will be footing this expensive bill to fill the void in areas such as:

  • “Work and study habits
  • Oral communications/public speaking
  • Doing research
  • Science
  • Applying what [a student] has learned to solve problems
  • Mathematics
  • Writing
  • Computer and technology skills
  • Reading and understanding complicated materials.”

Notably, a whopping eighty-seven percent of those persons questioned as part of this survey said “they would have worked harder if expectations had been higher.” It’s not a stretch to link higher expectations to homework requirements and teachers urging their students to read, write, calculate, practice, study hard and understand what is at stake. Without a good-paying job, the pursuit of other life dreams is challenging.

None of these findings can be good news for the investment management industry. At a time when global regulations are increasing and the effectiveness of a fund’s compliance team (assuming one exists) is being scrutinized, it is paramount that talented and capable individuals are available for hire. Additionally, it is critical that an asset manager, broker-dealer, bank, consultant and their institutional investor clients (i.e. buyers of investment services) be able to document that adequate due diligence has been carried out. Call it homework for the money set and you get the idea. Preparedness is key and that necessarily means doing enough research to make an informed decision and revise thereafter as needed. Famed NFL star Merlin Olsen cautioned that “One of life’s most painful moments comes when we must admit that we didn’t do our homework, that we are not prepared.”

Let’s hope that skipping post-class assignments is a short-lived trend.

More About Fiduciary Outsourcing

Posted in ERISA, Fiduciary Liability, Pension

Charles Humphrey Esquire

In an earlier commentary entitled “Fiduciary Outsourcing Considerations” (March 4, 2015), I talked about the expectations gap that arises when “a plan sponsor thinks that certain activities are going to be done by a fiduciary adviser, but the fiduciary adviser does not believe they are obliged to do such work…” I mentioned the work of the ERISA Advisory Council and its report about “Outsourcing Employee Benefit Plan Services.”

In reply, ERISA attorney Charles G. Humphrey wrote to me, wanting to let readers know about what he believes is extremely important. A principal of Law Offices of Charles G. Humphrey, he writes the following: “There is a nugget buried in your description of the Report that needs to get more attention than it has to date. This is the Council’s recommendation to DOL to clarify the legal framework for outsourcing. The clarification sought relates to the general fiduciary and co-fiduciary liabilities of the ‘appointers’ in relation to their appointees. As old as ERISA is, many of these questions do not yet have clear cut answers. Plan sponsors need to be sensitive to these questions and act defensively, especially as they move to more encompassing 3(16) arrangements where plan administrator responsibilities normally residing in sponsors are outsourced to third party professionals.”

Interested readers can click here to learn more about “A Guide to ERISA Fiduciary Responsibilities” by Charles G. Humphrey, Esquire. For information about ERISA Section 3(16) tasks, click here to read an article from the National Society of Compliance Professionals.

Heroism in Business and Politics

Posted in Banking, Compliance, Ethics, Governance, Regulation

Bold Hero

Coincidentally, two lectures I attended this weekend focused on the concept of heroism, individual rights and integrity. Although the speakers drew from different historical events, their interesting anecdotes about people who made a difference offer important lessons for modern time decision-makers.

In “The Heroic City: New York As A Microcosm of America (March 7, 2015), Robert Begley talked at length about the formation of New York City and the leading lights who contributed to its reputation as a center of banking and trade. President of the New York Heroes Society, author and public speaker, Mr. Begley singled out Alexander Hamilton as his top choice for the most important contributor to what was formerly known as Mannahatta or the island of many hills. Forced to work for his economic survival as a young boy, this man of conviction was instrumental in creating a monetary system to help a young United States repay federal war bonds and thereby pave the way for prosperity without debt. Notably, his many accomplishments as George Washington’s right hand man, first head of Treasury and founding father are showcased in a soon-to-be Broadway musical called Hamilton – based on the best-selling biography by Ron Chernow.

Separately, on March 8, 2015, Charles Slack enthusiastically described the cauldron of post-Revolutionary War politics that had lawmakers tussling over immigration, policy discourse and chilling legislative mandates such as the Sedition Act of 1798. In his new book, “Liberty’s First Crisis: Adams, Jefferson, and the Misfits Who Saved Free Speech” (March 2015), this award-winning author explains how President John Adams and like-minded persons pushed for jail time and fines to silence critics. The good news is that a groundswell of popularists pushed back hard (and sometimes at great personal expense) for reform, resulting in a non-renewal of this and other punitive laws. As an aside, Mr. Slack penned Hetty: The Genius and Madness of America’s First Female Tycoon and Noble Obsession: Charles Goodyear, Thomas Hancock, and the Race to Unlock the Greatest Industrial Secret of the Nineteenth Century.

While we could talk at length about what heroism means and why it is important to ponder on a regular basis, I am glad for the dual reminders that the power of one is real, actions count and integrity is important. Applied to the subject of this investment compliance blog, I invite readers to consider the notion of heroism and investment stewardship. Doing the right thing with other people’s money has a big impact in a positive way.

Fiduciary Outsourcing Considerations

Posted in ERISA, Fiduciary Liability, Investment Management, Regulation

Outsource Hire Buttons Show Subcontracting Or Freelancing

Plan Sponsor contributor, Judy Ward, takes a hard look at what many believe is a growing trend to outsource certain activities by retirement plan fiduciaries. A central theme in “Fiduciary Outsourcing Options” (February 2015) is that buyer and seller must be clear about the scope of work and document the agreement accordingly. This conversation importantly starts with a decision by a plan sponsor as to what fiduciary duties it seeks to delegate to consultants, asset managers and other types of advisors (to the extent legally allowable). By extension, this means that a plan sponsor should take inventory of resident skills, how much it can afford to spend on full-time employees versus contractors and whether there is a comfort level to perform certain tasks on its own. Notable quotes from “Fiduciary Outsourcing Options” include the following:

  • “Searching for an outside fiduciary ‘is an exercise in risk management…A sponsor should consider many factors about a fiduciary outsourcer’s capabilities…” (Dr. Susan Mangiero)
  • “An outsourcing provider should welcome a sponsor’s questions and lend support for its thorough due-diligence selection process…the sponsor and outsourcer should discuss how their communications would work once the relationship starts.” (Attorney Kim Shaw Elliott)
  • “Not all companies promoting themselves as outsourced fiduciaries have the same ability to meet those responsibilities…You really have to look at their experience.” (Attorney Ary Rosenbaum)
  • “There can be a disconnect between what the outsourcer promoted that it will do and what the contract actually says the outsourcer will do.” (Mr. Ronald Hagan)
  • “Being a fiduciary means you need to have a prudent process. You have to have a basis and a rationalization for making the decision.” (Attorney David Levine)
  • “If a plan sponsor thinks that certain activities are going to be done by a fiduciary adviser, but the fiduciary adviser does not believe they are obliged to do such work, there is an expectations gap.” (Dr. Susan Mangiero)

Based on my experience, there are a lot of ways to get things wrong. My view is that the Request For Proposal (“RFP”) process to select an outsourced fiduciary entails education and feedback from ERISA (or public pension plan) counsel, prior to signing on the dotted line. Understanding that there are different kinds of fiduciaries is one aspect. Plan sponsor decision-makers are charged with monitoring delegates. This means that buyers must have a good sense as to how to best benchmark a service provider, once hired.

Nuts and bolts of contracting are addressed in “Expert Q&A on Outsourcing Fiduciary Investment Responsibilities” (Practical Law, February 2014) by Attorney David Levine and Attorney Allison Tumilty. Also check out “Outsourcing Employee Benefit Plan Services” (ERISA Advisory Council, 2014). Note the recommendations that the U.S. Department of Labor: “(A) educate plan sponsors on current practices with respect to outsourced services; (B) clarify the legal framework under ERISA for delegating responsibility to service providers; (C) provide additional guidance on the duty to select and monitor service providers; (D) facilitate the use of multiple employer plans and similar arrangements as a means of encouraging plan formation and easing administration burdens: and (E) update and provide additional guidance on insurance coverage and ERISA bonding of outsourced service providers.”

Service providers have a golden opportunity to stand up and deliver help to prospective and existing retirement plan clients as they explore the use of outsourced fiduciaries. Building and maintaining a fiduciary outsourcing relationship can be complex and the professional liability is real. It is important to exercise care at the beginning and thereafter.