401khelpcenter.com Logo

Guest Article

Brand Name Consultant vs. Independent Advisor

By Thomas B. Bastin, JD, LLM, AIF, CEBS

    

There is a legitimate question in the minds of many as to whom they should be working with to assist in the management of their retirement program. The easy way out is to go with a large brand name consultant or financial institution. After all if they are large and branded they must be competent, right? That is an assumption rather than a careful consideration of what service is actually being offered. In order to answer the real question titled above you must first understand your responsibility/options, and then understand the industry.

ERISA dictates that any person responsible for making decisions impacting ERISA plans are labeled plan fiduciaries. There are four duties imposed on qualified retirement plan fiduciaries under ERISA Section 404(a)(1). First is the duty of loyalty identified as operating in the sole interest and for the exclusive purpose of the plan and participants (ERISA Section 404(a)(1)(A)). Second, the duty of prudence (ERISA Section 404(a)(1)(B)). Third, the duty of diversification (ERISA Section 404(a)(1)(C) and (4). Fourth, the duty to adhere to plan documents (ERISA Section 404(a)(1)(D)).

Let us begin by focusing on the second duty of prudence. You often hear people state that in managing a retirement plan one should act as a "prudent man" would. Prudence is code for process. A proper process involves parties that possess the required expertise and accept liability for their actions. The Department of Labor on their website has stated that LACKING investment expertise, a fiduciary WILL WANT TO HIRE someone with the professional knowledge necessary to carry out the investment & other functions. ERISA has even included a safe harbor definition of a "prudent expert" to be either:

(1) A Registered Investment Advisor
(2) A Bank
(3) An Insurance Company

These three "entities" qualify as prudent experts provided the "entity" accepts liability in writing for the advice of their staff. Thus, consulting firms and individual brokers fall outside of the prudent expert safe harbor and as a result the plan sponsor must document their expertise to justify the service provided. The key fact to recognize here is the government expects a prudent expert to accept fiduciary liability in writing for their advice (a safe harbor requirement). Hiring a consultant who refuses to accept liability runs contrary to the government definition of a prudent expert. The first question to ask a consultant is if they do not qualify as a prudent expert how can you possibly have implemented a prudent process that relies upon their service (remember they provide no advice)?

In the hiring of a prudent expert plan sponsors can reduce their liability for the management of plan assets in two ways:

(1) Appoint a co-fiduciary who accepts liability in writing to assist the plan investment committee in creating an investment policy statement, establishing proper criteria for fund selection, retention and removal, and making written recommendations for the committee to consider when making investment decisions. This will aid the committee in reducing liability by establishing and documenting that a prudent process was followed with the assistance of a prudent expert. The plan sponsor retains ultimate authority over the investment options offered to participants.

Potential Result: In a litigious situation, members of the investment committee retain personal liability for their actions with respect to the investment decisions made.

Potential Result: In a litigious situation, members of the investment committee will be called to testify regarding their investment expertise and decisions made along with the Advisor.

(2) Appoint a Registered Investment Advisor will to accept status as an ERISA Section 3(38) Investment Manager via a written agreement to take over the selection, monitoring and replacement of investment options offered to participants. This option provides the most protection to plan sponsors as their duty shifts from participating in investment decisions to monitoring that the Advisor has followed their stated process for making investment decisions. Ultimate authority for investment decisions lies with the Advisor.

Potential Result: In a litigious situation, members of the investment committee will be called to testify regarding their actions in monitoring that the Advisor followed their stated process. No investment expertise is required to monitor that someone else follows their own stated process. One simply has to review the work product.

Potential Result: In a litigious situation, the Advisor will be called to testify regarding their investment expertise and decisions made. Who do you want on the stand answering these difficult questions an investment expert or a committee member? Who would you want on the stand dealing with prudent process questions an ERISA expert or a committee member?

There is a third option which is to hire a brand name consultant that fails to accept liability for the services provided. Not only would your committee members have to defend their investment decisions for which they lack expertise, but they would also have to defend the decision of using the services of a person who is not considered prudent under the Government's Safe Harbor Definition. The question that really needs to be asked, which surely the plaintiff's lawyer will ask the jury, is why didn't you hire a prudent expert? What will your answer be? I find it unlikely the jury will be as impressed with the brand name credential as you are. Especially when that brand name consultant takes the stand and disavows any and all responsibility for the service they have provided. In fact, a former partner for a large brand name consultant recently disclosed that they were forbidden from ever entering into a services contract of any kind with clients for fear they would actually have to identify the service being provided. I have to think that wouldn't look good to a jury when you testify the brand name assisted with your prudent process yet you failed to even enter into a services agreement with them. Add this to your good friend the consultant looking like an Olympic gymnast jumping from your side of the table to the other safe side where non-fiduciaries congregate and you have some real issues to overcome.

Why not just serve as a fiduciary and prevent guys like me from making this an issue? Brand Name Consulting Firms with big dollar budgets can just as easily buy E&O insurance to cover the liability as I have done. For that answer we need to go back to the first duty which is loyalty. As a plan fiduciary every decision made has to be for the sole purpose and in the exclusive interest of the plan and participants. No conflicts of interest can exist. As you might suspect the reason for refusing to become a plan fiduciary has nothing to do with the liability and everything to do with their refusal to avoid conflicts of interest. Think about the players in this industry and the conflicts they might deal with.

  • Brand Name Consultants - In the past we have seen consultants recommending vendors which they had direct financial interest in, or indirect via other consulting, soft dollar or pay to play arrangements. Some Consultants are so large, and the conflicts so numerous, they could never operate solely and for the exclusive purpose of the plan and participants.

  • Banks & Mutual Fund Companies - It would be a little tough to have any other banking business with a client and also serve as a plan fiduciary. In addition, it would be impossible to stuff the retirement plan with proprietary funds and still serve as a plan fiduciary. Finally, it would be forbidden to retain revenue sharing without disclosing to the client and still serve as a fiduciary.

  • Brokerage Houses - Quite impossible to negotiate undisclosed kickbacks from retirement plan vendors in return for offering their products to the brokers and also serve as a fiduciary. Also forbidden to offer high payouts to brokers who place proprietary funds inside retirement products and still serve as a fiduciary.

Discovery can be a powerful weapon in the hands of the plaintiff's bar. They can find conflicts you would never be privy to. The prudent process you thought was implemented can just as easily be turned around to demonstrate your lack of prudence in hiring vendors. Once you lose the jury via a vendor's conflict you have probably lost the case.

As I tell all potential clients you must implement a prudent process that will stand up in court. However, the decision on whether to hire a consultant or independent advisor is really quite easy. You should identify those services desired then seek the appropriate vendor. For instance will they provide the following?

  • Serve as a Section 3(38) investment manager accepting liability in writing,
  • Provide an investment policy statement with stated criteria for selecting, monitoring and replacing investment options,
  • Identify appropriate asset classes to offer participants,
  • Provide Quarterly Investment Reviews, document issues for investments on the watch list and replace funds that fail to meet stated criteria,
  • Document annually you adherence to stated fiduciary practices,
  • Support stated fiduciary practices with case and regulatory law,
  • Provide full fee disclosure and transparency with annual reporting,
  • Serve as your Section 404(c) fiduciary and provide an annual 404(c) checklist documenting your adherence to this code section thereby shifting liability for participant investment decisions away from the plan sponsor and to participants,
  • Provide an annual vendor stability report so you can be comfortable you assets are safe (have you ever looked into the stability of your vendors),
  • Provide ERISA consulting and M&A services as desired,
  • Serve as the quarterback to your plan answering all plan related questions.

You can have all of this OR you can hire a consultant with the brand name and do it yourself. Just as it would be easy for the large brand name firm to buy E&O insurance and provide these services it would be just as easy for myself to join the brand name. Unfortunately for those reasons listed above neither will happen. They are unwilling to forgo the conflicts and I am unwilling to provide substandard service with no advice.

I can understand why someone would find comfort in a brand name. My problem has always been the focus is on the wrong brand. Rather than the name of entity your Advisor works for you should be investigating the brand behind the E&O policy which backs up their advice. That is the "only" brand name offering you protection!!! Honestly, what value does a brand offer if they refuse to stand behind their service? To answer the titled question what is the difference between a brand name consultant vs. an independent registered investment advisor: "The Advisor works as your Head Coach calling plays and accepting responsibility while the consultant sits in the stands chirping and second guessing without ever becoming a member of your team".

Thomas B. Bastin, J.D., LL.M., AIF®, CEBS® is the President & General Counsel of ERISA Fiduciary Advisors, Inc., an independent Registered Investment Advisory Firm. As both a former practicing ERISA attorney and owner of a third party administration firm, he brings a unique background, knowledge & set of experiences to his clients. Mr. Bastin can be reached via email (tom@efadvisor.com) or telephone (866.606.4015). This article is protected by copyright laws © 2009.

###

401khelpcenter.com is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of 401khelpcenter.com. This article is for informational and educational purposes only and doesn't constitute legal, tax or investment advise.


About | Glossary | Privacy Policy | Terms of Use | Contact Us

Creative Commons License
This work is licensed under a Creative Commons Attribution-NoDerivatives 4.0 International License.