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Guest Article Independent: What Does it Really Mean?By Jeb Graham CEBS, CIMA® of CapTrust Financial Advisors, an independent consulting/advisory practice focused on the institutional retirement plan market, serving corporate, closely held, non-profit and governmental organizations. You may contact Jeb at 813.218.5008 or jeb.graham@captrustadv.com. In a recent visit with a prospective client, the committee member I met with stated that they were currently working with an independent advisor. As the conversation continued into more detail, it came out that the advisory team was in fact employed by a well known national securities brokerage firm. When questioned as to the matter of independence, it was explained that the advisors were independent of the provider. My response was a simple question, "Do you think the brokerage firm derives any revenue from securities trading conducted by your provider's fund managers?" This plan fiduciary said he needed to think about that. In 1974, legislation (ERISA) was passed that established the foundation for the regulatory framework of qualified retirement plans. ERISA, and its regulatory interpretation over the years, has defined who is and is not a plan fiduciary, and lays out parameters of fiduciary prudence. One aspect of such prudence is the responsibility to conduct appropriate due diligence in the selection of advisors to the plan so to ensure competency and avoid any conflicts of interest. But nowhere is anything written as to advisors being independent. Given that advisors are frequently paid either directly or indirectly from plan assets, evaluating competency of potential advisors is obviously an important step in due diligence. It goes without question that a plan committee would assess the expertise and experience of any potential advisors (unless it was a brother in law of a committee member). Evaluating potential conflicts of interest is another matter. This is where the issue of being independent enters the picture. In the minds of plan committee members, independent may mean different things. To some it means being free to select a wide range of products or services. To some it relates to employment structure, as in an independent contractor that is not employed by a broker dealer. To others, it means not having to promote proprietary products or platforms. This author believes that a plan committee, in general, would expect any consultant to be objective in providing advice. But the complex nature of both formal and informal relationships between service providers and the underlying revenue sharing arrangements often cloud the desired objectivity. Many large banks and brokerage firms have multiple lines of business that, as defined by law, create potential prohibited transaction issues in the delivery of advice to a committee. Any claim of being independent should be measured against potential conflict of interest related to their plan. Interesting conflicts A common example of conflict of interest occurs when the bundled service provider is the plan committee's primary source for guidance on investment selections. A case in point would be a bank or mutual fund service provider that has a direct relationship with the plan committee, absent any third party. It only makes sense that a primary factor in selecting investments would be revenue sharing arrangements that allow the provider to lower the overall stated service costs. The service providers recognize this conflict and are very careful to avoid giving "advice", but must also take care in dealing with committees that don't want to engage an outside fiduciary. Another potential conflict often overlooked by plan committees, as described above, is that of advisors being employed by a securities brokerage firm. The brokers may not be promoting proprietary funds, but most broker dealer firms have financial arrangements with mutual fund companies. These arrangements are all legal and above board, but they nevertheless exist. One form is a trading arrangement to conduct buy/sell transactions inside mutual funds or separate accounts. Another involves a fund company being an "educational sponsor" of training events in which they can indirectly promote their products to potential distribution channels within the broker dealer. Brokerage firms obviously have "shelf space" considerations, thus being an active supporter of such activities is important. It would appear to be very hard to say that an employee of a securities firm has no potential conflict of interest in selecting funds. Another conflict that has been well publicized in recent years is the "pay-to-play" arrangements instituted by large national consulting firms. The consulting firms hosted events in which investment managers were required to pay "sponsor" fees upwards of six figures. The purpose of such an event was to familiarize the consultants and prospective clients with the investment managers. But only those paying sponsor fees were in attendance. The question is then, in the selection of funds, do the consultants lean toward the investment manager "sponsors" by whom they were courted? One could certainly question just how independent these consultants actually are? In the past few years several large national insurance brokerage firms were reported to have engaged in behind the scenes revenue sharing involving their "independent" consulting divisions. These firms were allegedly being paid large undisclosed overrides by insurance companies…the very insurance companies on whom they were supposedly conducting due diligence as part of the provider search consulting services being delivered to plan sponsors. Conclusion. Not all potential conflicts of interest are related to degree of independence. Conflict can be inherent in relationships beneficial to other areas of the organization. But, as applied to a retirement plan committee charged with fiduciary prudence, selecting advisors that are independent from potential conflicts of interest is a key factor in the objectivity necessary to perform in a fiduciary role. This material is distributed solely for information purposes and is not a solicitation of an offer to buy any security or instrument or to participate in any trading strategy. The views contained herein are the opinions of the author. It is not intended as legal or tax advice. CapTrust Advisors, LLC is a Registered Investment Advisor with the SEC. CapTrust is not a legal or tax advisor. Other articles by Jeb Graham: Looking Under the Hood of Your 401k to Understand the Real Costs, Target-Date Funds and "Glideance" Counseling and The Importance of Legal Counsel Review. ### 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. | ||||
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