Cruise Control vs. Auto Pilot: The Need for a Third Party Review of Plan Fiduciary Functions

By Robert J. Higgins, JD CEBS AIFA. Mr. Higgins is a Senior Fiduciary Consultant with the firm Benefit Plans Plus, LLC of St. Louis, MO. He may be reached at 314.983.1200 or rhiggins@bpp401k.com.

Diligence is a good thing, but taking things easy is much more--restful. Mark Twain

The recent literature on qualified plan governance is replete with violations of ERISA and common law principles. By properly scrutinizing these cases, plan sponsors can learn a valuable lesson in behavior avoidance.

A common pattern we often see is the self-perpetuating behavior of sponsors, fiduciaries, administrators and advisors where inertia takes over and decision-making ceases being the product of a prudent process. Everyone is in a comfort zone and, consciously or unconsciously, fiduciary concerns are slighted because we stick with what we know. Let's call this the "auto pilot" stage.

Being in the "auto pilot" stage is not good because fiduciary decisions aren't made in a vacuum and must be constantly monitored. Company circumstances, industry and market forces, costs, participant demographics and resource availability constantly evolve. These and other environmental factors should be considered by fiduciaries when monitoring service provider behavior and the effectiveness of past decisions.

Most plans view monitoring providers' performance as a fundamental fiduciary responsibility. Unfortunately, these same plans often fail to review their own performance. Making a decision, then failing to evaluate its effectiveness and letting inertia take over, creates plan risks. If your process and governance don't encourage plan fiduciaries to be critical and demanding on behalf of participants, they will be less effective. An objective, independent review by a third party fiduciary adviser can prevent complacency and renew this fiduciary commitment.

Without advocating or condemning any particular investment approach, I'd like to provide an example of inertial, "auto pilot" decision-making:

In 1990, Company adopts a new 401k plan. After reviewing investment consultant advice and legal counsel, the sponsor chooses a money market, a GIC, two bond funds and six managed equity funds as investment options. No written Investment Policy Statement is adopted because participants will have all the authority. The money market fund is selected as the default investment option should a participant fail to make an election. Meetings and communications focus on asset allocation and the importance of diversification.
In 1995, due to participant demand and market availability, the plan --- after considerable review and deliberation -- adds sector equity funds, a total market stock index and a junk bond fund. The default investment option is not mentioned in the Committee minutes. Plan communications retain their emphasis on diversification.
In 2000, while considering GUST amendments and meeting with legal counsel, the plan adds three "lifestyle funds." Again, the default choice is not reviewed.
It's now 2005, the plan's investment consultant has mentioned automatic enrollment and "targeted maturity funds," but recommends no additional changes.

Can you spot any possible fiduciary problems here? While not taken from an actual case, this behavior isn't uncommon. Investment options are added, not after appropriate deliberation, but in response to participant demand, market advertising or adviser recommendations. Often, "flavor of the month" investments are added without considering their long-term appropriateness, or benefit to participants.

Multiple potential problems have arisen. External influences changed significantly, but the fiduciary didn't adapt to the proper ones. Initial plan design decisions were made deliberately, but once the plan was in place, inertia took over. "Auto pilot" --- especially if the fiduciary is "asleep at the wheel" -- can cause problems for everyone involved.

Sponsors, having procured legal and investment advice and IRS approval, assume that nothing need be done. (Advisers will notify them if changes are needed!)
Participants receive identical investment information at enrollment, annual meetings and in quarterly statements. (Diversification and asset allocation are emphasized, but default investment is a money market fund!)
Investment advisers fail to critically review the performance of current funds (particularly if they don't deem themselves a fiduciary rendering investment advice, but merely an order taker.) Many will merely suggest adding funds.
Legal counsel isn't contacted - no one has said the plan needs to be amended and there are no perceived problems. If they are contacted, their review is limited to documents.
Fiduciaries forget they have the ultimate responsibility (and liability) for the plan's administrative and investment decisions. They also forget that doing nothing and failing to monitor the results of prior decisions is a decision.
The plan is no longer being properly scrutinized and managed.

A plan fiduciary can never totally relinquish its responsibility --- "auto pilot" doesn't work for a plan. The reasoning is the same for airline pilots who ignore "auto pilot" when flying through severe storms. Despite its sophistication, an "auto pilot" system is incapable of discerning and responding to important environmental variables while eliminating the inconsequential. Plans on "auto pilot" have lost that professional discernment.

At this stage an independent review can be indispensable in reconnecting fiduciary and advisers to their fundamental responsibilities. The focus of any review should be on the fiduciary decision making process - reassess plan goals, review the current situation, recommend process improvements, and provide a template for prospective implementation.

An objective assessment moves everyone from "auto pilot" to "cruise control" --- a superior way to manage fiduciary fulfillment. The independent adviser helps the fiduciary reestablish and communicate fundamental goals at the onset. All parties understand their role in the context of plan processes, have clearly defined expectations and understand they'll be continually monitored for adherence to their objective. The navigational assistance provided by advisers will improve and help the fiduciary recognize problems and adjust en route.

Decisions are no longer made in a vacuum. The fiduciary establishes standards for selecting and evaluating all providers. Scheduled meetings and formal agendas help fiduciaries to continually weigh legal, human resource and investment developments. They can then communicate their policies, evaluation criteria and expectations to participants and service providers. Having established new ground rules for advisors, fiduciaries can refocus on the primary objective - income replacement for plan participants at retirement.

If your plan has been on "auto pilot," assess your situation. An independent review is a great way to get an objective assessment. The importance of "independence" and "objectivity" cannot be overemphasized. Many reputable national, regional and local firms can help you.

Remember, this is a fiduciary decision! Some suggestions: in procuring the services of a fiduciary adviser:

In your RFP or discussions emphasize that this is a one-time project.
Do not accept proposals from current providers or their affiliates.
Do not accept proposals from anyone with a connection to any plan party-in-interest.
If reviewing investment choices, insist that the bidders not receive revenue from investment providers for referrals.
Don't allow for "soft dollar" or other indirect compensation.
Demand disclosure of all revenue sources from bidders.
Insist on making a direct payment to the provider.

This may sound like a huge project and expenditure to some. Because external and internal influences constantly change, fiduciaries should continually evaluate their advisers' and their own performance. Before dismissing these suggestions, watch for articles on the prosecution of, settlements with, and lawsuits against plan fiduciaries or corporate boards -- it won't take long.

Other articles by Robert J. Higgins: Using a Fiduciary Charter as the Framework for Your Plan Operations.

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