A landmark federal court decision last year on a 401(k) sponsor's mismanagement of a retirement plan could have big implications for advisors. Although the ruling is being appealed, the decision in Tussey v. ABB was extraordinary because it constitutes a warning to every advisor who operates as an investment fiduciary.
Using the Investment Advisors Act of 1940 and ERISA as standards, the Tussey ruling imposed a hefty cost on the defendants. The decision, issued by a federal district court in Missouri, is more than 80 pages long, More importanly, it's precedent setting.
In the financial services industry, much of the way we operate has been shaped by the courts. Tussey created case law describing how to operate as a fiduciary to ERISA plans. I realize, of course, that not every advisor deals with ERISA plans, but for those who work with one or more of the roughly 1.2 million plans, this is an important addition to your everyday business operations. And even if you don't deal with 401(k)s or other ERISA plans, don't assume you won't be affected by the case.
At the recent fi360 conference, I attended an extraordinary panel discussion on the case, led by the former FPA chief lobbyist Duane Thompson, now the president of Wahsington consulting firm Potomac Strategies, and including one of the expert witnesses, a lawyer on the plaintiffs' team and another attorney. The expert witness, Al Otto - a principal with Shepherd Kaplan in Atlanta who serves as a professional consultant and fiduciary to ERISA plans - said at the conference that the decision "gives a clear outline of how fiduciaries must operate."
If you operate as an investment advisor under the 1940 Act, you have virtually the same responsibilities as an ERISA fiduciary to many of your clients. If you ignore these legal developments, you might face costly consequences; ABB is now appealing a $36.9 million judgment against it. In considering the ramifications of the ruling, I'll share what my firm, Savant Capital Management, is doing to act as a fiduciary in all cases.
The court found numerous breaches of fiduciary duty by the various defendants, which included industrial equipment maker ABB, the plan sponsor, the company's pension review committee and officials at the company, and the recordkeeper, Fidelity Management Trust. Chief among the problems:
* A failure to monitor the plan's recordkeeping costs, which were deemed to be excessive.
* A failure to negotiate rebates from Fidelity - a breach of the ABB 401(k)'s investment policy statement.
* Other breaches of the investment policy statement, including the selection of higher-cost classes of investment options when lower-cost choices were available, as well as the imprudent substitution of certain Fidelity investment choices for existing plan options.
* Allowing the 401(k) plans to subsidize the expenses of other ABB plans, such as a health plan, as well as nonqualified plans.
* Fidelity's failure to allocate the income received from overnight investment of plan funds for the exclusive benefit of the ABB 401(k) plans.
AVOIDING LEGAL WOES
With the case on appeal, the final outcome is uncertain. Nonetheless, it appears likely that at least some part of the decision will be upheld and become part of case law affecting your business.
My firm is working to ensure that, as a consultant and advisor to many ERISA plans, we abide by the rules set out in the Tussey decision. Here are some changes we've made - moves you can make, as well.
The Centre for Fiduciary Excellence (also known as CEFEX) promotes the highest fiduciary standard investment behavior internationally, through annual audits of investment practices. We have implemented an annual look at our own investment policy statements, bringing in a CEFEX-licensed audit firm. The audit confirms our adherence to the group's strict standards for fiduciary investment selection.
CEFEX audits are the gold standard of world-class fiduciary investment practices, and when SEC auditors have shown up, they have been visibly impressed by our CEFEX audit results. It isn't cheap to get your first audit done, but it is one way to substantially lower your exposure to a potential lawsuit.
We also use our firm's size - we have more than $3.2 billion under management - to try to negotiate lower prices on everything we buy, including fund fees. Every penny of those lower fees passes to our clients, which of course increases returns.
I would argue that failing to negotiate better terms might be a violation of fiduciary responsibility. As a result, I recommend you have a frank talk with your fund vendors about pricing.
STANDARDIZE & SEPARATE
I also strongly recommend you simplify your portfolio construction, and turn the job over to qualified staff who invest and manage investments full-time. The reality is that most financial advisors are not trained to manage portfolios. It's a full-time job to get it right; if you're making all the right portfolio moves, are you finding enough time to advise clients properly?
At another recent industry conference, I heard a presenter say his firm had individually analyzed client portfolios after the global financial crisis and discovered a wide variance in portfolio construction - which caused substantial difficulty in rapidly adjusting to the markets' downturn. When the firm examined the time and effort required to manage each portfolio individually, it decided to scrap individual advisor portfolio management in favor of a more standardized approach. We came to the same conclusion about 20 years ago.
Finally, my firm has created a separate division, Savant Institutional, which deals with qualified plans exclusively. Clearly, your firm will likely attract trouble if you commingle expenses and income between plans in a single entity.
ARE YOU COVERED?
You may think these issues are concerns you don't have to worry about. But are you certain that it isn't happening at one of your client companies?
I recommend you review each qualified plan you oversee, and find out how the company is paying for your firm's services other than your investment management. Be holistically aware of all the parts of the plans you manage - from the investment policy statement to investments, fees and billing - even if you don't control all of those parts.
We have full-time ERISA professionals on our staff to make sure the plans are in compliance, that we're in compliance and that everyone involved - the custodian, the fund providers, the trustees and the participants - is doing the right things for the right reasons. As we see with the Tussey ruling, ignorance is no excuse, and doing what seems natural for a business might be just enough to cost you millions in penalties.
Even though the final decision in the Tussey case hasn't been handed down, the handwriting is on the wall. Make sure your firm is reading it properly.
Glenn G. Kautt, CFP, EA, AIFA, is a Financial Planning columnist and vice chairman of Savant Capital Management, based in Rockford, Ill.