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Fiduciary Responsibilities And Risks — Presentation Transcript

1. Fiduciary Responsibilities and RiskMark D. Mensack, AIFA®Piedmont

Independent FiduciariesJoanne Szupka, CPARoland J. O’Brien, CPARobert A.

Lavenberg, CPA, JD, LL.MBDO USA, LLP

2. AGENDAFiduciary Risks & ResponsibilitiesChallenges to fulfilling

fiduciary obligationsTechniques to overcome these challenges

3. Who is a Fiduciary?“A fiduciary is someone who has undertaken to act for

and on behalf of another in a particular matter in circumstances which give rise

to a relationship of trust and confidence.” Bristol & West Building Society v

MathewA fiduciary is anyone “exercising any discretionary authority or control

regarding the management or disposition of plan assets…” ERISA §3(21)(A)

Fiduciary Responsibilities And Risksby Mensack on Feb 05, 2011

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An overview of the fiduciary responsibilities and risks facing 401k plan sponsors.

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4. Two General Types of FiduciariesNamed Fiduciary- Someone specifically

named in the plan document, or appointed by the plan sponsor.Functional

Fiduciary– Someone who acts in a fiduciary capacity based on their job duties

or responsibilities with respect to a plan.Individuals serving on investment

committees, selecting service providers to a plan, and/or having influence or

any discretionary authority over a plan are typically considered to be Functional

Fiduciaries.

5. Are you a Functional Fiduciary?Do you exercise authority, control, or

influence in managing the plan?Who chose the salesperson?Who chose the

product or service provider?Who chose the investment options in the plan?Who

selects, monitors, or replaces investment options?Do you ever tell a participant

how to invest their 401k?Do you ever approve a broker’s recommendations?

6. A FiduciaryFiduciary status is determined either:intentionally by being

specifically named or appointed; or unintentionally by the functions one

performsFunctions whereby one exercises authority, control or influence over

the plan are fiduciary functions:Hiring or firing service providersSelecting or

changing investment optionsMaking decisions, including approval of

recommendations

7. The ORC/Infogroup Survey August 19-23, 2010 60% of U.S. investors

mistakenly think that “insurance agents” have a fiduciary duty to their

clients.66% of U.S. investors are incorrect in thinking that stockbrokers are held

to a fiduciary duty.76% of investors are wrong in believing that “financial

advisors” – a term used by brokerage firms to describe their salespeople - are

held to a fiduciary duty.

8. Non-Fiduciary Service ProvidersRecord-keepersThird-Party Administrators

(TPA)AuditorsCPA’sStock Brokers = “Financial

Advisors/Consultants”Insurance Agents

9. Fiduciary Service ProvidersTrust CompanyRegistered Investment

AdvisorsNecessarily assumes non-ERISA fiduciary status under the Investment

Advisor’s Act of 1940Independent Fiduciaries who by contract assume:ERISA

3(21) Fiduciary StatusERISA 3(38) Fiduciary Status

10. Personal Liability IA fiduciary is personally liable for any losses the plan

incurs by reason of its breach. A fiduciary who has breached its duty is liable to



restore to the plan any profits the fiduciary made through its use of plan assets

and for any other equitable or remedial relief deemed appropriate by the court,

including removal of the fiduciary. ERISA § 409The DOL can also access a

civil penalty against a fiduciary who breached its duty or any person who

knowingly participated in a breach in the amount of 20% of the amount

recovered in a settlement with the DOL or awarded in a civil suit. ERISA § 502

(l)

11. Personal Liability IILaRue vs. DeWolfe – February 20th, 2008 the Supreme

Court decided that individual employees can sue their employer for breach of

fiduciary responsibility.“The threat to employers from an explosion of suits is

real…I think it's meaningful for employers because it will open up the

flood gates with respect to litigation." Ken Raskin, White & CaseThe relative

benefit to a participant is small but meaningful and the plaintiff attorney stands

to reap a substantial pay day for his or her efforts especially with the courts

poised to award reasonable attorney's fees and costs according to ERISA

502(g)(1) regardless of the size of the claim. Fred Barstein, CEO of

401kExchange, Inc.

12. Newark Star-Ledger August 28th, 2010

13. A Breach of Fiduciary Responsibility could result in:Extinction-level event

for your firmNegative impact on the retirement security of your

employeesFinancial ruin for you and other firm leadershipCriminal penalties

including imprisonment:ERISA Section 501 contains criminal fines of up to

$5,000 with potential imprisonment of up to a year.Sarbanes-Oxley increased

these to a maximum of $100,000 with potential imprisonment of 10 years.

14. Fiduciary RiskFiduciary responsibility carries personal liability.There is no

“corporate veil” for fiduciaries.DOL Sanctions can be between 20%-50% of

plan assets.The 2008 LaRue decision permits individual participants to sue plan

sponsors for fiduciary breaches.The Plaintiff’s Bar sees over $3 trillion in US

401k assets.There are potential criminal penalties including imprisonment

15. What is Fiduciary Responsibility?Act solely in the interest of plan

participants and their beneficiaries and with the exclusive purpose of providing

benefits to them;Carry out your duties prudently;Follow the plan documents

(unless inconsistent with ERISA);Diversify plan investments; andPay only



reasonable plan expenses. Fiduciary obligations are among the “highest known

to the law.” Brussian v. RJR Nabisco, 5th Circuit Court, 2000

16. ERISA Fiduciary Responsibility OverviewDuty of Prudence– A fiduciary

shall discharge his duties with respect to a plan solely in the interest of the

participants and beneficiaries :-with the care, skill, prudence, and diligence

under the circumstances then prevailing that a prudent man acting in a like

capacity and familiar with such matters would use in the conduct of an

enterprise of a like character and with like aims;ERISA § 404 (a)(i)(b)Duty of

Exclusive Purpose - “A fiduciary shall discharge his duties . . for the exclusive

purpose of:(i) providing benefits to participants and their beneficiaries; and(ii)

defraying reasonable expenses of administering the plan. . . .” ERISA §404(a)

(1)(A)

17. ERISA Fiduciary Responsibility OverviewDuty to Diversify – A fiduciary

must diversify investments so as to minimize the risk of large losses. Where

participants make the investment decisions, at least three diversified investment

option with materially different potential risk and reward characteristics must be

available. ERISA § 404 (a)(1)(C)Duty to follow plan documents unless contrary

to ERISA - A fiduciary must discharge his/her “duties in accordance with the

documents and instruments governing the plan insofar as such documents and

instruments are consistent with the provisions of Titles I and IV of

ERISA.ERISA §404(a)(1)(D)

18. ERISA Fiduciary Responsibility OverviewDuty to avoid Prohibited

Transactions ERISA 406 (a)(1)(c) prohibits all transactions between a plan and

a party in interest, and lists several specific transactions that constitute self-

dealing or a conflict of interest. Existing ERISA 408(b)(2) provides exemptions

to ERISA 406 (a)(1)(c) if three requirements are met:The service must be

necessary for the establishment or operation of the plan.The service must be

furnished under a contract that is reasonable.No more than reasonable

compensation may be paid for the service.

19. Reasonable Fees & Compensation“assure that the compensation paid

directly or indirectly by [a plan to a service provider] is reasonable, taking into

account the services provided to the plan as well as any other fees or

compensation received by [the service provider] in connection with the

investment of plan assets. The responsible plan fiduciaries therefore must obtain

sufficient information regarding any fees or other compensation that [the



service provider] receives with respect to the plans investments….to make an

informed decision whether the [service providers] compensation for services is

no more than reasonable.” DOL - Frost (97-15A) and Aetna (97-16A)“engage

in an objective process designed to elicit information necessary to assess the

qualifications of the provider, the quality of services offered, and the

reasonableness of the fees charged in light of the services provided. . . such

process should be designed to avoid self-dealing, conflicts of interest or other

improper influence.”DOL Field Assistance Bulletin 2002-3 (Nov. 5, 2002)

20. Self-dealing, Conflicts of Interest or Other Improper Influence Affect

ExpensesPlan Sponsor – “We aren’t changing our service provider; we’re with

ABC Bank and we have our lending relationship there.”Firm selling 401k

products – We only provide our clients with 401k products that pay us for

“shelf space.”401k Product Provider – We only include mutual fund options on

our platform that pay us for “shelf space.”TPA – I recommend XYZ 401ks;

once we have $25 million with them they pay us an additional 10 bps

overrideSalesperson – I recommend investment options that pay me a higher

12b-1 fee.

21. Effect of Fees & CompensationAssume that you are an employee with 35

years until retirement and a current 401(k) account balance of $25,000. If

returns on investments in your account over the next 35 years average 7 percent

and fees and expenses reduce your average returns by 0.5 percent, your account

balance will grow to $227,000 at retirement, even if there are no further

contributions to your account. If fees and expenses are 1.5 percent, however,

your account balance will grow to only $163,000.The 1 percent difference in

fees and expenses would reduce your account balance at retirement by 28

percent.A Look at 401(k) Plan Fees, DOL,Employee Benefits Security

Administration

22. Rule 408(b)(2) Interim Final Service Provider DisclosureService providers

receiving at least $1,000 must:Disclose all direct and indirect compensation it,

or its affiliates or subcontractors, receives. Provide a description of the services

to be provided.Disclose whether they are providing any fiduciary services.Final

regulation is effective as of July 16, 2011 It also includes a class exemption

from the prohibited transaction provisions for a fiduciary who enters into a

contract without knowing that the service provider has failed to comply with its

disclosure obligations.



23. Form 5500 Schedule CApplies to “large plans.” (100+ eligible Participants)

Compensation above $5000 is reportableCompensation TypesDirect – Paid

directly from the planIndirect – “Revenue Sharing,” investment management

fees, finder’s fees, float revenue, brokerage commissions, securities lending

revenue, etc.See section on Moral Hazard/Fallacy of Disclosure

24. Challenges to FulfillingFiduciary ObligationsFiduciary ExpectationMoral

Hazard / Fallacy of DisclosureRevenue Sharing

25. Fiduciary ExpectationAuditor says:There were no noteworthy issues found

during our audit.TPA says: You’ve passed your ADP & ACP testingBroker

says: Morningstar gives all of the plan’s funds at least three starsEmployees

say: We have no complaints about our 401kPlan Sponsor hears: I am fiduciarily

squared-away!

26. Fiduciary ExpectationFiduciary Non-fiduciaryTPA(service provider)Plan

SponsorHas all fiduciary responsibility and all potential liability.Recordkeeper

(service provider)CPA/Attorney(service provider)Consultant(s)(service

provider)Custodian(service provider)

27. Moral HazardMany types of 401k sales people offer fiduciary education,

advice or assistance, but then deny in writing fiduciary responsibility. For

example:ABC Firm and ABC Firm Financial Advisors do not provide tax or

legal advice, are not “fiduciaries” (under ERISA, the Internal Revenue Code or

otherwise) with respect to the services or activities described herein, and this

material was not intended or written to be used for the purpose of avoiding tax

penalties that may be imposed on the taxpayer. Individuals are urged to consult

their tax or legal advisor before establishing a retirement plan or to understand

the tax, ERISA and related consequences of any investments made under such

plan.The fine print on the “Fiduciary Warranties” offered by many 401k sales

people is similarly eviscerated, and provides little, if any, fiduciary protection.

Moral Hazard QUIZ

How many documents must a plan sponsor review in order to read all of the available information before adopting a group

annuity 401(k) plan?

(Lets assume there is just one mutual fund in the plan!)

What are the total number of pages in all of these documents?

How many of these pages address fees, compensation or potential conflicts of interest?

a) 2 / 127 / 6 b) 7 / 542 /56 c) 34 / 827 / 99



Moral Hazard Quiz Answer: B

Prospectus – 72 pgs

9 pgs reference fees, compensation or conflicts of interests

SAI– 285 pgs

17 pgs reference fees, compensation or COIs

Annual Report – 44 pgs


Semi-Annual Report – 36 pgs


Group Annuity Contract – 33 pgs


Plan Level Documents – 58 pgs


Adm Service Agreement – 11 pgs


7 Documents

542 Pages

Moral Hazard

Found on one of 542 pages. Your plan assets spent on:

Payments for placement of funds on a Financial Intermediary’s list of mutual funds available for purchase by its

customers or for including funds within a group that receives special marketing focus or are placed on a “preferred list”;

“Due diligence” payments for a Financial Intermediary’s examination of the funds and payments for providing extra

employee training and information relating to the funds;

“Marketing support fees” for providing assistance in promoting the sale of fund shares;

Sponsorships of sales contests and promotions where participants receive prizes such as travel awards, merchandise, cash

or recognition; etc.

SAI Page 180 of 285

Revenue Sharing I

Revenue Sharing generally refers to a compensation practice in which money is paid to plan service providers out of the

401(k) investments, or by their managers (and affiliates.) It can be straightforward, hard to find, or hidden. Here are just

two types, the first of which is straightforward, and the second of which is sometimes harder to find:

12(b)(1) fees - Ongoing “trail” commission paid to sales company for distribution and service. Typically range between

0.25% - 1% and deducted from fund assets.

Sub-TA fees (Sub-Transfer Agency) – Asset-based fee and/or a per head fee and deducted from plan/fund assets. Intended

to pay for administration performed by an intermediary; e.g. record keeper or TPA.



Revenue Sharing I

Mutual Fund Share Class

Revenue Sharing I

$11,141.18 $3,941.08

Revenue Sharing I

$7,726.30 Hard Dollar

$11,141.38 12(b)(1) fees

$3,941.08 Sub-TA fees

$22,808.76 Total (67.7% higher )

$15,082.46 Undisclosed by service provider

Revenue Sharing IIGroup Annuity Separate Accounts

“Insurance-company charges sometimes range as high as two to four percentage points annually. Added to management

fees of the underlying investments, typically mutual funds, "You can be looking at annual charges of 3% to 5.5%...”

Matthew D. Hutcheson

Keller Rohrback is investigating 401(k) and 403(b) variable annuity plans for charging excessive and unreasonable fees,

and engaging in self-dealing through revenue sharing kickback schemes with the mutual funds providers selected for the

plans.

www.erisafraud.com

Revenue Sharing II

Revenue Sharing IIGroup Annuity Separate Accounts

Expense Ratio of underlying fund* 0.26

Administrative Maintenance Charge 0.50

Sales & Service Fee 0.25

= Expense Ratio of Separate Account 1.01

Base Charge 0.60

Participant Fee 1.00

Total Cost 2.61%

*Vanguard Value Index Fund, Investor Share

Info provided by: David Wade, 401k Direct. Uncovering Hidden Fees in Insurance Company 401ks

Techniques to Overcome These Challenges

Prudent Process

Prudent Expert

Delegation – Fiduciary Line of Defense



Finding Fiduciaries

Benchmarking

Total Retirement Outsourcing

Prudent ProcessInvestment Policy Statement

First step in Prudent Process

Most Fundamental Fiduciary Function

Supports the “paper trail.”

Keeps investment process intact during market volatility.

Provides working framework for fiduciaries

Sets guidelines for making investment decisions.

Negates “Monday morning quarterbacking.”

Prudent Process - Monitoring

Prudent Expert

“Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a

qualified, independent expert.”

DOL Reg. § 2509.95-1(c)(6)

“…where the trustees lack the requisite knowledge, experience and expertise to make the necessary decisions with respect

to investments, their fiduciary obligations require them to hire independent professional advisors.”

Liss v. Smith, 991 F.Supp. 278, 297 (S.D.N.Y. 1998)

Prudent ExpertERISA 3(21)(A)(ii)

Plan Sponsor

Recordkeeper

(service provider)

CPA/Attorney

(service provider)

TPA

(service provider)

Fiduciary Advisor

ERISA 3(21)(a)(ii)

Custodian

(service provider)

Fiduciary Delegation

ERISA section 402(c) allows for a plan sponsor to delegate fiduciary responsibility. A prudently selected and appointed

fiduciary can alleviate a plan sponsor from nearly all fiduciary liability. The one residual fiduciary responsibility is to



monitor the performance of the appointed fiduciaries.

An Investment Manager under ERISA 3(38)

An Independent Fiduciary under ERISA 3(21)

Fiduciary DelegationERISA 3(38)

Plan Sponsor Fiduciary Line Non-Fiduciary

of Defense Service Providers

Plan Sponsor

Recordkeeper

(service provider)

CPA/Attorney

(service provider)

TPA

(service provider)

Formal Appointment

ERISA 3(38)

Investment Fiduciary

Custodian

(service provider)

Fiduciary DelegationERISA 3(21) Full Scope

Plan Sponsor Fiduciary Line Non-Fiduciary

of Defense Service Providers

ERISA 3(21)

Full Scope

Fiduciary

Plan Sponsor

Recordkeeper

(service provider)

CPA/Attorney

(service provider)

Formal Appointment

TPA

(service provider)

Formal Appointment

ERISA 3(38)

Investment Manager



Custodian

(service provider)

Fiduciary Resources

www.e-Luminary.com

www.BrightScope.com

www.MyNRSP.com

SUMMARY

Identify & educate plan fiduciaries

Confirm in writing fiduciary & non-fiduciary service providers

Maintain a “Prudent Process”

Discover & evaluate all fees & compensation

Retain a Prudent Expert

Delegate to an Independent ERISA 3(38) or 3(21) Fiduciary

Monitor & Document

Fulfilling one’s fiduciary duties enhances the probability of retirement income security for one’s participants

Failure in fulfilling one’s fiduciary duties could be an extinction-level event for one’s firm, and financial ruin for the

fiduciary

Mark D. Mensack, AIFA®

Mark is a Managing Director and the Chief Ethics Officer of Piedmont Independent Fiduciaries, a Fee-only SEC

Registered Investment Advisory firm. With more than 15 years experience in financial services and a background in

ethical philosophy, Mark focuses on the ethical imperative of fiduciary responsibility to educate plan sponsors and other

fiduciaries on their fiduciary duties. As an independent fiduciary, Mark assumes ERISA 3(21)(a)(ii) and/or ERISA 3(38)

status in order to protect and enhance the retirement income security of retirement plan participants.

Piedmont Independent Fiduciaries

Managing Director,

Chief Ethics Officer

T: 856 528 9524

E: [email protected]

Joanne Szupka, CPA

Joanne Szupka has over 13 years of accounting experience with regional and national public accounting firms in areas of

employee benefit plans. She has been responsible for all areas related to audits and reviews of single employer,

multiemployer and multiple-employer sponsored plans, including defined benefit, defined contribution and health and

welfare benefit plans.

BDO USA, LLP

Assurance Manager,



Employee Benefit Plan Specialist

T: (215) 636 – 5591


Roland J. O’Brien, CPA

Roland O’Brien has over 25 years of accounting experience with local, regional and national public accounting firms. He

has been responsible for all areas related to the audits and reviews of single employer, multiemployer and multiple-

employer sponsored plans, including employee benefits, qualified retirement, health and welfare and fringe benefits plans.

Roland has been responsible for creating and presenting technical training programs, as well as providing quality

assurance services related to employee benefit plans.

BDO USA, LLP

Director,

Employee Benefit Plan Practice

T: (215) 636-5778


Robert Lavenberg, CPA, JD, LL.M

Bob Lavenberg has more than 25 years of experience with the Employee Retirement Income Security Act of 1974

(ERISA) and related business advisory services. His expertise spans reporting, government compliance and assessment of

tax implications for plans, including employee benefits, qualified retirement, health, welfare, and fringe benefits. Bob

currently serves as the Chair of the AICPA Employee Benefit Plan Audit Quality Center Executive Committee and is a

former member of the AICPA Employee Benefit Plan Audit Expert Panel.

BDO USA, LLP

National Partner in Charge of Employee Benefit Plan Audit Quality, Chair of AICPA’s 403(b) Plan Audit Task Force

T: (212) 885-8313


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Fiduciary responsibilities-an

Documents

chief ethics officer

employee benefit plans

retirement income security

including employee benefits

employer sponsored plans

prudent process

fiduciary responsibility

plan sponsor