The Truth About Fiduciary Duty Delegation

In early February, President Donald Trump signed an executive order that could well derail the final implementation of the Department of Labor’s fiduciary rule, which requires financial advisors to act as fiduciaries when dealing with Individual Retirement Accounts as well as pension plans and defined contribution plans.

The executive order directs the Labor Department to “prepare an updated economic and legal analysis” of whether the rule is going to disrupt the industry and raise costs for investors.

Although the rule has not been set aside, its full implementation will likely be delayed, which may come as an enormous relief to some advisors. But those advisors who want to serve the $4.8 trillion 401(k) market (according to the ICI) still need to be prepared to comply with fiduciary requirements. And yes, that’s trillion with a ‘T’.

In the past, you may have avoided working with clients’ 401(k) assets so you would not be subject to ERISA, the complex pension legislation enacted in 1974. But today, as many clients approach retirement age and need to strategize about turning their 401(k) assets into an income stream, advising on 401(k)s is hard to avoid. What’s more, as employment continues to improve nationwide, more and smaller firms are offering 401(k)s as a way to compensate and retain their talent. Business owners need advice and help setting up a plan. So it’s a good time to take a look at the enormous and growing 401(k) market.

If you are new to 401(k) advice, be aware that expert outsourcers are here to help you out. (Full disclosure—I am president of a firm that does exactly this.) 

How Outsourcers Handle Fiduciary Duties
Fiduciary outsourcers can help you with investment selection and monitoring, reporting and educational materials for plan participants. They can shoulder almost all fiduciary responsibility for both the advisor and the plan, based on how much you delegate. These outsourcers typically integrate tightly with third-party administrators who keep and distribute plan records and maintain compliance with the laws.

Fiduciary responsibility entails several specific duties, most of which you’ve read about. There’s the ethical principle of serving clients’ interest before your own, often termed as the ‘duty of loyalty.’ There are also the duties of care, diligence, prudence and competence. Conflicts of interest are to be avoided or managed in the client’s favor. You know what these words mean, but as legal terms, they require specific actions. Omitting these actions, or doing them poorly or dishonestly, can result in civil or even criminal sanctions.

Investment selection, however, is another thing entirely, and the meat of your engagements if you advise 401(k) plans. Choosing a menu of investments, monitoring them and switching out investments that do not perform—in partnership with a plan sponsor’s investment committee—is a complex assignment. You can delegate a portion of it, or all of it, to an outside firm. The method you choose depends on how much responsibility both the plan sponsor and you are willing to bear.

Pick a Rule
Delegating your fiduciary responsibility doesn’t completely eliminate your role. As the advisor, you work closely with the plan sponsor to make essential choices about the plan, such as creating an Investment Policy Statement. Then the outsourcer works to execute your decisions according to one of two rules: ERISA 3(21), under which the outsourcer acts as a Co-Fiduciary, or ERISA 3(38), under which the outsourcer acts as a Discretionary Asset Manager.

The 3(38) delegation is the highest level of discretion over the plan, and gives the manager the power to select, monitor and change the lineup of investments. This discretion isolates the plan sponsor from investment decisions and allows the manager to apply their expertise fully. An ERISA 3(21) delegation, which makes the outsourcer a co-fiduciary, will offer recommendations and expertise to the plan sponsor, who holds the ultimate decision-making power.

At no point can the plan sponsor, nor the advisor, completely evade responsibility, however. Even you decide on full fiduciary delegation, the sponsor is still charged with selecting competent asset managers and monitoring their performance—and will expect your help.

The chart below shows a full spectrum of fiduciary arrangements you can work with.

Click to enlarge

If after its review is complete, and assuming court challenges fail, the Department of Labor does finally implement its fiduciary rule, advisors will be looking at similar fiduciary requirements when they manage all retirement accounts, including clients’ Individual Retirement Accounts.

Now, we’re talking about a $7.8 trillion dollar market, which, combined with 401(k)s and other defined contribution plans, form the bulk of Americans’ retirement assets.  Politics aside, the rule will radically change the way many advisors do business—and change always brings opportunity.

For that reason alone, it’s smart to start looking at fiduciary outsourcers now. 

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See Nicole Newlin's previous blog posting, The Myth of Beating the Market.

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