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June 08, 2017 at 05:06 AM
I don’t believe the required disclosures associated with the DOL’s Conflict of Interest Rule will pose the greatest liability for firms. It will be the organizations’ inability to demonstrate their procedural prudence that will put firms at risk.
Many organizations are suffering from target fixation. This is a military term to describe a situation where a pilot becomes so absorbed in hitting their target that they lose track of their heading and altitude and actually crash into their objective.
It’s not surprising that firms are fixated on the rule. It’s long, complex and bears no resemblance to established fiduciary best practices or generally accepted investment management principles. So too, the majority of new “fiduciary” training programs are focused almost exclusively on the intricacies of the rule, and not on a fiduciary standard of care.
What most industry observers have overlooked is that besides the rule’s disclosure requirements, a firm also will have ongoing responsibility to demonstrate that their advisors, brokers and agents are procedurally prudent. Simply defined, procedural prudence is a legal term that requires a fiduciary to demonstrate the details of a prudent decision-making process.
Procedural prudence is the bedrock of an ERISA fiduciary standard of care, and has been for more than 40 years. It has been the wellspring for the development of our industry’s generally accepted investment management practices. For example:
- Procedures for identifying a client’s goals and objectives.
- Protocols for diversifying a client’s portfolio.
- Procedures for preparing a statement of a client’s investment strategy.
- The development of peer groups and due diligence criteria for analyzing money managers.
- Procedures for controlling and accounting for a client’s fees and expenses.
- Protocols for monitoring procedures and for preparing periodic performance reports.
The plaintiffs’ bar is very familiar with the above practices, which often serve as a checklist during discovery and depositions. What contributes most to fiduciary liability is often an omission, as opposed to a commission. It’s not what the fiduciary did, but what the fiduciary forgot to do.
Where there is widespread agreement is that the rule is going to expose the industry to significantly more litigation. Industry executives are concerned that the rule’s paperwork and complex disclosure requirements will be the primary source of liability.
