Mistakes Consultants Make By: Gabriel PotterMBA, AIFA® 2014.06.18

Last week, we focused on investment consulting.  This week, we’re going back to our fiduciary focus.  Long time readers of our blogs, and articles will know that we present fiduciary education – in accordance with our trademark – to “promote a culture of fiduciary responsibility”.    

We encourage best practices for everyone:   clients, peers, competitors, and so on.  So, we find it a little distressing when we notice mistakes being made by peers in the industry.  Lately, we’ve seen several investment focused consultants make a key mistake and we wanted to highlight it.  Specifically, they’ve been breaking a rule of fiduciary engagement.  Here is the basic rule:   a consultant shouldn’t act as a fiduciary to both the plan and the participants.   Investment focused consultants have sometimes adopted roles which are inappropriate, not out of malice, but with the best intentions.  They simply “don’t know what they don’t know”.

Under some circumstances, consultants can provide limited education to both, which conforms to the suitability standard.  Consultants can certainly act as a fiduciary to either the plan sponsor (or investment committee, or other named fiduciaries) or the participants, but a consultant cannot act as a fiduciary to both parties.

Why is this so?  A plan fiduciary – i.e. a member of the investment committee or a consultant - is supposed to act solely in the interest of plan participants, so what is the problem with advising participants directly?  In fact, a fiduciary is explicitly prohibited from “act[ing] in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants.” [ERISA Sec. 406(b)].  What is the conflict here?

To understand the potential conflict of interest, let’s look at what the requirements of being a fiduciary are.  The key legal requirement being breached is the duty of loyalty.  Specifically, “the distinguishing or overriding duty of a fiduciary is the obligation of undivided loyalty.” [Australian Securities and Investments Commission vs. Citigroup Global Markets Australia Pty Limited].

Now, let us consider the potential for legal problems inside the scope of retirement plan management.  As fiduciaries, the guidelines are defined by legal precedent.   There are many legal cases which demonstrate the potential for dispute, and therefore, a conflict of interest between the plan participants and plan fiduciaries.  (For example, some lawsuits brought by retirement plan participants against plan sponsors include Bidwell vs. University Medical Center, Gerald George vs. Kraft Foods, and Tussey vs. ABB Inc.)  Within these cases, an investment consultant typically advocates on behalf of named plan fiduciaries while the plaintiffs are typically the employees.  Thus, a consultant cannot act or advocate on behalf of both plan fiduciaries and represent an independent duty to plan participants. 

A fiduciary is required to avoid situations where his fiduciary duty conflicts with another fiduciary duty.  In other words, it’s like having a trial lawyer trying to represent both the plaintiff and the defense.  Loyalty is divided and this expressly prohibited from the fiduciary standard. 

Like any basic rule, there are exceptions.  For example, the aforementioned ASIC vs. Citigroup case, provides an exception for “informed consent” on behalf of fiduciary breaches of duty but, practically speaking, the participants’ best interests are not being served by actively avoiding accountability through a technicality of the law.  It isn’t a best practice to avoid protecting the participant’s best interest.  Instead, the best practice would instead be a clear division of duties, with advocates for both sides.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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