New Handbook Outlines Prudent Practices For Fiduciary Advisers

By James Eccleston

he Financial Planning Association (FPA) has published a handbook containing practice guidelines for "Fiduciary Advisers" as that term is defined in the Pension Protection Act of 2006. The FPA states that the handbook "represents a standard of excellence for fiduciary advisers." As such, it is a must-read for anyone providing investment advice to pension plan participants or beneficiaries with respect to plan assets for fees or other compensation, including those fiduciary advisers employed by trust departments, insurance companies, brokerage firms, registered investment advisers and any agents or affiliates.

The handbook defines "prudent, or best, practices", and it is organized under a four-step investment management process. The four steps are: (1) Organize; (2) Formalize; (3) Implement; and (4) Monitor. Each practice falls within one of those four steps. For each practice, there are "criteria" that define the scope or detail of each practice. Sometimes, a "suggested procedure" is provided to demonstrate how a particular practice should be implemented.

Let's examine the more important practices, criteria and suggested procedures under the four-step investment management process.

Under the first step (Organize), Practice A-1.2 provides that investment advice must be in accordance with applicable laws, trust documents and written investment policy statements (IPS). This best practice emphasizes that investment advice must be appropriate, and must reflect "definitive goals and objectives with the participant and beneficiary that are consistent with the scope of the engagement."

Likewise, Practice A-1.4 provides that the fiduciary adviser must adhere to the general fiduciary standards of loyalty and care under ERISA, the Pension Protection Act and other applicable laws. Important guidance includes the fiduciary adviser's reviewing his/her client agreement and IPS at least annually to ensure consistency with the needs of the client, having legal counsel review amendments to the client agreement as well as to the "eligible investment advice arrangement" (the written agreement between the plan sponsor and the fiduciary adviser), and conducting an independent audit to determine if the fiduciary adviser has any compliance deficiencies.

Under the second step (Formalize), Practice A-2.1 states that the fiduciary adviser will analyze investment options and review them with the client. The review should include discussing passive versus active investment strategies, as well as the risks of market timing. Moreover, the review should include the advantages and disadvantages of investing in an employer stock fund (if available). The review should be documented.

Additionally, Practice A-2.2 provides that the fiduciary adviser should identify and document the investment time horizon for the client. This includes the "sources, timing, distribution, and uses of the client's current and future projected cash flows from the portfolio." It also includes identifying and discussing whether or not there are sufficient liquid assets to meet contingency plans or emergencies.

After complying with Practice A-2.3 (identifying and discussing the client's risk tolerance) and Practice A-2.4 (indentifying, discussing and documenting the client's expected investment return necessary to meet the client's investment objectives), Practice A-2.5 suggests the procedure by which advisers should recommend particular asset classes for the client. Appropriate diversification, considering time horizon, risk tolerance and investment objectives, is required.

Finally, Practice A-2.6 states that the "preparation and maintenance of a client's investment policy statement (IPS) is one of the most critical functions performed by the fiduciary adviser, even if it is not stipulated by law or regulation." The best practice recommends utilizing an IPS because, among other things, it sets forth the duties and responsibilities of all parties involved, defines diversification and rebalancing guidelines, defines the due diligence criteria for selecting investment options within the qualified plan, and defines the monitoring criteria for the investment options.

Under the third step (Implement), Practice A-3.1 suggests that the fiduciary adviser assist the client in understanding the implementation process. Practice A-3.2 requires fiduciary advisers to comply with the "safe harbor" provisions of the Pension Protection Act.

Under the fourth step (Monitor), fiduciary advisers are called upon to keep the client informed of material information. Accordingly, Practice A-4.1 obligates fiduciary advisers to provide periodic reports to clients which compare investment performance against an appropriate index or peer group and against the objectives of the IPS. A "watch list" of underperforming investments is encouraged, and the fiduciary adviser should advise the client how to periodically rebalance investments in the portfolio.

Likewise, Practice A-4.2 recommends that the fiduciary adviser periodically evaluate the qualitative and/or organizational changes of investment managers or other investment decision-makers which may affect the investment offerings within the plan, including corporate stock of the plan sponsor. Fiduciary advisers are expected to notify the client in writing of any unsatisfactory news regarding a material holding in the client's portfolio.

Finally, Practice A-4.3 requires the fees paid for advisory services to be reasonable and consistent with agreements and with all applicable laws. Fiduciary advisers must periodically examine fees, and also must compare them periodically to industry peer groups and/or benchmarks.

As one can see, the FPA's new handbook, "Prudent Practices for Fiduciary Advisers" is a laudable effort to implement best practice standards in this very important area of investing.

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James Eccleston, an attorney specializing in adviser and broker-dealer issues, is a partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston in Chicago.