THE FORK IN THE ROAD
Implications of The Pen sion Protection Act of 2006 And the Evolution of
Fiduciary Respon sibility
AN ARTIFEX FINANCIAL GROUP WHITE PAPER
Doug Kinsey, CFP®, AIFA®
Darren Harp, AIF®
28 Eas t Ra h n Road , Sui t e 209 , Dayto n O H 4 5429 • t el e p ho n e :9 37.660 .8316 • f ax : 480 .287 .9566
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You stand at the fork in the road
The road on the left represents doing nothing - the path of least resistance. It’s a well-traveled road, used by
many sponsors of retirement plans over time. It provides for your basic needs, but may cause you to encounter
many more potholes and dangers than the road less traveled.
The alternate route takes some additional thought and due-diligence, while embracing change for the benefit of
yourself and your employee participants. Once embarked upon, the path is smooth and enables you to travel
more safely and swiftly toward your destination - a fruitful retirement.
As a retirement plan sponsor, you are witnessing a time of unprecedented change and volatility in the
financial services industry. Traditional providers of 401(k) plans are swept up in rapid evolution and
regulatory scrutiny as a result of misconduct, market turmoil and technological innovation. How do you
respond to this “creative destruction” and what steps should you take to ensure the well being of your
employee participants as well as yourself? In this white paper, we will address the changes taking place and
identify potential pitfalls and opportunities presented by this time of change.
Evidence of the growing importance of the role of Fiduciary can be seen in a variety of ways within the
financial planning and investment communities. Consider these developments that have occurred in the last 10
The Center for Fiduciary Studies at the Joseph M. Katz Graduate School at the University of Pittsburgh was
established in 1999 to evaluate and promote “best practices” for fiduciaries, including retirement plan
In 2007, the successful challenge of the “Merrill Lynch Rule” by the Financial Planning Association has
prompted a thorough critique and analysis of the non-fiduciary status of Wall Street brokerage firms.
Effective July 2, 2008, revisions to the CFP Code of Ethics that recognize and codify a Fiduciary
Responsibility on the part of CFP Certificants.
The “Focus on Fiduciary” campaign initiated by the National Association of Personal Financial Advisors.
An increasing awareness by the plaintiff’s bar of breaches of fiduciary duty and a noticeable rise in classaction lawsuits against retirement plan sponsors.
Possibly most importantly for employers offering 401(k) plans, the passage of the 2006 Pension Protection
We will make the argument that following sound fiduciary principles will enhance investment performance
and efficiency over time and reduce the exposure to plaintiff lawsuits.
Before we go on, perhaps a definition of Fiduciary is in order. According to Encyclopedia Britannica, a
“In law, a person who occupies a position of such power and confidence with regard
to the property of another that the law requires him to act solely in the interest of the
person whom he represents. Examples of fiduciaries are agents, executors and
administrators, trustees, guardians, and officers of corporations...”
The Center for Fiduciary Studies defines an Investment Fiduciary as:
“Someone who is managing the assets of another person and stands in a special
relationship of trust, confidence, and/or legal responsibility.”
It should be noted that anyone who sponsors, makes purchase or investment decisions, hires advisors,
provides investment advice, or manages money for a corporate retirement plan is considered to be in a
Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;
Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same,
And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.
I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.
--Robert Frost, The Road Not Taken - 1920
How did we get here?
In the beginning, the 401(k) concept was born. Many would say that the idea of a retirement plan that
provides additional opportunities for employees to invest and save toward their own retirements while
taking advantage of the United States tax code was a giant leap forward. When these programs were
originally developed, insurance companies were the main providers. The investment vehicle of choice was a
“group annuity” with individual subaccounts that resembled or mirrored mutual funds. The primary
advantage to the employer was that it was a “bundled” plan that provided all of the record keeping,
valuation, testing, and investment options in one program. The fees and expenses could basically be buried
within the accounts so the participants wouldn’t be bothered with such trivialities as advisor,
administrative and investment manager compensation. The advantage to advisors was that all you really
needed to have to sell on of these plans was a state life insurance license.
The banks and stock brokerage firms soon got into the game, and also provided their own brand of “bundled”
401(k) programs that provided similar advantages (and disadvantages) to the participants and sponsors.
Over time, corporations increasingly replaced traditional “defined benefit” pension plans with these new
plans that share responsibility with the employee for their retirement well-being.
Many employers were not fully aware of the fiduciary responsibilities of offering and managing these plans
and are just now starting to educate themselves on “best practices”. Commissions and high expense charges
were collected by money managers, administrators, banks, insurance companies, and brokers. “Trusted”
financial advisors rushed to the party to provide their business owner clients with their version of a
packaged 401(k) plan. Very little attention was paid to real due diligence. Meanwhile, the stock market kept
roaring ahead, so why worry about these plans? The participants will be just fine...all they have to do is put
all their money into technology stocks, right?
With the bursting of the stock market bubble in 2000-2001, regulatory attention became focused on the
investment and securities industry. Eliot Spitzer began his investigations into all manner of improprieties
and inattention to fiduciary responsibility. Financial planners who believed in acting as fiduciaries began to
voice their opinions about the state of the industry. The Center for Fiduciary Studies was founded.
Morningstar created “Investment Stewardship reviews and ratings”. The CFP Board began to reconsider the
importance of Fiduciary within their Code of Ethics, and the Financial Planning Association successfully
sued the Securities and Exchange Commission over rule 202 (a) which exempted brokers licensed with the
NASD from registering as investment advisors when delivering financial planning advice and further called
into question their acceptance of their roles as fiduciaries for their clients.
Today, employee participants are becoming more aware of their rights as beneficiaries of corporate 401(k)
plans and employers are becoming more aware of their responsibilities. After all, a sizable portion of the
assets in these plans belongs solely to the participants - it is the employee deferrals that predominantly drive
the asset growth in 401(k) plans. The employer’s role as plans sponsor is strictly that of fiduciary for the
Where are the Potholes and Washouts?
We have reviewed all of the developments that effect your role as a retirement plan sponsor and offer the
following summary of 10 potential dangers for fiduciaries:
1. The plan has not been reviewed in the last year by an independent, fiduciary consultant. Preferably a
professional with one of the following designations:
Certified Financial Planner® who is also a Registered Investment Advisor and/or a
member of the National Association of Personal Financial Advisors (NAPFA), the only
advisor association that is truly “fee-only”.
Accredited Investment Fiduciary®
Accredited Investment Fiduciary Analyst®
Certified Public Accountant (CPA)
An actuary specializing in employee retirement plans
2. All plan fiduciaries have not been identified and a formal process for selecting, monitoring, and
reporting on the various investment choices has not been established.
3. An Investment Policy Statement has not been created at the plan level, and at the portfolio level (if
4. If an Investment Policy Statement exists, it is not being adhered to in terms of monitoring, performance
benchmarking and making investment decisions.
5. Procedures benchmarks, and monitoring criteria have not been identified regarding investment options,
service providers, plan expenses, investment expenses, and vendor compensation.
6. Investment decisions are not delegated to prudent, fiduciary advisors.
7. Safe harbor provisions are not being followed.
8. Number and type of investment vehicles are not appropriate for the plan size, number of participants,
and/or sophistication level of participants.
9. Regular periodic reviews of the investments are not being prepared and presented to the plan
10. The plan allows for education or investment advice, but it is not delivered by either an automated
model or a qualified fiduciary advisor.
This may seem like a daunting task, and the Center for Fiduciary Studies has actually identified 46 “best
practices” that a prudent plan fiduciary should consider incorporating as proof that they adhere to a
“defined global fiduciary standard of excellence”. The upside is that by educating yourself and following
these guidelines, your investment performance should be improved over the long-term, while reducing
Your Compass Rose
To find your way in your fiduciary journey, rely on a carefully designed investment policy statement (IPS)
that accurately reflects the various goals, benchmarks, processes, selection criteria, limitations, and ongoing
due diligence that you will follow as a plan sponsor. Don’t rely on a template IPS that is loaded with
terminology and criteria that either don’t adhere to a fiduciary standard or with which you cannot possibly
To start with, you should contact an independent fiduciary advisor for an initial consultation and review of
your IPS, Summary Plan Description, latest 5500 filing, investment choices, fees and participation statistics.
The advisor should then advise you as to whether or not your IPS should be amended and if your plan should
be thoroughly reviewed and possibly redesigned. If your plan is large enough, consider hiring a consultant to
provide a CEFEX (Center for Fiduciary Excellence) certification that involves a documented review and a
certification based on an internationally recognized ISO registration process.
The destination should be to have a 401(k) plan that adheres to fiduciary best practices which will provide
you with a defensible position and better-performing investment vehicles. The IPS and the criteria identified
within this document are truly your compass rose which will keep you on your selected path.
Let’s take a look at a sample investment selection and some of the criteria that identify a top-performing
fiduciary fund on the next page.
This is a recent fund summary report that illustrates some of the criteria that should be incorporated into an
investment due diligence process and an effective investment policy. Our firm utilizes a tool which integrates
selected IPS requirements into the monitoring process so that the fiduciary due diligence that a plan sponsor
or advisor says they are performing is actually followed. General statements and limitations regarding
performance and timeframes, ratios, fund composition, fees and expenses, etc. can be defined in the IPS.
At the time of this report, Brandywine Blue represents a fund that exceeds the fiduciary criteria in practically
Perhaps you’ve heard the Boy Scout motto once or twice in your lifetime. It’s actually one of the best things a
young person can learn. The various lessons taught by the Boy Scouts tend to favor outdoors activities, such
as planning a hike or being prepared in case you are involved in an emergency of some sort (getting lost or
injured, for example). We may never need to rely on our preparations, but we have to be ready nevertheless.
Imagine starting a journey without first plotting your course. Doesn’t make much sense, does it?
This may not be the most exciting thing for a young person to learn, but by the time we reach adulthood, we
understand the importance of that simple phrase. Many young people (and some adults) test this motto at
various times of their lives. Ever flunk a midterm or final exam? How about that term paper that you didn’t
score too highly on? What about that client presentation that you waited until the last minute to prepare for?
Not many of us need to learn the lesson more than once.
“Being prepared” when it comes to investments and serving as a fiduciary is not very exciting either, however
positive differences in performance have been documented as a result of following a diligent and robust
To illustrate this potentially large benefit, we show an actual plan review in Exhibit A that we conducted
this year for a client. Although the data is historical in nature, it shows how adherence to best practices can
enhance returns and reduce costs.
In this case, the plan had never been reviewed by an independent fiduciary and was currently advised by a
broker with a large New York brokerage firm. The administration firm was a national payroll firm and the
mutual funds available on the custodial platform were very limited. The client employs 300+ people
throughout Ohio with various levels of investment knowledge.
By hiring us to perform a thorough analysis and provide recom
mendations, the client and the employee
participants will realize the following benefits:
• Lower investment costs – on average, the expense ratios of the funds selected are over 1.33% less with
the recommended plan.
• Better historical and expected returns - looking at the average returns over a 5-year period, the
recommended funds have outperformed the existing funds by 8.20%.
• Significantly better historical Alpha (manager outperformance) and Sharpe (risk-adjusted
performance) ratios, which can add substantiation to return analyses.
• Much lower portfolio turnover rates, which can significantly impact the costs to the fund portfolios
(as trading costs and commissions are not part of mutual fund expense ratio reporting).
• Overall costs to the plan were reduced by .95% (including the fees for administration/recordkeeping
and for ongoing fiduciary investment advice and monitoring).
• Ongoing access to education provided by independent fiduciary advisors.
This is typical of the results that can be obtained by incorporating a fiduciary process into your plan and
ensuring that you are taking advantage of the latest technological and design flexibility that is now available
in the marketplace. We encourage you to contact us if you would like to discuss your situation in more detail,
or if you simply have questions about anything contained in this report. We are happy to serve as your
guides on your fiduciary journey and help you to arrive safely at your destination!
Foundation for Fiduciary Studies: http://www.fi360.com/main/foundation_studies.jsp
Certified Financial Planner Board of Standards, Inc.: http://www.cfp.net/aboutus/Standards.asp
Press Guide to the Pension Protection Act (Fi360): http://www.fiduciarystudies.com/press/pdfs/ppa.pdf
National Association of Personal Financial Advisors (NAPFA) Focus on Fiduciary Website:
Financial Planning Association (FPA) Challenge to SEC Broker-Dealer Rule:
Link to summary of recent 401(k) plan lawsuits:
Department of Labor Pension Reform Website: http://www.dol.gov/EBSA/pensionreform.html
Current Investment Options
BlackRock International Value B
Evergreen Core Bond B
Loomis Sayles Core Plus Bond B
Davis NY Venture B
BlackRock Fundamental Growth B
Van Kampen Aggressive Growth B
Oppenheimer Quest Balanced B
BlackRock Value Opportunities B
JPMorgan Dynamic Small Cap B
BlackRock Global Allocation B
Sample Co. 401(k) Plan
1 Yr Rtn 3 Yr Rtn 5 Yr Rtn Expense Ratio
Foreign Large Value
Recommended Investment Options
Dodge & Cox International Stock
Dodge & Cox Income
Fidelity Spartan Total Market Index Inv
T. Rowe Price Growth Stock
Vanguard Windsor II
Vanguard Mid Capitalization Index
T. Rowe Price Balanced
Vanguard Short-Term Investment-Grade
Northern Small Cap Value
T. Rowe Price Retirement 2025
1 Yr Rtn 3 Yr Rtn 5 Yr Rtn Expense Ratio
Foreign Large Value
This scenario is derived from actual analysis of a corporate 401(k) plan reviewed by Doug Kinsey in May of 2007. Plan was advised by a major NY Brokerage firm and
a national payroll firm provided the administration. The client opted for an unbundled solution incorporating the recommended investment options and customized
(1)Averages are simple averages of all funds included in the plan divided by the number of funds.
(2)Difference represents the advantage provided by the recommended mutual funds over the current funds
Data provided by Fiduciary Analytics, Inc.