Philip Chao, Principal and Founder of Chao & Company, recently published an article for InvestmentNews on the DOL Investigation of Matthew D. Hutcheson and its implications for the fidicuary standard. For your convenience, the article is reproduced below, or you can find it online by clicking the following link: http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20120108/REG/301089991
Recent reports concerning a Labor Department investigation of Matthew D. Hutcheson may have disturbing implications for the movement to require a fiduciary standard for those dealing with retirement plans.
Mr. Hutcheson, who founded Independent Fiduciary Training LLC to teach financial professionals how to be independent fiduciaries under the Employee Retirement Income Security Act of 1974, allegedly breached his duties as an independent fiduciary to a number of retirement plans that he serves.
An article in InvestmentNews (Nov. 20) noted that the DOL’s probe of Mr. Hutcheson, “a high-profile 401(k) fiduciary advocate, could cost advisers business,” and suggested that the investigation “is raising fears that small businesses will shy away from offering plans or from turning to advisers.”
The article went on to say that the “investigation is a concern to the retirement industry, as it comes at a time when regulators and legislators are preparing to clash over the Labor Department’s upcoming re-release of a rule that would expand the definition of “fiduciary’ for retirement plans. As a result, some have questioned whether the investigation will set back efforts in the push for higher standards. Others expect greater skepticism and scrutiny coming from plan sponsors who are looking to hire an adviser or adopt a retirement plan.”
Regardless of the outcome from Mr. Hutcheson’s experience, it is a stretch to suggest that this one case slams the brakes on efforts by small employers to sponsor ERISA retirement plans or to use financial advisers. Even if he is found guilty of all the alleged malfeasance, breaches, indiscretions, fraud, poor judgments and failures, such a case doesn’t and shouldn’t have the purported impact.
ONE CASE DOES NOT REFUTE PRINCIPLE
To further suggest that this one case may negatively affect the much-needed push for a higher standard among investment advisers is that much more incoherent. This line of thinking either assumes too much influence on the part of Mr. Hutcheson or demonstrates a lack of understanding and appreciation for the fiduciary standard (either the best-interest standard under the Investment Advisers Act of 1940 or the sole-interest standard under the ERISA regime).
Bernard Madoff, the disgraced Ponzi scheme operator who defrauded billions of dollars from investors, served as chairman and on the board of governors of NASD, the predecessor to the Financial Industry Regulatory Authority Inc. Does this mean that we should distrust every member of the Finra board or disband Finra?
Mr. Madoff was held to a higher standard of trust. In a position of power (real or imagined), he exploited the trust that his investors bestowed upon him and his firm.
This example shouldn’t lead us to suggest that we as a society are so simple-minded that because there are those who wronged us by exploiting our vulnerabilities, we should tear down institutions and core values that protect us.
Under a retirement plan, the plan sponsor or plan administrator is in a place of power and should be held to the highest standard. Employees’ retirement assets, either through voluntary contributions or through employer contributions, are entrusted to the plan administrator.
As a fiduciary, the plan administrator has an obligation to meet the fiduciary standard promulgated under ERISA. The basic obligation of a plan sponsor/plan fiduciary is to:
- Operate without conflicts. A fiduciary must discharge his or her duties in the “sole interest” of the participants and beneficiaries.
- Do what you say you will do. Maintain and adhere to an ERISA-compliant written plan and for the “exclusive purpose” of providing benefits to the participants and -beneficiaries.
- Don’t put all the investment eggs in one basket. Invest or make investment options available that would minimize risk of asset loss through asset diversification.
- Clearly understand that it is somebody else’s money. A fiduciary has the duty to select and monitor service providers prudently, and control plan expenses.
These four requirements are straightforward and reasonable. Every investor (in this case a participant or a beneficiary to a retirement plan) should expect no less from any person in a position of trust who has the discretion to administer or manage their money.
To provide further fiduciary guidance, ERISA Section 404 offers the “prudent-man rule,” where a fiduciary must operate “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” This principles-based standard has been refined over the years and is now often referred to as the “prudent-expert standard.”
In Marshall v. Snyder, the 2nd U.S. Circuit Court of Appeals in 1978 recognized that the prudence standard “is not that of a prudent layperson but rather that of a prudent fiduciary with experience dealing with a similar enterprise.” And in Donovan v. Cunningham, the 5th U.S. Circuit Court of Appeals in 1983 stated: “A pure heart and an empty head are not enough.”
Most retirement plan fiduciaries don’t think that they have the skill or experience to serve as a prudent expert, and rightfully elect to appoint professional investment fiduciaries to serve in that capacity. These investment fiduciaries, as so defined under ERISA Section 3(21) or 3(38), also have to adhere to the same set of standards.
THE HUTCHESON CASE
In the situation that has come under scrutiny, Mr. Hutcheson created a multiemployer retirement plan structure where the plan sponsor appointed him as the ERISA 3(16) plan administrator to have complete discretion over all administrative, management and investment fiduciary duties.
The problem with this approach is that the plan sponsor still has an obligation to prudently monitor the plan administrator — Mr. Hutcheson — yet gives up all control of the plan. If he is found guilty of the charges, there will be no question that he has fiduciary obligations to the plan.
Thus the fiduciary and personal liability under ERISA Section 409 applies, but the plan sponsor also may share in the fiduciary obligation if the plan sponsor is found to have failed to have prudently selected and then prudently monitored Mr. Hutcheson, the service provider.
Having discretion over and managing other people’s money carries a heavy burden. No law or rule can prevent any fiduciary from intentionally doing harm or failing to comply.
After all, any set of laws is to keep honest people honest and set the penalty so great that it discourages bad behavior. Even if Mr. Hutcheson is found to have violated his fiduciary duties, an outcome that would be personally tragic, the result should have no effect on the arguments for raising or expanding the standard for all those who offer investment advice to the public.
In fact, the Hutcheson episode reminds plan sponsors to be better stewards, and to prudently select and monitor all service providers and appoint fiduciaries. Although appointing an independent Section 3(16) plan administrator may seem to make sense instinctually, independent checks and balances must also be installed to prevent concentration of authority and power.
Plan sponsors are dealing with other people’s money, and as fiduciaries, they can never be careful enough.
The only two things I have learned from the developing Hutcheson story are 1) minimize the incentives and opportunities for anyone to take inappropriate courses of action; and 2) trust but verify.
Strengthening and applying the fiduciary standard should be the battle cry of all investors. They should expect the highest standard from their retirement plan investment advisers, who should be working without conflict and in their sole interest.
Philip Chao (pchao@chaoco.com) is principal of Chao & Co. Ltd.