With the DOL‘s new fiduciary rule and the introduction of the Best Interest Contract prohibitive transaction exemption, questions have arisen regarding the definition of reasonableness when a fiduciary deals with plan fees and costs. Many practitioners and observers suggest that, especially in light of all the new ERISA fee litigations, reasonable fee needs a DOL definition and that reasonable fee is synonymous to lowest fee.
Some observers want to have a black and white rule for fiduciaries to simplify their reasonable fee decision. To set such a rule requires ceteris paribus. If every aspect of the relationship, services, advice, contract terms, and value is identical among the providers, then the only variable would be the cost in delivering the service. Under this scenario, the lowest cost provider would be the “reasonable” fiduciary choice.
I must say that during my years in providing wealth/investment management and fiduciary investment consulting services, I do not recall a single scenario where I can honestly say that ceteris paribus existed. I believe the law and regulations understand that in practice, “other things being equal” is not the condition under which a fiduciary or an investor would face when making a fee decision. This is one of the reasons that the ERISA fiduciary standard applies to retirement plan fiduciaries making any decisions. Under Section 404(a)(1)(B), a fiduciary must act “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 implies that a fiduciary is not armed with all the facts when making a decision. Without all the facts, the condition of ceteris paribus cannot be met. A fiduciary, or for that matter any investor, operates at best with incomplete information. Even for fees and expenses, looking backward alone is not indicative of future value and experience. It is not the measurable variables a fiduciary must be concerned with, but also the qualitative factors in making a hiring or selection decision.
ERISA fiduciary framework allows each fiduciary to make informed and reasoned decisions under the circumstance for the sole interest of the participants. This includes the duty to make prudent selection and monitoring decisions. Controlling plan expenses, which includes investment expenses, is an important duty since it materially affects the outcome of the investment over time and the duties of loyalty and prudence dictate caution. It is common knowledge that under ERISA, and the SEC, hiring the lowest cost provider is not a required decision factor.
The use of a “reasonable” standard forms the guardrails for fiduciaries to analyze costs is the right approach. The system rightfully places the decision to hire service providers or selecting investments squarely on the fiduciary shoulders. Taking away a fiduciary’s ability to make informed and reasoned decision and defaulting to a lowest cost framework would be harmful to those who entrusted their money to the fiduciary. As such, I do not expect a clearer definition to the term “reasonable” by the DOL. This undermines the very nature of reliance on fiduciaries to carry out their duties and the resilience of the fiduciary standard.
I think the “reasonable” standard, although frustrating to some, is the most reasonable under the circumstances.