Westminster Consulting Brochure Endowment & Foundation | Page 17

Improper Roles for Advisors
By Gabriel Potter AIFA

®

Senior Investment Research Associate at Westminster Consulting

White Paper

“There are known knowns. There are things we know that we know.
There are known unknowns. That is to say, there are things that we know we don’t know.
But there are also unknown unknowns. There are things we do not know we don’t know.”
US Secretary of Defense, Donald Rumsfield

A FRIGHTENING TREND: IMPROPER
DUTIES FOR ADVISORS
At Westminster Consulting, we typically select topics where we
can offer some unique insights while being entertaining or, at
least, informative. Still, there are times when our consultants have
noticed widespread errors so egregious that we feel compelled to
provide a universal warning. It is our hope that employers and
institutions recognize and correct these mistakes before lasting
damage is done.
The mistake we see far too often is this: employers have tasked
non-fiduciary advisors with fiduciary duties and vice-versa.

HOW THIS HAPPENS: A TYPICAL SCENARIO
The laws that govern institutional investing are constantly in
flux. The Employee Retirement Income Security Act (ERISA),
having started in 1974, is relatively mature but the application and
expansion of these legal constructs are ongoing. For example,
Uniform Prudent Management of Institutional Funds Act
(UPMIFA) and the Pension Protection Act (PPA) circulated in a
wave of reform in 2006 through 2007.
On the other hand, institutional relationships with advisors and
brokers may not change for decades. A complacent relationship can
easily develop over the years between a plan sponsor and advisor.
Over time, an institution’s assets may grow beyond the level of
expertise and sophistication of the advisor. Eventually, prices
become uncompetitive and, ultimately, abusive to the client’s trust
and loyalty. Without pressure, the service level may devolve and
the plan’s interest is no longer being served. Such relationships
may operate in the advisor’s interest, but not the plan sponsors and
their employees.
Even the best run relationships, with fair costs and high service
standards, should periodically conduct a Request-For-Proposal to
ensure that the client’s best interests are being served.
The lowest level of this untested relationship occurs when the
long established advisor believes that the back office changes in
business operations mean that the entirety of the advisor’s actions
has therefore conformed to the law. The unsophisticated advisor
may observe updates to compliance procedures and suggest to the
client that they are conforming to the changes in the law with an
incomplete understanding of what the law actually requires.

A casual and trusting relationship with a client can even result in
inappropriate investment advice, subject to fiduciary principles &
liabilities, being given by the non-fiduciary advisor with serious
consequences for the client and the advisor. The advisor, without
malice, continues business as usual. The client thinks: “My advisor
has assured me we are following the rules so I’m protected.” In
reality, the client is often not protected because neither they, nor
their advisor, have fully understood their duties. In other words,
“they don’t know what they don’t know.”

A BRIEF REVIEW OF FIDUCIARY VS.
SUITABILITY STANDARDS
The trustees of any institution – foundation, retirement plan, union
pension, and so on – are making decisions for money that does not
belong to them. They are entrusted with other people’s money and
therefore obligated, legally and ethically, to act with the owner’s
best interests as the sole guiding principle. In other words, these
trustees are fiduciaries.
“A fiduciary must act with care, skill, prudence, and diligence
under the circumstances then prevailing that a prudent man acting
in a like capacity and familiar with such matter would use in the
conduct of an enterprise of a like character and with like aims.”
[ERISA Sec.404 (a)(1)(B)]
An advisor who adopts fiduciary status bears a burden similar to
the institutional trustee; they must act with undivided loyalty to
the interests of the owners and avoid (or disclose) any possible
conflicts of interest. This is the fiduciary standard.
Conversely, non-fiduciary advisors are subject to a lesser burden:
the suitability standard. Legally, this often means that the financial
advisor is required to offer an individual investor options which
only meet their needs based upon their particular circumstances.
Advisors may select products or services that are “suitable” for the
client, but not necessarily the best choice.
“A fiduciary … may employ one or more persons to render advice
with regard to any responsibility such fiduciary has under the plan.
[ERISA Sec. 402 (c) (2)]”
However, recent court decisions point to a more vigorous
monitoring of the choices being offered by these non-fiduciaries.
In other words, the investment choices being given should be more
suitable for the client(s) and less self-serving to the non-fiduciaries
and the companies they serve. Closer scrutiny is being paid to these
transactions which both buyers and sellers should start paying
closer attention to moving forward.

Re-engineering Fiduciary | 15