The Fiduciary Advisor
In this issue:
Fiduciary Pitfalls of a Bear Market
The Importance of Keeping Perspective
Employee Education is Critical During Bear Markets
FIDUCIARY PITFALLS OF A BEAR MARKET
By Bryn Torkelson
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“Nobody thinks about fiduciary liability when the stock market
is doing well, but when it’s not, people will be looking for someone
to blame.” Source: CFO.com
As of late December, the NASDAQ is down -40% and the S&P 500 -10%.
In light of these declines, many investors are having a reality check.
What will happen if we retreat to an average stock market return of 10%
or worse?
What if we repeat a time period like 1965-1974 when stocks returned an
annualized 0.3%?
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The stock market has averaged an 18.4% return over the past
10 years (one of the highest periods of return ever). This booming stock market
has disguised several disturbing trends that fiduciaries of retirement plans
need to address.
Plan expenses are too high.
Administrative and fund management expenses tend to
be overlooked during periods of high investment returns. These expenses will
be much more noticeable with single digit (or lower) returns.
Inappropriate asset allocation for participants.
Participants tend to be more aggressive with their investment allocation strategies
during good market times. This can be particularly hazardous for older participants.
Poor fund selection and research.
High returns lend plan fiduciaries the belief that they are experts in fund
selection, which is much easier in a bull market. As the saying goes, “All
ships rise when the tide is coming in.”
Participant expectations for returns are too high. A recent study suggests
that the average 401(k) participant expects a return of 25% per year over the
next 10 years. This has never been achieved by the stock market over a 10 year
period of time.
Employee education. Employee educational services promised by 401(k)
vendors are sometimes forgotten during a bull market when participants are happy.
Today’s market volatility will put plan fiduciaries to the test for the
first time in years. These issues that are neglected during periods of great
stock market returns will come to the forefront during a bear market.
It is important now to set aside the time for fiduciary pencil sharpening, conducting
employee meetings, reviewing investment policies, and taking minutes of quarterly
investment review meetings.
Plan participants are going to start demanding accountability for fund selection,
competitive fees, and better educational services to satisfy their concerns.
Consider for a moment the impact of a bear market on your older
participants. A participant who loses 30-40% of his savings just before retirement
will certainly be looking for someone to blame, possibly you.
THE IMPORTANCE OF KEEPING PERSPECTIVE
The average annual return of the market over the past 10 years
has been 18.4%.
Over the last 40 years, however, the market has averaged just
10%.
EMPLOYEE COMMUNICATION IS CRITICAL
DURING BEAR MARKETS
By MacGregor Hall, CIMA
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If 2000’s stock market volatility and negative performance continues
into 2001, things could start to get ugly for plan sponsors with inadequate
participant communication programs.
How can communicating effectively with your employees minimize your liability
as a plan fiduciary? What should you say to your employees? And who should
say it?
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Make sure your plan complies with ERISA. Have an ERISA compliance
audit of your plan document by an attorney or plan consultant who specializes
in the law. With the IRS requirement for all plans to be re-qualified by the
end of the 2001 plan year, now is a great opportunity to make sure your plan
is in compliance.
Know what your responsibilities are. Before you can limit
your fiduciary liability, you need to know the scope of your responsibilities.
If you don’t know what your fiduciary obligations are, get an expert opinion
from a plan consultant or ERISA attorney. Knowing what your responsibilities
are can help assure you that you are meeting the ERISA requirements for acting
“solely in the interests” of your plan participants.
Delegate fiduciary responsibility where possible. What you may not know
is that some fiduciary responsibilities can actually be delegated to an independent
third party. In fact, one of your responsibilities as a plan sponsor is to seek
expert advice when making plan decisions which fall outside your area of personal
expertise.
Know what you must disclose to your participants. Know what your disclosure
requirements are under ERISA. Disclosure is the heart of your participant communication
program. Disclosure challenges by participants are becoming increasingly more
common in 401(k) plans now, especially related to investment options. If plan
participants have become more litigious during the past 10 years while experiencing
20% plus returns, just picture the lawsuits after a period of negative returns.
For participant-directed plans, complying with Section 404© of ERISA can
afford additional fiduciary protection. However, an even greater level of disclosure
must be provided in order to meet the requirements of that section.
Your plan consultant or ERISA attorney can outline your ERISA disclosure obligations
in detail. But beware; meeting the minimum requirements may not be enough to
protect you in the event of a disgruntled participant. Your employee education
program should pass the ERISA test and go the extra step of giving your participants
confidence in your retirement plan program.
Be proactive and consistent. Work with your plan consultant
to develop a communication program specific to your employees. Having regularly
scheduled meetings and consistently distributed materials will keep your participants
informed so there are no surprises with year-end statements. Give participants
lots of information and don’t wait for them to ask for it. If your employees
know its been a tough year for the financial markets, they won’t be expecting
to see 20% returns on their statements and may be less likely to blame you for
the flat or negative performance.
Customize your program. Do your employees have internet savvy? Would
they feel more comfortable with small one-on-one sessions? How you deliver the
message is sometimes as important as what you say. Work with a 401(k) communication
specialist to analyze your participant demographics and deliver messages in
a style your employees relate to via the medium most likely to reach them.
Keep it simple. If participants can claim they don’t understand
the technical jargon used in materials and meetings, you may not be meeting
disclosure requirements under ERISA. Find a plan consultant or service provider
who will provide ERISA compliant communication materials and conduct educational
meetings on your premises. Hire an expert experienced in communicating with
many types of employees to discuss the financial markets and field tough investment
questions. As participant understanding increases, so will their confidence
in the program and its investments.
Devote enough resources to your plan. Make sure you devote the resources
necessary to insure that the plan runs smoothly and efficiently—and remains
legally compliant. Human resources departments are busy places. If you don’t
have the resources internally, outsource. An experienced plan consultant can
help you select the right service providers to seamlessly get the job done.
Monitor, review, and revise your program as needed. Developing a state-of-the
art participant communication program is an important component in protecting
you from fiduciary liability, but don’t stop there. The program should
be ongoing with at least an annual review to make sure it still fits your needs.
There is almost always room for improvement and your employees will thank you
for it.
Next Issue:
Diversification
Are your funds really different? How can you be sure?
Requalifying your plan
What the IRS says you need to do in 2001