W. Scott Simon
This month’s column is the second part of a multi-part series that examines the contents of an agreement between a K-12 school district (School District) and a large insurance company (Big Insurance Company) concerning the School District’s 403(b) plan. The first part was interrupted for two months by fast-breaking (as it were) news in the Fiduciary Wars. I strongly urge readers to review my January column before reading this month’s column to bring themselves up to date.
The insurance company-drafted agreement in question here is, yes, rather boring and generally quite difficult to understand. Indeed, in many parts it’s impossible to understand. Such confusion can plague anyone who attempts to read the 15-25 mind- numbing pages of such an agreement. This often plays right into the hands of an insurance company. After all, few fiduciaries in charge of retirement plans will sit still and try to understand all the legalese in an agreement and the oftentimes sloppy drafting practices of the insurance company’s legal department (or outsourced legal counsel). Even when fiduciaries outsource legal review of the agreement, it’s often the case that their legal counsel are not well versed in retirement plans and how they actually operate. That shows up in awkward, unclear wording.
The usual upshot of this general confusion is a rubber-stamping of the agreement, especially in the area of costs, which, well, are simply undecipherable. They’re opaque, of course, not because they’re low but because they’re high. After all, if you were a retirement plan provider like, say, an insurance company that truly offered low costs, wouldn’t you be screaming about them from the rooftops, instead of rendering them undecipherable in an agreement?
It bears emphasizing that legal agreements–not oral or written marketing materials (which is usually how retirement plans are really sold)–are where the rubber meets the road in fixing fiduciary liability (or the lack thereof). So it’s useful to deconstruct the agreements in an attempt to decipher their darker, innermost recesses.
Before getting on with the rest of this month’s column, the comments received by an astute reader of January’s column have required me to begin offering some clarifications. He notes: “In reading your first column, it surprised me that an investment manager under section 3(38) of the Employee Retirement Income Security Act (ERISA) was even involved since that is very rare.”
My reply: I agree that in such agreements this kind of language is rarer than hen’s teeth. Nonetheless, the 3(38) language is there. Note, however, that no entity was actually appointed as a 3(38) in the situation at hand. This begs the question of why there’s any reference to an ERISA section 3(38) investment manager in the first place since the agreement states that the K-12 403(b) plan in question is not subject to ERISA.
This is the kind of sloppy drafting practices that I referenced previously. This isn’t to say that an agreement between a school district and, say, an investment advisor cannot contain language stating that even though the district’s 403(b) plan is not subject to ERISA, the district will act as if the plan is governed by certain provisions of ERISA, such as the fiduciary duties under section 404(a) including, say, the appointment of an investment manager under section 3(38).
The reader further notes: “Even the fact that the agreement suggested the school district is a fiduciary is in the extreme; I’ve yet to ever see such language in agreement.”
My reply: Me too. However, the plan’s trust document states that the members of what’s called the “Committee” are fiduciaries with respect to investment and administrative duties, and since they’re appointable by the school district, that would seem to confer fiduciary status on the school district. In the case at hand, it may be that the school district would have to actually make the Committee appointments to make it a fiduciary.
Further: “The question I have for you concerns the insurance company–why do you think it (which essentially is only the record-keeper) should have a fiduciary responsibility?”
My reply: I’m not suggesting that it should. I’m just making clear that the insurance company repeatedly states in the agreement that it’s not a fiduciary. Nonetheless, the school district’s chief decision-maker adamantly believes otherwise. This goes back to my previous assertion that retirement plans are usually sold on the basis of oral or written marketing materials, not on the basis of a legal document.
The reader continues: “Secondly, what specific fiduciary duties would you have them serve?”
My reply: None. Again, I just want to make sure people understand that the insurance company is not a fiduciary, which is contrary to what a lot of decision-makers at 403(b) (and other) plans believe. Perhaps that mindset also allows them to more easily believe they never have any fiduciary duties at all (which, in fact, is usually the case).
The reader: “In my experience, a record-keeper that is purely doing record-keeping has no reason to be a fiduciary in the traditional sense (other than the normal duty of compliance).”
My reply: Agreed. But, again, plan decision-makers often think the complete opposite.
A seemingly mundane but actually very critical section of the agreement between the School District and Big Insurance Company reads as follows:
School District acknowledges that Big Insurance Company has disclosed to School District through the Services Agreement and related documents that School District confirms it received and understands:
- The nature of Big Insurance Company’s business relationships with each issuer of a funding vehicle that may be used in the School District’s 403(b) plan;
- A description of Big Insurance Company’s receipt of compensation payable by each funding vehicle;
- A description of Big Insurance Company’s receipt of all other compensation payable in connection with the Services Agreement; and
- A description of the charges, fees, penalties or other adjustments that may be imposed under the funding
I would be willing to bet my life that Big Insurance Company never made any such disclosures to the School District–at least in a way that the School District’s decision- makers would have any chance of understanding. In my view, a disclosure can be legally sufficient only insofar as it engenders a knowing understanding in the relevant decision-maker to whom it is directed. After reviewing the agreements at issue here, my partners and I in our registered investment advisory firm collectively could not identify all the actual costs of the 403(b) plan and the identity of all the relationships that mutually benefit from those flows of money.
That’s the punch line of this series: If experts cannot identify costs and relationships, how can decision-makers at school districts do so–even apart from the issue of whether or not they are fiduciaries? These are the fundamental underlying problems faced by decision-makers at 403(b) plans whenever attempting to understand their insurance company-drafted agreements.
Next month, I’ll start to get into the specifics of the agreement between the School District and Big Insurance Company–unless, of course, there’s more fast-breaking news in the Fiduciary Wars.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.