Proposed Criteria for the Annual Audit of the Fiduciary Adviser

Don Trone

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• Publié par: Iprie
• Nombre de lectures: 54
• Langue: English

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Proposed

Criteria for the Required Annual Audit of the Pension

Protection Act’s “Fiduciary Adviser” and Computer-Based Model

Introduction

The Pension Protection Act of 2006 (PPA) requires certain audits to be performed every

year: (1) Of the “eligible investment advice arrangement” entered into between a

fiduciary adviser and an independent fiduciary (typically the plan sponsor); and (2) Of

any computer-driven advice model used as an eligible investment advice option. The

details of these audits were not defined in the PPA, but will be by the Secretary of Labor

(Secretary) at some point in the near future.

In the interim, Fiduciary360 has prepared the following auditing criteria. The actual

auditing procedures are based on those defined by ISO-19011 (www.iso.org), a globally

recognized auditing standard, and CEFEX (www.cefex.ca), the international certifying

body for investment fiduciaries.

This auditing criteria represent both industry best practices and the specific requirements

that have been identified by the PPA. It is anticipated that this auditing criteria will be

more extensive than the standards that eventually will be defined by the Secretary.

What is defined by PPA is that the auditor must: (1) be independent; (2) have appropriate

technical training or expertise and proficiency; (3) make such representations in the audit

report; and, (4) present in the audit report specific findings regarding compliance with the

PPA.

The auditing criteria were prepared under the assumption that the fiduciary adviser

(“adviser”) is a fiduciary to the plan and, therefore, may be co-liable for a breach by the

plan’s other fiduciaries, most notably the plan sponsor’s investment committee.

Therefore, the audit begins with an assessment of the plan sponsor’s procedural prudence.

After all,

the best participant advice in the world will still fall short if the plan is not

being prudently managed

.

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The audit is based on fiduciary

practices

outlined in the handbooks,

Prudent Practices

for Investment Stewards

and

Prudent Practices for Investment Advisors

.

The assessment of the plan sponsor’s procedural

prudence (Part 1 of the audit) includes references

to

practices

from the

Stewards

handbook.

The assessment of the adviser’s procedural

prudence (Part 2 of the audit) includes references

to

practices

from the

Advisors

handbook.

The

Practices

are fully substantiated by ERISA,

case law, and regulatory opinion letters; and are

covered in the handbook,

Legal Memorandums

,

which was prepared by the law firm of Reish

Luftman Reicher & Cohen.

Editorial Note

: This document uses the terms “adviser” and “advisor.”

“Adviser,” as in “fiduciary adviser,” is in reference to the term defined by the

2006 Pension Protection Act.

“Advisor,” as used by Fiduciary360 throughout its materials, refers to the

professional who is providing comprehensive and continuous investment advice.

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Part 1 – Assessing the Procedural Prudence of the Plan Sponsor

1.

The plan is managed in accordance with all applicable laws, trust documents, and

written Investment Policy Statement (IPS). (Practice S-1.1)

2.

The roles and responsibilities of all involved parties (fiduciaries and non-fiduciaries)

are defined, documented, and acknowledged. (Practice S-1.2)

3.

There is no indication that fiduciaries and parties in interest are involved in self-

dealing. (Practice S-1.3)

4.

Service agreements and contracts are in writing, and do not contain provisions that

conflict with fiduciary standards of care. (Practice S-1.4)

5.

The plan’s assets are within the jurisdiction of the appropriate courts, and are

protected from theft and embezzlement. (Practice S-1.5)

6.

The plan’s investment options are appropriate for the participant demographics.

(Practices S-2.1, 2.2, and 2.3)

7.

The asset classes represented by the plan’s various investment options provide

participants the ability to prudently diversify their portfolio. (Practice S-2.4)

8.

The plan’s investment options are consistent with the plan sponsor’s implementation

and monitoring constraints. (Practice S-2.5)

9.

There is an IPS which contains the details to define, implement, and manage a

specific investment strategy. (Practice S-2.6)

10.

The IPS defines appropriately structured, socially responsible investment (SRI)

strategies (when applicable). (Practice S-2.7)

11.

The plan’s investment options have been prudently selected. (Practice S-3.1)

12.

If the plan sponsor is seeking a 404(c) “Safe Harbor,” the following requirements are

being met (Practice S-3.2):

a.

Investment decisions are being delegated to a “prudent expert(s)” (registered

investment adviser [including mutual funds], bank, or insurance company).

b.

The fiduciary can demonstrate that selection of the prudent expert(s) followed

a due diligence process.

c.

The prudent expert(s) is being given discretion over the assets.

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d.

The prudent expert(s) acknowledges their co-fiduciary status in writing

(mutual funds are exempted from this requirement—the prospectus is deemed

to serve as the fiduciary acknowledgment).

e.

The plan sponsor is monitoring the activities of the prudent expert(s) to ensure

that they are properly performing the agreed-upon tasks using the agreed-upon

criteria.

f.

Plan participants are notified in writing of the plan sponsor’s intent to

constitute a 404(c) plan, and seek liability relief through these safe-harbor

procedures.

g.

Participants are offered at least three investment options with materially

different risk/return profiles.

[Proposed by the Secretary] As an alternative, the plan sponsor can offer

participants a “qualified default investment alternative,” defined as: (1)

age-based life cycle or targeted-retirement-date funds or accounts; (2)

risk-based balanced funds; or, (3) an investment management service. The

“alternatives” can be offered even if the sponsor does not intend to

constitute a 404(c) plan.

Employer stock is permissible if the stock is held or acquired by a

registered investment company or pooled investment vehicle that is

independent of the employer, and is acquired as a matching contribution

from the employer and held at the direction of the participant.

h.

Participants receive information and education on the different investment

options.

[Proposed by the Secretary] When a “qualified default investment

alternative” is offered, the participant is provided details of the

“alternative” and how to obtain additional information on the option.

i.

Participants are provided the opportunity to change their investment

strategy/allocation with a frequency that is appropriate in light of market

volatility.

[Proposed by the Secretary] When a “qualified default investment

alternative” is offered, the participant must be notified 30 days in advance

of the first investment, and at least 30 days in advance of each subsequent

year, of the opportunity to transfer assets to any other investment

alternative available without financial penalty.

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13.

If the plan sponsor is seeking a Fiduciary Adviser “Safe Harbor,” the requirements

are being met. (Practice S-3.2)

a.

The plan sponsor has prudently selected a qualified fiduciary adviser.

b.

The fiduciary adviser has acknowledged fiduciary status in writing, and has

disclosed all conflicts of interests and all forms of compensation.

c.

The plan sponsor has determined that the fiduciary adviser’s “eligible

investment advice arrangement,” including the associated fees and expenses,

is appropriate for the plan’s participants.

d.

The plan sponsor is prudently monitoring the fiduciary adviser, and ensures

that both the arrangement between the plan sponsor and the fiduciary adviser,

and the “eligible investment advice arrangement,” are audited on an annual

basis.

14.

Investment vehicles are appropriate for the plan size. (Practice S-3.3)

15.

A due diligence process was followed in selecting service providers, including the

record keeper and the custodian. (Practice S-3.4)

16.

The plan sponsor receives periodic reports comparing the performance of each

investment option against an appropriate index, peer group, and IPS objectives.

(Practice S-4.1)

17.

The plan sponsor makes periodic reviews of qualitative and/or organizational changes

of investment decision-makers. (Practice S-4.2)

18.

The plan sponsor has control procedures in place to periodically review that all fees

for investment management are consistent with agreements and with all applicable

laws. (Practice S-4.4)

19.

The plan sponsor has control procedures in place to periodically review all “finder’s

fees” or other forms of compensation that may have been paid for asset placement are

appropriately applied, utilized, and documented. (Practice S-4.5)

20.

The plan sponsor has a process to periodically review the organization’s effectiveness

in meeting its fiduciary responsibilities. (Practice S-4.6)

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Part 2 – Assessing the Procedural Prudence of the Fiduciary Adviser

21.

All fiduciary advisers to the plan have (Practice A-1.3):

a.

Acknowledged their status in writing, including their qualifications to serve as a

fiduciary adviser

b.

Received “express authorization” from an independent plan fiduciary (normally

the plan sponsor) to function as a fiduciary adviser. The auditor should obtain

copies of the authorizations.

c.

Identified the “eligible investment advice arrangement”—the use of a computer

model and/or level fee arrangement

d.

Provided the plan sponsor and the participants any other disclosures required by

the adviser’s registration with regulators (such as the ADV for a RIA).

The key determination for the auditor to make is to identify the various parties that

may be serving as a fiduciary adviser to the plan, and whether they are operating in

the level fee or computer model context: the individual(s) who provide the advice;

their firm; and a third-party that designs and/or markets the computer model (if one

is used).

22.

Documents pertaining to the adviser’s investment management process are filed in a

centralized location and maintained for a period of six years. The fiduciary adviser

should have a procedure for providing information to a participant about the adviser’s

investment process (Practice A-1.2):

a.

Prior to the time they receive any advice, and annually thereafter

b.

Upon request

c.

In the event of any material change in the adviser’s information.

23.

The adviser has provided in writing to the plan sponsor and each participant (Practice

A-1.3):

a.

An acknowledgment of fiduciary status

b.

A disclosure of all conflicts of interests

c.

A disclosure of any material affiliations with any other parties involved with the

plan and/or the investment options

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d.

A disclosure of all forms of compensation, including amounts provided by a third

party. The Secretary is to issue a “model notice” form for the purpose of

disclosing compensation.

e.

The past performance of the plan’s investment options, even if the information is

also supplied by another adviser or provider

f.

The types of services provided by the fiduciary adviser in connection with the

provision of investment advice

g.

That investments occur solely at the direction of the participants

h.

That participants may use other advisers that have no material affiliation with, and

receive no compensation from, the investments.

Explanations provided to participants must be written in a clear and conspicuous

manner, and in a manner the average plan participant can understand. They also

must be sufficiently accurate and comprehensive to reasonably apprise the

participant of the information required in the notice.

24.

All employees of the adviser annually acknowledge the organization’s ethics policies,

and agree to disclose any potential conflicts of interest. (Practice A-1.4)

25.

The adviser’s agreements and contracts are periodically reviewed by legal counsel to

ensure consistency with the needs of the plan and its participants. (Practice A-1.5)

26.

The adviser can demonstrate that the sources, timing, and distribution of retirement

savings for each participant have been taken into consideration. (Practice A-2.1)

27.

The adviser can demonstrate that each participant’s retirement time horizon has been

taken into consideration. (Practice A-2.1)

28.

The adviser can demonstrate that each participant’s level of investment risk has been

taken into consideration. (Practice A-2.2)

29.

The adviser can demonstrate that an “expected” or “modeled” return which takes into

account all of the participant’s sources for retirement income has been calculated for

each participant. (Practice A-2.3)

30.

The adviser can demonstrate that participant assets are appropriately diversified to

conform to each participant’s specified time horizon, risk/return profile, and asset

class preferences. (Practice A-2.4)

31.

The adviser’s methodology and tools used to establish appropriate portfolio

diversification are effective and consistently applied. (Practice A-2.4)

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32.

The adviser can demonstrate that the advisor has the time, inclination, and knowledge

to effectively implement and monitor the plan’s investment options. (Practice A-2.5)

33.

Each participant’s Participant Policy Statement (PPS) defines the duties and

responsibilities of the adviser. (Practice A-2.6)

34.

Each participant’s PPS defines a suggested investment option that is consistent with

the participant’s risk tolerance, asset class preferences, retirement time horizon, and

expected return; also taking into account other sources of retirement income. (Practice

A-2.6)

35.

Each participant’s PPS defines rebalancing guidelines. (Practice A-2.6)

36.

Participants are provided relevant and timely information about the performance of

their investment options. (Practice A-4.1)

37.

The adviser’s operations are periodically reviewed to foster continued improvement.

(Practice A-4.6)

Part 3 – Auditing Computer-Driven Advice Models

38.

The computer-driven advice model (model) has been certified by an independent

“eligible investment expert.”

39.

The model applies generally accepted asset allocation and optimization theories that

take into account the historic returns of different asset classes over defined periods of

time.

40.

The model utilizes relevant information about the participant (RATE)

R - Risk tolerance

A - Asset class preferences

T - Time horizon, till retirement/life expectancy

E - Expected return, also considering other sources of savings.

41.

The model utilizes objective procedures to provide prudently diversified portfolios.

42.

The model utilizes prescribed objective criteria to provide asset allocation portfolios

comprised of investment options available under the plan.

43.

The model does not favor investments offered by an affiliated party.

44.

The participant is informed that the participant may request investment advice other

than what is suggested by the computer model, as long as the request has not been

solicited by the fiduciary adviser.

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45.

The participant is informed that any transaction that is a result of the computer-driven

model must occur solely at the direction of the participant.

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