Fiduciary Excellence Part 4: Monitoring the Client Engagement

Posted by Terra McBride, MBA, AIF®, Vice President of Marketing & Professional Development on February 01, 2019

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We’ve arrived at the fourth and final step of the Fiduciary Quality Management System - Monitor. Just getting here? Be sure to check out our posts on the first three steps, Organize, Formalize and Implement.

The duty to monitor is a fiduciary duty substantiated by… well, just about everything! ERISA, Advisers Act of 1940, UPIA, UPMIFA and UMPERSA all address this responsibility. So, pay attention because this is an important one.

We find that most advisors struggle with this step. For starters, the duty to monitor is the most time consuming and expensive because technically it never ends. In addition, this is where a fiduciary breach is most likely to occur. There are a couple of reasons for this.

First, at this stage, your new client transitions to an older client. As we look at our long list of to-dos each day, it feels like the right move to bump activities associated with newer clients up on the priority list and to let the tasks associated with older clients move down the list.

Second, it’s human nature to become complacent. For these reasons, it’s so important to implement a prudent process that will help keep you on track with ALL clients.

The three major pieces of this step are:

• Quantitative and qualitative reviews
• Fees and Expenses
• Fiduciary Reviews (what can I do better?) -> Evaluate objectively how to make continuous improvement

We’re going to keep this post at a higher level but if you’d like to get into some details, check out Rich Lynch’s fantastic webinar focused on Step 4 of the Fiduciary Quality Management System.

Quantitative and Qualitative Reviews

Performance reports are a huge part of the quantitative side of reviews. You’re examining the performance of investment managers and comparing that performance to an appropriate index, their peers and, most critically, to the objectives of the Investment Policy Statement (IPS).

The IPS should clearly articulate who is responsible for putting together the performance report, which should be delivered quarterly at a minimum and during a face-to-face meeting at least once a year. In the instance of litigation, the court will look for quarterly documentation of a performance review.

Depending on the client, you may need to report on performance more frequently. While the process for working with clients should be consistent, the following factors should be considered when determining the frequency of performance reporting for each client.

• Specified fiduciary requirements
• The size of the investment program
• The investment strategies employed
• The sophistication of the investment program
• The volatility of the investments selected
• The general economic and market conditions then prevailing

This is largely a number-crunching exercise. But the advisor truly demonstrates value, not in the numbers in the report, but in the analysis of those numbers.

A qualitative review is more of an art than the quantitative review. You’re watching for signals or red flags that will trigger you to ask additional questions. Periodically review information such as:

• Staff turnover
• Organizational structure
• Level of service provided
• Quality of reports
• Quality of responses to requests for information
• Investment education
• News headlines that may indicate something isn’t right with an organization

Control and Account for Investment Expenses

Controlling for expenses is the meat of the Monitor step, and also the piece that many advisors find challenging. We get it! This is an area of intense scrutiny by regulators and through lawsuits so we know you want to get it right.

Plans must evaluate and account for investment-related fees, compensation and other plan expenses, which are disclosed in 408(b)(2) disclosures. It’s our position that other institutional accounts like endowments and foundations should also provide 408(b)(2)-type disclosures. Given the scrutiny in this area, why wouldn’t you?

The IPS must include a description of how the fiduciary will control for fees and expenses. In other words, figure out who is being paid and for what services. It’s important to note that fees and expenses go well beyond the investment managers. I point this out because we’ve had several advisors assume they’ve done their duty by simply disclosing the expenses associated with the money managers. But there are really four categories that should be addressed:

1. Investment or Money Manager: Fees and/or annual fund expenses
2. Execution – Brokerage: Trading or processing costs (i.e. commissions, soft dollars, directed brokerage and 12b-1 fees)
3. Consultant or Advisor: Consulting and admin costs
4. Custody – Recordkeeping: Custodial fees and transaction charges

While it may not seem tightly associated on the surface, controlling for fees (Step 4-Monitor) and uncovering conflicts of interest (Step 1-Organizez) are directly related. We tell our advisors, “If you ever wonder whether there is a conflict of interest that is problematic, follow the money.” When you understand who is getting paid and for what services, you have a clear picture of the plan and whether there are issues that need to be addressed.

What Is Fair and Reasonable?

“Fair and reasonable” is generally examined according to a “relative to what” standard. In other words, the fees and expenses are evaluated relative to the charges that would be incurred if the same services were supplied by a leading competitor. This is why a formal RFP process is suggested to select service providers and, as much as possible, to make apples-to-apples comparisons. Fi360’s RFP Director is a tool many advisors use to simplify, standardize and document this process.

There are two factors to consider when evaluating whether fees and expenses are reasonable.

1. Can the fees be paid from the portfolio or plan assets? This must be considered from both a legal perspective and whether the organization itself will allow it.
2. Are the fees reasonable considering the services provided? Data sources, like Fi360’s Fee Benchmarker^®, can assist with this analysis.

We recommend making it a practice to evaluate fees and services every three years with the client. Get everything out on the table, what’s working and what isn’t, on both sides of the relationship. A lot can change over three years. The client will appreciate your willingness to regularly refine the relationship. You can strengthen an ongoing relationship and maybe even uncover an area where you can improve, which will help you remain competitive.  

Fiduciary Review

The fiduciary review is where you objectively evaluate where improvements can be made. There’s a lot to consider. So here is a recommended schedule for you to use as a guide.

• Monthly – Review custodial statements
• Quarterly – Review overall portfolio and individual investment performance
• Annually – Review IPS, service providers and your own fiduciary performance. It’s extremely important you make sure the process and the IPS align exactly. If they no longer do, it’s time to make updates.
• Every three years – Revisit vendor contracts
• Impromptu –Reviews as circumstances dictate

The Process of Monitoring

The plan steward is looking to you for guidance on adhering to their fiduciary duties of loyalty and care. You will instill confidence and gain their trust by demonstrating that you have a thoughtful, prudent process. Apply an evidence-based approach by gathering and analyzing the facts surrounding the plan. Then provide points of action based on what you uncover. Act on your findings by taking any necessary corrective actions and then document everything. If you deviate from any precedents you have established for decision making, document, document, document!

Everything Fi360 delivers to the industry is rooted in our Prudent Practices. This step-by-step process ensures an investment strategy is being properly developed, implemented and monitored according to both legal and ethical obligations, taking the guess work out of how to work with your clients.

I hope you’ve enjoyed this series! As always, we are here to help make the fiduciary care you provide for your clients simpler.

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Feb. 28, 2019 is National Fiduciary Day! Join us at one of our capstone events to earn your AIF^® Designation. Already a designee? Celebrate with us! Share a story of your own fiduciary excellence on social media. Tag @fi360 or use #NationalFiduciaryDay and we will repost to our account.