Source: https://www.erisa.com/why-you-should-consider-using-an-investment-manager-instead-of-a-financial-advisor/
Timestamp: 2020-08-06 00:39:52
Document Index: 318153311

Matched Legal Cases: ['§ 3', '§ 405', '§ 80', '§ 404', '§ 3', '§ 405', '§ 3', '§ 405', '§ 405', '§ 405', '§ 405', '§ 3']

Why You Should Consider Using an Investment Manager Instead of a Financial Advisor - ERISA
Why You Should Consider Using an Investment Manager Instead of a Financial Advisor
Fiduciary__Investments
Generally speaking, there are two types of investment service providers in the retirement plan space, financial advisors and investment managers.
At a surface level there are a few differences between the two. First, ERISA only defines the term investment manager.1
To be an investment manager, a provider must satisfy three requirements:
Have independent power to make decisions about all plan assets
Be a registered investment adviser, a bank, or insurance company allowed to operate in multiple states
In writing, acknowledge that he is one the plan’s fiduciaries.
If the service provider does not meet all of these requirements, then the provider is a financial advisor.2
Second, plan fiduciaries (e.g. employers acting as a trustee) who hire investment managers delegate their duty to invest and manage plan assets to the investment manager.3 Conversely, most financial advisors reject all decision-making authority and limit their duties to providing advice and educational services.
Why there are two types of financial service providers offering similar services
ERISA is heavily influenced by laws and principles governing trusts, and these principles are why two types of investment advisory service providers exist. Originally, trust law forbid trustees from delegating their authority to other people and it held trustees responsible for every decision.4 Financial advisors mirror this historical approach to trust law.
As financial markets and the law grew more complicated, trustees’ ability to delegate tasks greatly expanded, and even shifted into a duty. For example, the main reference book for legal principles of US trust law states, “[a] trustee has a duty personally to perform the responsibilities of the trusteeship except as a prudent person comparable skill might delegate those responsibilities to others.”5 Investment managers mirror this modern approach by assuming decision making authority.
Historical differences aside, at a basic level both of these service providers are plan fiduciaries, which means that they owe a heightened standard of care to a plan, plan participants, and plan beneficiaries.6 ERISA explicitly grants fiduciary status to investment managers,7 assigning them and their client special protections.8 Financial advisors become fiduciaries under a catchall provision.9
How these differences affect financial advisors’ and investment managers’ clients
One of the ways this statutory difference affects financial advisors’ and investment managers’ clients is tied to co-fiduciary liability and the special protections ERISA offers to investment manager’s clients.
According to ERISA, a fiduciary is his brother’s keeper. If someone breaches a fiduciary duty they owe to a plan, then every other plan fiduciary could be personally liable for that mistake.10 This concept is called co-fiduciary liability.
Roughly speaking, co-fiduciary liability applies to every fiduciary who either
Knowingly participates in or conceals a breach,
Enables someone else’s breach by committing his own breach (i.e. a domino effect or chain reaction), or
Knows about a breach and does not make a reasonable effort to fix it.11
To put this into real world terms, many participants have sued plan fiduciaries in recent years for offering overly expensive investment options to their 401(k).12 In these situations, the plaintiffs normally allege that an investment manager or financial advisor included a fund on a 401(k) investment menu that was prohibitively expensive and then try to use one of the criteria listed above to extend liability to the trustees, plan administrator, etc.
ERISA places a liability firewall between investment managers and the people who appoint them.13 Specifically, this firewall prevents plaintiffs from extending co-fiduciary liability on the basis that the appointing fiduciary (e.g. employer acting as plan administrator) knowingly participated in or concealed the breach (i.e. number 1 in the list above).14
No such firewall exists between financial advisors and other plan fiduciaries (e.g. trustees and plan administrators).15
In simpler terms, this means that there are situations where an employer’s decision to hire a financial advisor or investment manager will be the only thing standing between him and personal liability.
How financial advisors limit liability
The only way for financial advisors and their clients to limit liability is to shrink the scope of the financial advisor’s fiduciary duty.16 In other words, to limit liability, financial advisors limit their discretionary authority. This is why most financial advisors tell their clients that they do not have any decision-making authority and that even though they can offer advice and carry out their clients’ wishes, they cannot make independent decisions.
To use an analogy, hiring a financial advisor is like hiring one of two employees. The first has no decision-making ability and reacts to problems instead of proactively and independently solving them. In order to accomplish anything, the employee has to ask their manager for permission and detailed instruction. The second employee is an accident waiting to happen. Most days, he does his job well, but there’s a possibility that he’s going to make a huge mistake that puts his employer out of business.
Hiring an investment manager is like outsourcing a task to another company. The employer still has to periodically check in on the other company to make sure they’re doing what they are supposed to, but if something goes wrong, it’s the other company’s fault.
With smaller retirement plans, the decision to hire a financial advisor or investment manager usually sits with an employer. As the financial sector grows in complexity and the number of suits alleging fiduciary breaches grows, embracing the modern view of trust law and delegating financial duties to an investment manager makes sense. Not only are investment manager more proactive and independent, but they can protect their clients in ways financial advisors are not legally able to.
In short, the difference between investment managers and financial advisors are best summarized with the words of Ben Franklin, “well done is better than well said.”17
1ERISA § 3(38).
2To compare consider Dieticians and nutritionists. Anyone can call themselves a nutritionist, but only people who meet certain educational and licensing requirements can use the title Dietician. Investment managers are like Dieticians and financial advisors are like nutritionists.
3ERISA § 405(d)(1).
4E.g., Winthrop v. Attorney General, 128 Mass. 258 (1880) (holding that the trustees cannot delegate their duty to other trustees in spite of massive cost savings because merely changing trustees would fundamentally frustrate the trust’s original intent). Accord, Turner v. Corney, (1841) 5 Beav. 515 (Rolls Court) (“I must observe that trustees […] have no right to shift their duty on other persons; and if they employ an agent, they remain subject to responsibility towards [the trust].”
5Restatement (Third) of the Law of Trusts § 80.
6ERISA § 404(a) (defining the “Prudent Man Standard of Care”).
7Id. at § 3(38).
8Id. at § 405(d)(1).
9Id. at § 3(21)(A).
10Id. at §§ 405(a), 409(a).
12E.g., Complaint Class Action, Kirk v. Retirement Comm. of Community Health Sys., Inc., No. 3:19-cv-00689 (M.D. Tenn. 2019) available at https://www.napa-net.org/sites/napa-net.org/files/CHS%20SUIT.pdf.
13ERISA § 405(d)(1).
14Id. at § 405(a)(1).
15See, Whitfield v. Cohen, 682 F.Supp. 188, 196 (citing ERISA § 405(d)(1)). Accord, Perez v. WPN Corp., No. 14-1494 at pp 9, 26 (W.D. PA 2017) (quoting In re Williams Co. ERISA Lit., No., 02-CV-153 (N.D. Okla. Aug. 22, 2003) (DOL Amicus Brief, attached as Ex. A to Def. Supp. Br., at p 8)) available at https://www.govinfo.gov/content/pkg/USCOURTS-pawd-2_14-cv-01494/pdf/USCOURTS-pawd-2_14-cv-01494-1.pdf.
16ERISA § 3(21)(A) (stating financial advisors are only fiduciaries to the extent they either 1. possess or exercise discretionary authority over plan assets; 2. are hired to render investment advice to the plan; or 3. possess or exercise discretionary authority over plan administration).
17Benjamin Franklin, Autobiography. Poor Richard. Letters, 239 (D. Appleton and Company 1904) available at https://archive.org/details/cu31924014323376/page/n275.
By Kirk Vaughn, JD