While
the news article alleged the investigation, it specified that the fund in
question had between 4% and 13% of its underlying holdings in private-mortgage
debt that was rated and also underwritten by that same firm. To those
operating in a fiduciary environment, this shouts conflict of interest
(i.e. prohibited transaction) and is a potential violation of ERISA. If the
DOL were to find that the firm violated ERISA with respect to the investments
within the fund it could have a domino effect. The plan sponsors who
welcomed this fund into their 401(k) plans, and the advisers who recommended
it, could be liable for improper due diligence and a breach of their fiduciary duty.
How does a plan sponsor protect itself when considering (or being sold) an opaque investment structure such as a Fixed Account or GIC?
A stable value fund's stability cannot simply be assumed. Plan trustees, and their financial advisers, have a fiduciary responsibility to conduct thorough due diligence when evaluating a plan's stable value option. This is easier said than done. Proper due diligence isn't simply a matter of reviewing underlying holdings, manager pedigree, or declared interest rates. It is far more complex. Is the provider who is guaranteeing the stable value option financially strong? Are rates consistent? Are costs/fees reasonable? Are contract limitations onerous?
As a
discretionary trustee for our clients, my firm's Trust Investment
Committee (TIC) has implemented several decisions and due diligence process' to
help ensure that the Stable Value investments offered to our clients are
transparent regarding its holdings and its fees. Some of the items
we look at are:
- Insurer Quality - Annually, TIC conducts a review of the fund. Part of the review is a detailed investigation of the Insurer. Of particular focus, is the claim's paying ability, which backs the guaranteed rate that makes up the difference between Market and Guaranteed Values. We also monitor the "spread" between the Market Value and Book Value on a weekly basis, and customarily review their capacity to take on added risk, defined as more assets in our fund or funds they are insuring.
- Holdings - Annually, the Investment Committee interviews each Portfolio Manager about their holdings. During this interview process they are reviewing factors such as what the holdings are, the credit quality and duration against their benchmarks.
- Structure - Structure of this asset class is very important. We prefer the structure of a Common Collective Trust. They are required to be audited annually at the request of the Office of the Controller of Currency of the U.S. Treasury. The holdings are examined separately by an outside independent auditor. As a prudent measure, the committee opted for a Separate Account structure that allows us to isolate the assets from the creditors of the Insurer. Thus, our clients are protected against instability and the fund is potentially portable between insurers, under a "worst case" scenario.
- Fees - Most fixed accounts/GIC's are opaque when it
comes to fees. Typically, they are embedded in the difference between
the fund's gross yield (what the provider earns), and the fund's net yield
(what the client receives). These funds often quote an expense ratio
of 0%, and the yield is expressed as a percentage as well. Given the Collective Trust structure, we can identify precisely how much cost is
associated with each manager and the fund as a whole. This amount is
then expressed the same way as a mutual fund cost would be shown.
To
answer the original question, one way that a Plan Sponsor can protect itself is
to hire a professional fiduciary that has built a solid and prudent due
diligence process that includes a thorough investigation of the Stable
Value/Fixed Account offering.
