Timing Trials

By Fred Reish

These are trying times for 401(k) fiduciaries. The conduct of many mutual fund complexes, banks, and brokerage firms has been illegal or unethical, or both. They have favored short-term speculators over long-term investors -— the few and the rich over the average investor and 401(k) participant. Their motive was simple and obvious -— to increase their fees.

Several large public retirement plans have fired the offending investment advisors or removed their funds. Should you follow suit?

ERISA does require action, but only after engaging in a prudent process to evaluate the facts and their impact on your participants. If you have a fund or fund family that is mixed up in the scandals, even if only at the level of rumor, then you need to understand and evaluate the facts and the likely consequences. The first step in that process is to gather the facts and carefully examine them, either on your own or with the help of an advisor.

While ERISA does not specifically address issues of mutual fund management, it does require that a fiduciary give “appropriate consideration to those facts and circumstances that . . . the fiduciary knows or should know are relevant to the particular investment.”

It seems clear that these issues are relevant to your decision to offer particular funds in your plan —- and to continue to offer those funds to your participants. As a result, you need to reevaluate those decisions in light of any newfound information about the mutual funds.

The examination should be “objective, thorough, and analytical” -— based on the facts, rather than newspaper headlines or political posturing. It also may be helpful to look at how knowledgeable fiduciaries of other private retirement plan are responding in these matters. The principal goal of the examination is to make a reason decision about the ability of the mutual fund management company (or investment advisor) to provide quality investment returns in the future. In other words, the past and the present must be analyzed to make the best possible decision about the future. Such examinations may be ongoing, as new facts come to light.

Fiduciaries need to determine whether all of the implicated fund companies are unsuitable for investing participants' money, or whether some have made mistakes and corrected them, both retroactively and prospectively. Was the improper activity the result of an isolated, but fixable, problem? Or, did it reflect a deep cultural philosophy, one that prioritizes the profits of the management company over the fiduciary duty to the fund's shareholders? In evaluating your response, plan fiduciaries may want to consider the following:

• Has the organization terminated the people involved in the improper conduct, even if it was not illegal, including the senior managers who oversaw the people involved? That will give you some insight into whether the organization views the issue as a legal matter or a cultural and ethical matter.

• Has the fund instituted specific procedures to eliminate late trading and market timing? The first step is for the fund to publish a statement that it will not tolerate either practice. Then, look for specific fixes, like a redemption fee for “buys-and-sells” of a fund within a limited time period—for example one week or 30 days.

• Has the fund issue a statement that it supports its long-term investors and will take steps to prohibit any activities that will deprived them of the full benefit of their investments?

Late trading and market timing are today’s issues. We can only imagine what will come next—-but we need to know that the investment advisors of the funds in our 401(k) plans are committed to delivering full value to participants.

In making a determination, it is important to be attentive to the principles underlying any judgment you make. Procedural prudence is at the heart of fiduciary actions, and procedural prudence requires consistency and even-handedness. The reasons for taking a particular action should be identified, will set a precedent for subsequent actions.

© 2004 Article was reprinted, with permission, from Plan Sponsor magazine (January 2004). Copyright 2004 Asset International, Inc. All rights reserved.

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