RIAs: Fiduciaries for What?
I recently served as a consultant and expert witness in a lawsuit against an RIA—registered investment adviser. More technically, I was the expert hired by the attorney for the IAR—the individual adviser representative. The broker-dealer/RIA had separate legal counsel and a separate expert.
The adviser was sued as a fiduciary for recommending a recordkeeper. Because of problems with the recordkeeper, the plan lost several hundred thousand dollars. Unfortunately, the recordkeeper went out of business and the plan was “left holding the bag.” That is, the plan was not able to recover the losses from the culpable party—the recordkeeper.
The adviser had an agreement with the plan that described the services to be provided. The agreement also acknowledged that the adviser would be a fiduciary. However, most of the services were not fiduciary services. In fact, the only fiduciary service was assistance with the selection and monitoring of the investments. Unfortunately for the adviser, though, the agreement could be interpreted to say that the adviser was serving in a fiduciary capacity for all of the services (which would include help in the selection of other service providers, investment education for participants, responding to questions about the plan, and so on). But, under the law, none of those services are fiduciary in nature.
As you might imagine, the plan’s attorney alleged that the adviser and the broker-dealer/RIA were fiduciaries for all of the purposes listed in the agreement. In other words, the attorney asserted that the prudent man rule, and the ongoing duty to monitor, applied to the help with the selection and oversight of the recordkeeper. My expert testimony, both in my report and at deposition, was that the adviser was not, and could not, be a fiduciary for selection of the recordkeeper.
In any event, because of the confusion about the meaning of the agreement, and the resulting risk of litigation, the case settled. While I do not know the settlement amount, I would not be surprised if the attorneys’ fees, expert witness expenses, court costs, deposition fees, and so on, were over $100,000. And, I suspect that there was a similar cost for the broker-dealer/RIA.
From my perspective, the moral of this story is two-fold. The first is that service agreements for RIA firms need to be well drafted. While that encompasses a number of issues, this case illustrates that the agreements should clearly distinguish between those services that are fiduciary in nature and those that are not. Once that distinction has been made, the agreement can further impose restrictions on liability for the non-fiduciary services. For example, the agreement could limit the liability for non-fiduciary services to the fees charged for them, to a stated dollar amount, or to damages resulting only from gross negligence or willful misconduct. However, fiduciary services cannot have those restrictions because of the ERISA prohibition on exculpatory clauses.
Secondly, the case demonstrates the cost and complexity of fiduciary litigation. For example, it can be difficult to prove—or disprove—fiduciary status. Then, once fiduciary status is established, there can be controversy over whether a particular activity is a fiduciary function. Finally, it is difficult and time-consuming to prove, or disprove, what is prudent in a given situation, particularly when both sides have different recollections of the facts and when there is little in the way of written documentation.
Because of these issues, advisers need to be prepared for the high cost of litigation. Of course, fiduciary liability insurance is one way to do that. As a word of warning, don’t rely on your malpractice, or errors and omissions, insurance to guard you against fiduciary breaches. Most have specific exclusions from fiduciary coverage.
Any tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.
© 2009
Reish Luftman Reicher & Cohen, A Professional Corporation. All rights reserved. The ERISA Controversy Report is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.
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