[email protected] donald b trone, aifa ® d efining a s tandard f or t he d elivery o f i nvestment a...

[email protected] B Trone, AIFA®

DEFINING A STANDARD FOR THE DELIVERY OF INVESTMENT ADVICE

Copyright © 1999-2005. Fiduciary360

Foundation for Fiduciary Studies Center for Fiduciary Studies Fiduciary Analytics

MANAGING THE NATION’S

INVESTABLE WEALTH

More than 5 million men and women serve as investment fiduciaries.

In turn, the 5 million manage more than 80% of the nation’s liquid investable wealth.

As critical as their function is to the fiscal health of the nation, not a single federal or state agency provides education and training to the 5 million.



“MAGINOT MENTALITY”

Following WWI, France built a series of interlocking forts to protect itself from another German invasion. When WWII broke out, Germany simply outflanked the Maginot Line and easily overran France.

Why did this formidable structure fail? The truth is, the structure didn’t fail — the failure was France’s leadership in recognizing the fundamental changes that were taking place in modern warfare.

Today, this form of leadership failure is referred to as “Maginot Mentality.”

Source: www.maginot-line.com



Example: “The Fiduciary Effect”*

Source: www.maginot-line.com

What does New York’s Attorney General understand that other regulators do not?

Spitzer understands fiduciary responsibility. He understands that there has been a fundamental shift in what the public expects from people who serve in a fiduciary capacity. The message is clear:

If the public puts you in a position of trust, you are a fiduciary, and you cannot parlay that position of trust for personal profit.

* Source: New York Times

“MAGINOT MENTALITY”



The vast majority of plan fiduciaries and participants rely on investment consultants (or similar sounding title). Unfortunately, investment consulting is a poorly regulated profession; the normal attributes are missing:

No one regulatory body

No defined standards of care

No advance education and training requirements

THE POORLY REGULATED PROFESSION



Brokers

Money Managers

Investment AdvisorsFinancial Planners (?)

Wealth ManagersFinancial Consultants

Estate PlannersBroker Consultants

Private Bankers

(Regulated by NASD)

(Regulated by new division of SEC)

(Regulated by SEC)

Suitability Standard Fiduciary Standard

Investment Advisers

Investment Consultants

Brokers

PROPOSED REGULATORY OVERSIGHT



“Society depends upon professionals to provide reliable fixed standards in situations where the facts are murky or the temptations too strong… They represent the best a particular community is able to muster in response to new challenges.”

Dr. Robert G Kennedy, St Thomas University

THE NECESSITY FOR DEFINED FIDUCIARY PRACTICES



ERISA

UPIA

MPERS

LEGISLATION

Employee Retirement Income and Securities Act (Qualified retirement plans)

Uniform Prudent Investor Act (Private trusts, foundations/endowments)

Uniform Management of Public Employees Retirement Systems Act (State, county, and municipal retirement plans)



UNIFORM FIDUCIARY STANDARDS OF

CARE

1. Know standards, laws, and trust provisions.

2. Diversify assets to specific risk/return profile

of client.

3. Prepare investment policy statement.

4. Use “prudent experts” (money managers)

and document due diligence.

5. Control and account for investment expenses.

6. Monitor the activities of “prudent experts.”

7. Avoid conflicts of interest and prohibited

transactions.



Analyze

CurrentPositio

nStep 1

Diversify –

AllocatePortfolioStep 2 Formalize

Investment

PolicyStep 3Implement

Policy

Step 4Monitor

andSupervis

eStep 5

FIVE-STEP INVESTMENT

MANAGEMENT PROCESS

Reconfirm goals and objectives

Copyright © 2001, Center for Fiduciary Studies

AnalyzeCurrentPosition

Step 1

DesignOptimalPortfolio

Step 2

FormalizeInvestment

PolicyStep 3

ImplementPolicy

Step 4

Monitorand

SuperviseStep 5

Rebalance

STEPS IN THE INVESTMENT MANAGEMENT PROCESS


UNIFORM FIDUCIARY STANDARDS OF CARE

1. Know standards, laws, and trust provisions.

2. Prepare investment policy statement.

3. Diversify assets to specific risk/return profile of client.

4. Use “prudent experts” – money managers – and document due diligence.

5. Control and account for investment expenses.

6. Monitor money managers and service vendors.

7. Avoid conflicts of interest and prohibited transactions.

The Matrix is constructed by using the five “Steps of the Investment Process” as the horizontal axis, and the seven “Uniform Fiduciary Standards of Care” as the vertical axis.


PRACTICES MATRIX

StepsStandards

1

7

1 5

CONSTRUCTING THE PRACTICES MATRIX



LEGAL CITATIONS, REFERENCES

AND SUPPORT

Each Practice is substantiated with a reference to:

ERISA

UPIA

MPERS

When applicable: Case Law and Regulatory Opinion Letter(s)

BENEFITS OF HAVING PRACTICES

Reduce fiduciary liability by uncovering omissions.

Provides educational outline.

Should improve long-term performance.

Enable fiduciaries to compare practices and procedures.

Assist in prioritizing projects.

Establish benchmarks to measure progress.

Negotiate lower “E&O” premiums.

1.

2.

3.

4.

5.

6.

7.



PRIMER ON PAY-TO-PLAY

1. Broker Pay-to-Play: SEC charges against Morgan Stanley’s “Partner’s List”

Important to distinguish between paying for shelf space and undisclosed compensation

2. Politician Pay-to-Play: Contributions to politicians in exchange for access to public funds

Watch also 529 Plans and Tobacco Settlement

3. Consultant Pay-to-Play: Selling “services” to money managers

Most egregious because consultant is hired to be an objective source



TRIANGULATING THE SEC’S POSITION

Mutual funds can’t direct brokerage for shelf space

Investigation into consultant “pay-to-play” schemes

Failure to repeal of broker-dealer exemption

?



MANAGER DUE DILIGENCE

Performance relative to peer group.

Performance relative to assumed risk.

Inception date of product.

Correlation to peer group.

Assets in the product.

Holdings consistent with style.

Expense ratios or fees.

Stability of the organization.

1.

2.

3.

4.

5.

6.

7.

8.



FIDUCIARY SCORE™

Each field is given a numerical value and then ranked against other funds in its peer group.

Passed – No fiduciary due diligence shortfalls. (Top Percentile)

Appropriate – Shortfalls, but still ranks in Top Quartile.

Watch (2) (3) and (4) – There are shortfalls; the fund may not be the best choice if being considered in a search, but may not need to be replaced (2nd and 3rd Quartiles).



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Fiduciary 360

438 Division Street

Sewickley, PA 15143www.fi360.com

Donald B Trone, AIFA®

[email protected]

(412) 741-8140Foundation for Fiduciary Studies

Center for Fiduciary Studies

Fiduciary Analytics

Don Trone is the president of the Foundation for Fiduciary Studies, the mission of which is to define the practices that detail a prudent process for investment fiduciaries. Don is also the co-founder and Co-Director of the Center for Fiduciary Studies, which operates in association with the University of Pittsburgh’s Katz Graduate School of Business. In addition, Don is the CEO of Fiduciary Analytics which develops web-based tools to support the decision making process of investment fiduciaries.

In 2005, Don was selected to the prestigious IA25, the listing of the twenty-five most influential people in the investment advisory industry. In 2004, The Center for Fiduciary Studies was selected to provide fiduciary training to the Directors of the Federal Retirement Thrift, the retirement plan for 3.2 million Federal employees, including members of Congress and the uniformed services. The Federal Retirement Thrift is the largest defined contribution plan in the world. In 2003, Don was appointed by the U.S. Secretary of Labor to represent the investment counseling industry on the ERISA Advisory Council.

Don is co-author of two industry bestsellers, Procedural Prudence and The Management of Investment Decisions (McGraw-Hill Publishing), and lead the development of the fiduciary handbook, Prudent Investment Practices. He graduated as president of his class from the United States Coast Guard Academy, and with honors from the US Naval Flight Training Program in Pensacola, Fl. He served on active duty for ten years as a long-range search and rescue helicopter pilot. In 1997 he was the recipient of the Coast Guard Academy Alumni Medal of Achievement for his distinguished military and business career. Don received his Master’s degree in Financial Services from the American College, and has completed post-graduate studies at Pittsburgh Theological Seminary and Trinity Episcopal Seminary.

[email protected] donald b trone, aifa ® d efining a s tandard f or t he d elivery o f i nvestment a...

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