The process of picking a co-fiduciary

Delegating such a major responsibility requires prudence, planning and procedures

By Blaine F. Aikin
August 16, 2009

By definition, prudence involves the exercise of skill and good judgment in the use of resources. It is a core fiduciary duty. Consistent with the stature of fiduciary obligations as the highest known to law, fiduciaries are expected to ensure that investments entrusted to their care are managed with the skill and judgment of a professional.

The courts have been clear and consistent in requiring fiduciaries lacking adequate training, experience and expertise to make necessary and proper investment decisions to engage competent independent financial advisers and managers to help handle the job. Thus, the duty of prudence is often associated with a companion duty to delegate.

A fiduciary who can’t demonstrate a professional level of investment ability must fulfill the duty of prudence by carefully selecting and monitoring co-fiduciaries who are investment experts.

There are powerful incentives for fiduciaries to delegate investment responsibilities properly.

In addition to substantially raising the odds that professional management will achieve better investment results for portfolio beneficiaries, fiduciaries who delegate properly can significantly reduce their fiduciary liability. Retirement plan sponsors, investment committees and other stewards who engage an adviser to perform asset allocation studies, make investment recommendations, assist in the selection of other service providers and provide other critical portfolio management functions are well-positioned to demonstrate prudence in selecting advisers.

Moreover, stewards and advisers who delegate discretionary management of securities to qualified investment managers are well-protected against claims of inappropriate or imprudent investment selections.

Proper delegation doesn’t simply mean signing over specific fiduciary responsibilities to any party willing to accept them. It hinges upon the rigor of the process used to select and monitor the “prudent experts” chosen for specifically delegated activities.

The process will necessarily involve four steps:

• Detailing the scope of the services required.

• Gathering pertinent information about the advisers or managers under consideration.

• Evaluating each candidate’s ability to perform the services required based on that information.

• Documenting the results of the analysis and the selections made.

Formality is important to assure a consistent approach, a sound selection and clear evidence that a prudent process is being applied. For this reason, a formal search process, such as through the issuance of a request for proposals, is highly recommended to establish well-defined selection criteria and to regiment the review of responses submitted.

Based upon relevant regulatory guidelines and legal precedents, criteria for the selection and monitoring of co-fiduciaries should focus on four areas of inquiry: expertise, experience, cost and independence.

For the most part, expertise, experience and cost are evaluated based upon direct comparisons among competing service providers.

However, technically qualified candidates may not be appropriate co-fiduciaries if they aren’t independent and objective. The courts have given strong consideration to the impartiality of co-fiduciaries in making a determination as to whether proper delegation of fiduciary duties has occurred.

Unlike the other areas of inquiry, the criteria used to establish independence are absolute rather than relative and center upon conflicts of interest: circumstances that make fulfillment of the fiduciaries’ duty of loyalty to the investors they serve less reliable.

Loyalty is the most important fiduciary duty of all and conflicts should be avoided when possible.

Prior to considering issues of technical competence and competitive pricing, potential co-fiduciaries should be screened to assure that they are prepared to acknowledge their co-fiduciary status in writing, disclose all compensation they and their affiliates receive, and demonstrate that such compensation doesn’t vary depending upon the advice rendered or investment recommended.

An adviser or manager who successfully wins the competitive selection process assumes the liability associated with performing the delegated duties and the obligation to be prudent in applying the professional skill and judgment that earned that privileged position of trust. This is as it should be, because fulfillment of the fiduciary duty of prudence ultimately places responsibility in the hands of those most capable of successfully meeting investors’ needs.

Blaine F. Aikin is president and chief executive of Fiduciary360 LP of Sewickley, Pa.