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WHY SERVICE PROVIDERS DON’T MAKE GOOD FIDUCIARIES: LESSONS FROM PRESIDENT LINCOLN | December 2013 By Philip J. Koehler, Esq.

The 150th anniversary of Lincoln’s Gettysburg address was last month.  President Lincoln came to Gettysburg on November 19, 1863 ostensibly to help commemorate the Gettysburg National Cemetery and honor the more than 20,000 Union casualties from the three-day battle that took place there four months earlier.  The recent Union victory notwithstanding, the survival of the country was hanging by a thread and Lincoln’s defeat in the next election was all but a foregone conclusion.  Yet, his common sense ability to explain the virtually inexplicable and his instinctive moral leadership drew large crowds whenever he spoke publicly.

In his first inaugural speech, two and half years before, Lincoln had pleaded with his countrymen to avoid the nightmare of civil war by heeding the “Better Angels of our Nature.”  Tragically, the country was unable to do that.  With the “butcher’s bill” on both sides now running well into the hundreds of thousands, and no end in sight, Lincoln took the stage after the spell-binding Edward Everett had held forth for over two hours.

Doing what he could to hide his elevated temperature and weakened condition brought on by complications from small pox, he spoke for a mere four minutes in words of enduring eloquence.  He told the crowd forthrightly that the outcome of the war would determine whether the “new nation” the country’s founders had “brought forth” can stand the test of time.  He wanted to convince them that, at the outset of his administration, had he accepted the secession of the southern states to prevent hostilities or, if after going to war, he accepted a negotiated settlement with the Confederacy instead of its unconditional surrender, then the nation’s form of government was fatally flawed.  Empirically, either outcome would have demonstrated that a government “of the people, by the people and for the people” was a utopian and impractical means of running a country because, ultimately, it must disintegrate to avoid violence and insurrection.  Despots and authoritarian regimes around the world would rejoice knowing that the United States and its democratic self-government was no longer a shining example to those movements seeking to improve the human condition elsewhere.

For these reasons, Lincoln argued, the war was not a war of choice; not for the Union at any rate.  The Confederacy had deluded itself into believing that it could borrow from the country’s foundational principles and establish a separate democratically elected form of government, while in doing so it was abandoning those same principles. In the face of so much carnage, this was no easy sell.  He was making a profound intellectual point in terms he hoped could reach the average person.

Surely, many in the crowd that day were too preoccupied with the somber reality of war to appreciate everything he was saying.  But he labored on knowing, perhaps, that he was talking to a much broader audience.  To make sense of the war and find meaning in the sacrifice of so many lives, Lincoln explained, the survivors must recommit themselves to the founders’ shared vision of a nation of free people successfully charting its destiny through self-government.  It is the resonance of this fundamental shared vision, echoing through each generation, he argued, rather than the voices of angels, that is the fulcrum on which the nation’s survival turned.  Thankfully, for his and all future generations, Lincoln persevered even at the cost of his own life seventeen months later.  It was a bitter, hard and unimaginably horrific slog to Union victory that he would see through to the end without the assistance of the “Better Angels of Our Nature.”

How is the Gettysburg Address relevant to a discussion about 401(k) Plan governance?  In my humble opinion, it’s not too much of a stretch to apply Lincoln’s views to any system of self-governance, no matter how grand or mundane.   By 1863 Lincoln clearly understood that no system of government can survive for long if settling internal conflicts depends on ready access to the “Better Angeles of Our Nature.”  When opposing parties take entrenched ideological or business positions, they become blinded by a narrower self-interest, and it’s too late for that.  What ensues is a test of the survival of the system itself.  If it does survive, it may yet experience a renewal or, as Lincoln put it, “a new birth of freedom.”  It’s a lesson that must have been seared into the conscience of the Civil War generation, but one could argue, has been forgotten.

Almost forty years ago, after consideration of the long history of abuses in the private pension system, Congress enacted ERISA with its scheme of fiduciary responsibility as the centerpiece of its model of plan self-governance.  This system is grounded in the undeniable fact that the public policy underlying a private pension plan requires robust fiduciary oversight.   It too cannot function over the long haul if resolving conflicts requires plan sponsors and service providers to channel the “Better [Fiduciaries] of Our Nature.”

It took ERISA’s straightforward standards of fiduciary responsibility and fiduciary liability enforcement provisions to make fiduciary oversight more than the ceremonial fig leaf it had all too frequently been in the past.  If the history of fiduciary breach litigation shows us anything, it’s that for many plans, inside fiduciaries, i.e. employees of the plan sponsor, are too compromised by their lack of independence to meet these standards.

We typically use the term “Independent Fiduciary” in a very narrow context, as a way of distinguishing outside professionals from inside fiduciaries.  However, ERISA’s standards of fiduciary responsibility make no such distinction.  Under these standards, the concept of “Independence,” in its broader legal formulation, is inseparable from the notion of being a fiduciary.   In the final analysis, the term “Independent Fiduciary” is redundant.

The service provider industry has matured over the last 40 years based on a pattern of working, by and large, with inside fiduciaries.  The members of the industry include many large, sophisticated organizations generating billions of dollars of annual revenue, whose financial interests are protected by the multiple political lobbying groups they fund.   On the other hand, the market for independent fiduciary services in general, and ERISA Section 3(16) independent fiduciary services in particular, is in a fragile early stage of development.

With business retention chief among the industry’s fundamental business objectives, it’s easy to see how oversight by fiduciaries who take their responsibilities seriously would pose a threat.   Historically, the members of the industry addressed this threat in a number of ways.  The best ones focused on improving the quality of their services and the professionalism of their staffs.   However, most also exploited the ERISA illiteracy that is prevalent among the plan sponsors who engage them.   While marketing complex administrative systems for which plan sponsors were increasingly unprepared to understand, let alone operate, the industry cultivated their dependence.   Yet, it took every opportunity, in the design of its standardized plan documents and the language of its administrative services agreements, to insulate itself from fiduciary responsibility, while leaving ill-prepared plan sponsors, often unwittingly, alone with this exposure.

There are troubling signs that some service providers, especially TPAs, are so concerned by this threat to business retention that they have decided to make a limited foray out from behind their protective fiduciary liability curtain, forming new affiliates and offering additional services as ERISA Section 3(16) fiduciaries.  Of course, it’s not at all clear, for example, how a decision by a fiduciary to engage/retain its affiliated TPA squares with ERISA’s admonition that a fiduciary avoid conflicts of interest.  This co-opting of the independent fiduciary market place has all the subtlety, as Lincoln might have put it with his renowned homespun wit, of the fox tip toing into the hen house to test the watchdog’s resolve.  It’s the old “ends justifies the means” approach, where the end is minimizing the risk to business retention and the means is manipulation of the fiduciary’s incentives to function with true independence.

Putting that glaring problem aside, a fiduciary affiliated with a TPA would also have an inherent conflict in evaluating the quality of the work performed by any other TPA.  This conflict arises because the TPA with whom the fiduciary is affiliated is either directly or indirectly (1) marketing its TPA services to the plan sponsor, or (2) competing for other business with the plan’s current TPA.  There is no credible way that a fiduciary can fairly evaluate the quality of the work performed by an affiliated service provider, or by any of the affiliate’s competitors, not to mention the reasonableness of their fees.  The notion that some TPAs are launching these new business ventures in the face of such apparent ethical and business conflicts, which should disqualify TPAs generally from acting as ERISA Section 3(16) fiduciaries, reveals a serious misunderstanding of ERISA’s fiduciary standards.

Furthermore, even if a service provider’s lack of independence was not an issue, it possesses no special insights into the performance of a fiduciary role.  There’s an inevitable degree of ”tunnel vision” that develops if a fiduciary’s background is based mainly on experience with a single provider or small group of providers.  As any for-profit business enterprise, a service provider is subject to the normal business pressures to control costs by streamlining administrative systems and procedures.  Inevitably, within the industry, the result has been a wide diversity of approaches to designing standardized plan documents, system development and interpretation of ERISA’s voluminous regulations and other guidance.  There are many technical administrative and legal issues on which they simply do not all agree.

It is the breadth of knowledge and experience, as well as their depth, that makes up the requisite fiduciary skill set.  Having a lot of experience as an employee of a TPA, for example, or even a handful of TPAs, may establish a mastery of the unique assumptions, quirks and tradeoffs imbedded in the documents, processes and programs developed by a particular firm or group of firms, but it also creates a bias in favor of “doing it that way.”  Such a bias unduly narrows the provider’s subject matter expertise.  Thus, the knowledge base of a highly experienced TPA may not overlap entirely with the documents, processes and programs in use by a plan that has engaged a different TPA.  A qualified fiduciary must understand the plan’s legal and administrative environment beyond these arbitrary constraints.

Lastly, we shouldn’t lose sight of the fact that the industry historically shunned any fiduciary responsibility in its principal lines of business and this shows no signs of changing.  There’s good reason to be skeptical that organizations, whose revenue streams are overwhelmingly sourced in their traditional ”nonfiduciary” activities, will demonstrate comparable alacrity in providing fiduciary services.  Furthermore, as was the case with plan document services, once it decides to control a market for professional services, the industry has a track record of subsidizing the cost of that venture by adopting a loss leader pricing strategy in order to undercut the competition from outside professionals.  This would usher in the inevitable race to mediocrity in ERISA’s centerpiece of plan governance and leave us very far from the voices of the “Better [Fiduciaries] of Our Nature.”

The much loftier issues of racial equality and the staying power of democracy as a form of government were, of course, what Lincoln was talking about in the Gettysburg Address.  He observed that the country’s founders enshrined their belief that “all men are created equal” in the Declaration of Independence, but he knew that many of them were slaveholders.  Lincoln understood that such base hypocrisy was a cancer on the country’s integrity.  Eighty-seven years later it had fallen to him to root it out by convincing the country that the founders had not impliedly placed asterisks in the Declaration or the Constitution regarding such fundamental rights and the nation’s fate depended in large part on whether these documents mean what they say.

With the emergence of a market for ERISA Section 3(16) fiduciary services forty years after enactment, one might well ask a few questions.  Do ERISA’s standards of fiduciary responsibility mean what they say?  Are plan sponsors and service providers committed to the shared vision of fiduciary responsibility allocated among persons who are qualified and unconflicted?  Or…with a wink and a nod, will the industry’s efforts at co-opting the fledgling market place succeed?  The new market for ERISA Section 3(16) fiduciaries survives only so long as it gives plan sponsors a real choice between appointing: (1) an outside professional fiduciary, for whom ERISA’s standards of fiduciary responsibility are reasonably attainable because of the fiduciary’s independence, background and training, or (2) a task-loaded executive for whom it’s much more of an open question.