Whoomp, There It is! – The New Prudent Fee Fiduciary Standard

“Essential to the plausibility of plaintiffs’ claims was the allegation that the Affiliated Funds ‘charged higher fees than those charged by comparable Vanguard funds-in some instances fees were more than 200 percent higher than those comparable funds'”.

With those words the United States District Court for Southern District of New York, provided the long-anticipated introduction, or more specifically the judicial verification, of Vanguard’s funds’ fees as a comparative basis for assessing excessive of fund fees was established. While the case is not binding on other courts, the rationale used by the court is persuasive and will undoubtedly be referenced by plaintiffs’ attorneys in both 401(k) and other cases where breach of fiduciary issues involving fee issues are involved.

The case involved is Marya J. Leber, et al. v. The Citigroup 401(k) Plan Investment Committee et. al., otherwise known as the Citigroup 401(k) action. The court’s decision is yet another in the continuing pro-plan participant decision s that have been handed down since the Supreme Court’s LaRue decision, recognizing that plan participant’s bear the risk in defined contribution pension plans.

More importantly, the court’s decision provides further support for the relevance of intrinsic costs and returns in analyzing both investment recommendations made by financial advisors and investment options offered by 401(k) plans and other retirement plans. I introduced a proprietary metric, the Active Management Value Ratio™ (AMVR™), as a means of assessing the prudence of actively managed investment products. The AMVR™ is a simple, straightforward metric that requires nothing more than simple subtraction and division. By using the incremental costs and incremental returns of an investment in the calculation process, the AMVR™ provides a truer evaluation of an investments benefits, or lack thereof.

Investment advisers and investment adviser representatives are fiduciaries by law. Many stockbrokers have told me that they do not have to worry about fiduciary issues since they do not manage customer accounts on a fiduciary basis and the law clearly states that a broker does not have any fiduciary duties with regard to non-discretionary customer accounts.

Those same brokers are surprised when I tell them about the cases of Follansbee v. Davis, Skaggs & Co. Inc. and Carras v. Burns. In both cases, the courts ruled that a broker can be held to owe a fiduciary to their customers, even in cases involving purely non-discretionary accounts. As the Follansbee court stated

The touchstone is whether or not the customer had sufficient intelligence and understanding to evaluate [a broker’s recommendations] and to reject one when he thinks it unsuitable.

The Carras court reiterated the Follansbee standard, stating that

the issue is whether or not the customer, based on the information available to him, and his ability to interpret it, can independently evaluate his broker’s suggestions.

As a result, I would suggest that broker’s may face imposition of a fiduciary standard more often than they believe. Therefore, all financial advisers, might find it beneficial to consider the impact of the Citigroup decision and the usefulness of the AMVR™ in both providing valuable services to their clients while reducing unwanted  and unnecessary liability exposure.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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