And Now the Fiduciary Radar Shifts to …

Now that the DOL has released its new fiduciary rule, advisers are wondering what could be “the next big thing” drawing upon the new rule. Canada has recently announced that it would conduct a sweeping investigation of the abusive marketing of “closet index” mutual funds. When one does a quick cost/benefit analysis of such funds, it is easy to see why litigation involving the marketing of such funds could easily be on the radar involving both civil and regulatory litigation. It would hard to envision a product that better meets the definition of “low hanging fruit” from a litigation and liability standpoint.

Professor Ross Miller crated a proprietary metric, the Active Expense Ratio, which calculates the effective annual expense fee for mutual funds with a high correlation of return score to an underlying market index, i.e., a high r-squared score. His findings were that such funds often had an effective annual fee significantly higher than the fund’s stated annual fee, often at least 4-5 times higher.

I created a similar metric, the Active Management Fee Factor (AMFF) , that produces a similar effective annual fee using some extra cost factors. The AMFF is generally very close to Miller’s AER, albeit slightly lower.

With the new DOL fiduciary rules, adviser need to be aware of the fiduciary rule’s emphasis on “best interests” and the challenges all advisers, in both the ERISA and non-ERISA context, will have in successfully defending fiduciary breach claims involving closet index funds.

To review I wrote earlier on the legal liability issues involved with closet index funds, click here.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ 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 and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
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