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Regulatory Compliance
Demonstrating Fiduciary Standards of Care
Three legislative acts provide the legislative basis for fiduciaries.
The first is the Employee Retirement Income Security Act, or ERISA. This is federal legislation that defines fiduciary conduct for qualified corporate retirement accounts (defined-benefit plans and defined-contribution plans, including 401(k) benefit plans).
The second is the state-enacted Uniform Prudent Investor Act, or UPIA, which defines the fiduciary practices for private trusts, foundations, and endowments. Approximately 40 states have enacted the entire, or a substantial part of, UPIA.
The third act was introduced in 1997 and it is proposed legislation called the Uniform Management of Public Employee Retirement Systems Act, or MPERS. This proposal is state-enacted legislation that defines the fiduciary conduct for state, county, and municipal retirement plans. As a fiduciary, RIAs or Money Managers have big responsibility to their clients to follow prudent investment practices and demonstrate a Fiduciary Standards of Care.
Tamarac Advisor is a core back-office technology that automates the areas of rebalancing, documenting trade recommendations and monitoring client portfolios. These processes, along with the Fiduciary Standards of Care, can create a safe-harbor environment for your advisory firm.
Advisory firms can protect themselves from certain liabilities by demonstrating the following five disciplines:
- Analyze the client's current position
- Diversify the client's portfolio
- Formalize investment policy statement
- Implement investment policy/strategy
- Monitor and Rebalance investment strategy
Analyze the client's current position. Make sure the investments are managed in accordance with applicable laws, trust documents, and written investment statements. Documentation should show the timing and distribution of cash flows and the payment of liabilities, and that assets are within the jurisdiction of the U.S. courts and are protected from theft and embezzlement.
Diversify the client's portfolio. Identify an appropriate risk level for the client and an expected, modeled return to meet the investment objectives, along with an investment time horizon. The selected asset classes should be consistent with the identified risk, return, and time horizon of the client, and the number of asset classes consistent with the portfolio size.
Formalize an investment policy statement. The investment policy statement (IPS) defines:
- Duties and responsibilities of all involved parties
- Diversification and rebalancing guidelines
- Due-diligence criteria for selecting and monitoring investment options and service vendors (such as the custodians)
- Procedures for controlling and accounting for investment expenses
- Appropriately structured, socially responsible investment strategies (when applicable)
Implement investment policy. Implement the IPS in compliance with the required level of prudence. The fiduciary is following applicable "safe harbor" provisions (when elected in writing in the IPS).
Monitor and Rebalance investment strategy. Periodic reports should compare investment performance against appropriate index, peer group, and IPS objectives, and note qualitative or organizational changes of investment decision-makers. Control procedures must be in place to periodically review policies for best execution, soft dollars, proxy voting, and revenue sharing.
Rebalancing is an inherent concept of diversification, where the goal is to create a portfolio that balances appropriate levels of risk and return. That balance, once achieved, can only be maintained by periodically rebalancing the portfolio to maintain the appropriate diversification.
Tamarac's core competency is automating portfolio review and rebalancing - supporting any rebalancing strategy, style and frequency.
If investment decisions have been managed by a committee or by an investment advisor, there are five generally recognized provisions to the safe harbor rules:
- Use prudent experts to make the investment decisions.
- Demonstrate that the prudent expert was selected by following a due-diligence process.
- Give the prudent expert discretion over the assets.
- Have the prudent expert acknowledge their co-fiduciary status.
- Monitor the activities of the prudent expert to ensure that the expert is performing the agreed-upon tasks.
Safe-harbor rules are voluntary, but when adopted, the fiduciary's liabilities associated with the management of the portfolio's assets may be reduced.
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