Can a prudent fiduciary approve a conflicted adviser?

[Peter Gulia]

I’m hoping for a little old-fashioned (and courteous) debate.

The Labor department’s EBSA has stated an informal view [FAB 2007-1] that the “level-fees” condition of the new statutory prohibited-transaction exemption for the first of the two different kinds of eligible investment-advice arrangements can be met looking only to the fees of the adviser, without counting fees of persons that control, are commonly controlled with, or otherwise are affiliates of the adviser if the affiliate does not render investment advice. I’m not seeking views on whether the view described in the bulletin is a correct interpretation of the statute.

The same bulletin reaffirms a view that a fiduciary who or that selects an investment adviser must do so prudently.

(To focus the discussion, let’s assume that the adviser that wants to use the new PTE is a company or other non-natural person, and that a human, if any, involved in rendering the advice is not himself or herself a registered investment adviser but rather is a representative or employee of the adviser company.)

Many practitioners might agree that at least some participants who use investment advice don’t know enough about the subject of the advice to evaluate independently whether an adviser gave advice that was compromised by a conflict of interests. (And those who do know enough might not need the advice.)

If a plan fiduciary believes this, how comfortable should he or she be in approving an arrangement concerning which an adviser is permitted to render advice that could be compromised by the adviser’s interests in recommending the investments and services of an affiliate?

1) Does the selecting fiduciary have a duty to consider independently the quality of the adviser’s disclosures about the conflicts?

2) Even if all conflicts are fully disclosed in very plain language, does the selecting fiduciary have a duty to consider whether some participants might lack the skills needed to evaluate whether a conflict compromised the advice rendered?

3) Even if the selecting fiduciary finds credible evidence that participants are capable of detecting whether a conflict compromised the advice rendered, is it sensible for a fiduciary to approve an arrangement that leaves a participant to pursue the plan account’s remedies only after the harm already happened?

4) Could a selecting fiduciary decide prudently that participants need advice so badly that even conflicted advice is better than none at all? If so, does it matter whether an unconflicted alternative is available to the plan?

5) What should a selecting fiduciary do to evaluate the probability or risk that the incremental investment returns that participants achieved because of following the adviser’s advice might turn out to be less than participants' incremental losses from following the adviser’s advice?

To be fair about starting the debate, my instinct is to doubt that a prudent fiduciary should approve an arrangement that lets a conflicted person render advice to a non-expert. But human nature doesn’t always neatly follow theory, my experiences are a less-than-complete sample, and I try to learn from others’ observations.

Your ideas, please?