Fixing the 401(k)

As readers of my book are aware, I am a big advocate for 401(k) plans utilizing the services of an ERISA-defined "Investment Manager" (full disclosure: my firm serves in this capacity). 

ERISA section 3(38) defines an investment manager as any fiduciary (other than a trustee or a named fiduciary) who:

1. who has the power to manage, acquire, or dispose of any asset of a plan;
2. is a Registered Investment Advisor (RIA), bank or insurance company;
3. has acknowledged in writing that he is a fiduciary with respect to the plan.

A named fiduciary can appoint and delegate certain plan functions to an investment manager (pursuant to ERISA section 402(c)(3)) and not be liable for the acts and omissions of the investment manager (pursuant to ERISA section 405(d)(1)).  I believe the appointment of an investment manager is a great way for plan fiduciaries to utilize the resources of prudent experts, achieve better results and minimize their liability.  Of course, the one caveat is that the appointment of the investment manager must be prudent and this responsibility lies solely with the appointing fiduciary. 

According to this article, last September the DOL filed suit against Dr. Anthony Ioriothe who owns Fairfield Podiatry Associates in Connecticut.  Iorio had appointed Lafferty & Partners LLC, a New Jersey-based investment firm as the investment manager for his firm's 401(k) plan.  Apparently, the owner of Lafferty & Partners (Jeffrey Lafferty) stole thousands of dollars from the plan and Iorio was charged with breaching his fiduciary duties by not adequately monitoring the activities of Lafferty & Partners.  According to the article, Dr. Iorio is required to restore $32,263.51 to the plan and to pay a $6,452.70 civil penalty.

I dug a little deeper and found this press release that confirms that Lafferty and his partner stole approximately $790,000 from their clients, many of which were podiatrists.  I was struck by this quote in the press release:

The clients received monthly statements from Lafferty & Partners that falsely represented that their money was invested. Lafferty issued fraudulent “dividend checks” to some of the out-of state investors to reinforce the appearance that their money had been properly invested.

It seems that Lafferty must have taken physical custody of the assets (rather than having them custodied independently) since his firm directly issued fraudulent account statements and he was able to actually withdraw the money.

Despite this specific case, I still believe that appointing an investment manager is the best step that plan fiduciaries can take.  However, there are a couple of key takeaways:

1.  It is critical for appointing fiduciaries to consistently monitor the activities of the investment manager.  This should be done through regularly scheduled meetings and by utilizing precise meeting minutes to document the process.

2.  Clients (ERISA or otherwise) should always utilize the services of an independent trust company or custodian to safeguard and report on assets.  They should also be wary if they receive monthly account statements or "dividend checks" directly from a broker or advisor, rather than from the custodian of the assets.  This was similar to what happened with Bernie Madoff and I believe the risk for fraud increases substantially when an advisor/broker has custody of assets.