401(k) Plans Carry Frequently Ignored Fiduciary Duties for Plan Administrators

Last year the U.S. Supreme Court held that a 401(k) plan participant could sue for an alleged breach of fiduciary duty as long as the allegations related to the proper management, administration, and investment of asset plans. This past Friday the St. Louis Business Journal published an article reviewing the millions of dollars in losses suffered by the 401(k) plans of dozens of large St Louis employers in 2008. Some of the plans noted in the article had losses exceeding 30%. While a mere substantial loss alone, particularly in such a difficult economic and market environment, is not a sufficient basis for a law suit, it may (hint-should) prompt you to have a professional take a look at your plan to make sure it is and was being administered diligently, prudently, and consistent with your and your other plan participants' best interests. Cosgrove Law, LLC works with investment professionals on a variety of matters, including the legal and financial assessment of 401(k) plans--plans in which rest your hopes for a decent retirement.

SEC REGULATORY OVERVIEW: COMPLIANCE EXAMINATIONS

Through routine compliance examinations, the SEC keeps a close eye on SEC-registered investment advisors, investment companies, broker-dealers, and other types of registered firms to ensure that these firms are maintaining compliance with federal securities laws, and also to identify any potential weaknesses in the SEC’s compliance and supervisory controls.

In June 2007, the SEC for the first time issued its "ComplianceAlert," which provides financial firms with a periodical summary of select compliance areas the SEC examiners are concerned with, thereby providing firms with a forewarning of these problem areas so that they can review and modify their practices where necessary. In its most recent ComplianceAlert, dated July 2008, the SEC noted concern over the following selected practices by SEC-registered firms:

(a) Investment Advisors/Mutual Funds

a. Personal Trading by Advisory Staff—SEC compliance examiners reviewed advisors’ international compliance controls surrounding their employees’ trading and trading by the firms for their own proprietary accounts.

b. Proxy Voting and Funds’ Use of Proxy Voting Services—SEC compliance examiners reviewed practices with respect to the use of third-party proxy voting services, including oversight and operational aspects of mutual funds’ proxy voting, and how advisors managed conflicts of interest in proxy voting.

c. Valuation and Liquidity Issues in High Yield Municipal Bond Funds—SEC compliance examiners reviewed the portfolio composition, valuation and transaction activity of high yield municipal bond funds.

d. Soft Dollar Practices of Investment Advisors—SEC compliance examiners reviewed the soft dollar arrangements maintained by registered investment advisors, including the arrangements these advisors may have with both third-party and proprietary providers.

(b) Broker-Dealers

a. Examinations of Securities Firms Providing “Free Lunch” Sales Seminars—SEC, compliance examiners, in coordination with FINRA and NASAA, performed over 100 examinations of broker-dealers, investment advisors and other financial services firms that offer “free lunch” sales seminars targeting seniors in particular.

b. Valuation and Collateral Management Processes—SEC compliance examiners, in coordination with FINRA, reviewed large broker-dealer firms to assess their valuation and collateral management practices as they related to subprime mortgage-related products, including the firms’ controls around the valuation process.

c. Broker-Dealers Affiliated with Insurance Companies—SEC compliance examiners conducted targeted reviews of a number of broker-dealer subsidiaries of insurance companies.

d. Supervision of Solicitations of Advisory Services—SEC compliance examiners reviewed broker-dealer firms that had designated their registered representatives as “solicitors” for an investment advisor, including how supervision was implemented for these registered representatives’ activities as solicitors.

e. Mortgage financing as Credit for the Purchase of Securities—SEC compliance examiners conducted risk-targeted examinations of broker-dealer firms to evaluate their practice of recommending that their customers finance the purchase of their securities by obtaining a second or reverse mortgage on their home through a bank affiliated with the broker-dealer.

f. Office of Supervisory Jurisdiction Supervisory Structure—SEC compliance examiners reviewed broker-dealer firms’ supervisory and compliance controls under an Office of Supervisory Jurisdiction (OSJ) structure, including each firm’s supervisory structure and practices, and its supervision of its branch offices.

(c) Transfer Agents

a. Practices with Respect to “Lost SecurityHolders”—SEC compliance examiners reviewed transfer agents in order to understand current practices with respect to the search process performed for “lost” securityholders and the use of third-party “search firms” that search for lost securityholders.

Notably, not all of the above-referenced practices are legal requirements, but instead some are merely suggestions by the SEC compliance examiners. Based upon the SEC’s June 2007 and July 2008 release dates for its prior ComplianceAlert letters, it is likely that the 2009 alert will be released shortly. We will provide you with a summary of the SEC’s most recent compliance concerns at that time.

CORPORATE GOVERNANCE MAY SOON GO UNDER THE MICROSCOPE

The latest in a wave of SEC proposals aimed at helping protect investors from more financial turmoil focuses on company disclosures during the proxy process. Under the SEC's newest consideration, corporate officers and directors would no longer be able to govern blindly at the risk of their shareholders. Instead, these governing bodies would be forced to disclose more detailed information in a more timely fashion to ensure that shareholders had the information necessary to make informed decisions during the proxy process.

The SEC's goal is not to provide additional disclosures, but rather to compel better disclosure in three specific proxy-related disclosure areas:

(a) Executive compensation—seeking better disclosure regarding the relationship between executive compensation policies and company risk;

(b) Director and nominee qualifications—seeking better disclosure regarding individuals' qualifications for board membership; and

(c) Board governance—seeking better disclosure as to a board's leadership structure and risk management role.

The SEC also wants to improve proxy voting disclosure by requiring more timely disclosure of annual meeting voting results. These considerations would inevitably increase transactions costs and thereby cost companies more money. However, the SEC feels that shareholders, as owners of these companies, have a right to proper disclosure by companies who are charged with managing their investments.

In addition, on July 1, 2009, the SEC issued a proposal to amend the proxy rules under the Securities and Exchange Act of 1934 to implement specific requirements for companies subject to Section 111(e) of the Emergency Economic Stabilization Act of 2008. Specifically, the proposed amendments would require that any companies receiving monetary relief under the Troubled Asset Relief Program (“TARP”) must permit a shareholder vote to approve executive compensation during the time period in which the company's TARP obligations remain outstanding. The SEC's proposal explains that “the proposed amendments are intended to provide useful, comparable and consistent information to assist an informed voting decision when registrants that are TARP recipients present to investors the advisory vote on executive compensation required pursuant to Section 111(e)(1) of the EESA.”

To read the proposed rule in its entirety, click here.

THE SEC TAKES AIM AT MONEY MARKET FUNDS

In an effort to avoid the problems experienced by money market funds during the financial crisis of 2008, the SEC has proposed rule amendments to enhance the regulatory regime for these types of funds. Money market funds are investment funds which aim to provide safe, low-risk investment for individuals while maintaining a net asset value of $1.00 per share. Although an important objective of money market funds is to maintain a stable net asset value, they are securities and are therefore subject to a potential loss of principal.

A press release by the SEC summarized the proposed amendments as having the following affects:

(a) Requiring that money market funds have certain minimum percentages of their assets in cash or securities that can be readily converted to cash, to pay redeeming investors;

(b) Shortening the weighted average maturity limits for money market fund portfolios;

(c) Limiting money market funds to investing in only the highest quality securities;

(d) Requiring funds to stress test fund portfolios periodically to determine whether the fund can withstand market turbulence;

(e) Requiring money market funds to report their portfolio holdings monthly to the SEC and post them on their websites;

(f) Requiring funds to be able to process purchases and redemptions at a price other than $1.00; and

(g) Permitting a money market fund that has “broken the buck” (net asset value fallen below $1.00 per share) and decided to liquidate to suspend redemptions while the fund undertakes an orderly liquidation of assets.

In her statement at the SEC open meeting on June 24, 2009, SEC Chairman Mary L. Schapiro noted that the proposed rules are consistent with President Obama's support to strengthen the money market fund regulatory regime, as explained in his recently-released white paper. In addition, Ms. Schapiro opined that the rule amendments will “go a long way toward better protecting investors and making money market funds more resilient to short-term market risks.”

The rule amendments above are merely proposals. As such, they are subject to public comments for 60 days after their publication in the Federal Registrar.

NEW FINANCIAL REGULATORY REFORM - THE DEVIL WILL BE IN THE DETAILS

Last week the Obama administration announced its financial regulation reform – the “White Paper.” There has been much discussion about the plan. Some critics argue that it calls for too much regulation, while others argue that the plan does not call for enough fundamental change in the financial systems. One thing is clear, while the proposal provides an outline of the Administration’s goals, there is a great deal of detail that will be left to Congress to figure out.

One of the tenants of the plan is the creation of the Consumer Financial Protection Agency (CFPA). The CFPA would be dedicated to protecting consumers in the financial products and service markets, except for investment products and services already regulated by the SEC or CFTC. The Administration proposes to give this agency broad power in rule making, supervising and enforcement. The stated goal of this agency would be to reduce the gaps in federal supervision, increase coordination between the states, and to promote the consistent regulation of similar products. The agency would have supervisory and enforcement authority over banking and nonbanking institutions.

The question that immediately rises is exactly what types of financial products and services will this Agency be responsible for monitoring? The White Paper specifically mentions the mortgage industry and consumer debt services, but there are a myriad of financial products available to the consumer. For instance while securities and commodities are regulated by the SEC and CFTC there are multiple exemptions in securities and commodities codes at the federal and state level. Will the sellers and issuers who work to ensure that these products qualify for exemptions now be subject to additional rules and regulations under the CFPA?

The Obama Administration’s Plan provides a broad outline for a new reform system, but it leaves much of the details to be filled in by the Hill– and we all know the devil is in the details. While we have a general idea of where financial regulatory reform may be headed there is a great deal more to be seen.

PIABA'S PROPOSAL TO THE SEC: ELIMINATE THE MANDATORY INDUSTRY ARBITRATOR REQUIREMENT IN FINRA PROCEEDINGS

Attorneys for the Public Investors Arbitration Bar Association (PIABA) recently submitted a proposal to the SEC to eliminate the requirement that a securities industry arbitrator sit in on all public investor cases arbitrated before the Financial Industry Regulatory Authority (FINRA) in which the amount in controversy exceeds $100,000.00. PIABA claims that investors are unfairly disadvantaged when they are forced to arbitrate their securities claims before an arbitration panel which includes a member of the securities industry.

PIABA's proposal opines that in today's financial industry, the vast majority of agreements entered into between investors and brokers-dealers require that any disputes be brought in an arbitration forum before FINRA Dispute Resolution. Accordingly, investors do not have the option to bring their claims before a court of law, and instead are limited solely to FINRA arbitration proceedings. As such, the FINRA Code of Arbitration Procedure is basically binding on investors who bring suits against brokers-dealers.

Under the current FINRA Code of Arbitration Procedure, arbitration claims which exceed $100,000.00 must be heard by a panel of three arbitrators. Section 12401(c). Of those three, one arbitrator must be a “non-public arbitrator,” which is defined in relevant part as “any individual who currently works in the securities industry, worked in the securities industry within the past five years, or retired individuals who spent a substantial amount of their career employed in the securities industry.” Sections 12100(p), 12401(c), 12402(b).

To eliminate the inherent unjustness associated with FINRA's current mandatory rule, PIABA proposes that the SEC revise the FINRA Code of Arbitration Procedure and give the parties an option to choose whether a securities industry arbitrator sits on the panel. In support of its proposal, PIABA cites the United States Supreme Court's ruling in Shearson/American Express, Inc. v. McMahon, in which the Court held that the SEC has the power to regulate securities self-regulatory organizations (SROs), including the “adoption of any rules it deems necessary to ensure that arbitration procedures adequately protect statutory rights.” 482 U.S. 220, 233-34 (1987).

PIABA's proposal is likely to cause an uproar in the securities industry, which will no doubt do everything in its power to maintain its representation in FINRA arbitration proceedings. We will keep a close watch on this issue.

Click here to read PIABA's proposal in its entirety.

THE SEC TO RE-ASSESS REGULATORY REGIMES GOVERNING FINANCIAL SERVICE PROVIDERS

On June 18, 2009, just one day after President Obama unveiled his white paper, SEC Chairman Mary L. Schapiro gave an address at the New York Financial Writers' Association Annual Awards Dinner in which she acknowledged that Obama's regulatory reform plan makes real progress in strengthening the SEC and ultimately improving investor protection.

In her address, Ms. Schapiro emphasized that under Obama's new plan the SEC still has an underlying duty to protect individual investors, and opined that one way to protect investors is to resolve the inherent problems associated with the regulatory regimes governing financial service providers. Accordingly, the SEC is re-assessing the standards of conduct applicable to all financial service providers in an effort to help investors more fully understand what is required of their financial professionals. “Investors are not well-served by a confusing array of varying disclosure, liability, recordkeeping and conflict management requirements,” Ms. Schapiro said.

Ms. Schapiro noted that although there are a multitude of choices for investors to consider when seeking financial advice or assistance, financial service providers often perform similar and overlapping functions. However, despite this commonality of services, financial professionals such as broker-dealers and investment advisors are subject to varying and inconsistent legal standards. Such a regulator structure, Ms. Schapiro stated, is faulty in that “when investors receive similar services from similar financial service providers, they should be subject to the same standard of conduct.” As such, the SEC is now focused on instituting consistent fiduciary standards of conduct applicable to all financial service providers that provide personalized investment advise about securities, regardless of their labels, which will help ensure that these professionals act at all times in the interests of the individual investors.

Harmonizing the regulatory regimes for financial service providers will no doubt minimize the confusion investors must face under the current regimes. However, in her address, Ms. Schapiro correctly acknowledged that the implementation of consistent fiduciary standards of conduct will do nothing to ensure that financial professionals adhere to the requisite standards. Instead, such a change is merely a first step aimed at protecting individual investors.

Our firm provides effective legal advice and representation for individuals who have been subject to investment fraud, negligent misrepresentation or breach of fiduciary duty by their financial advisers. For more information, please visit our website here.