What do you think of our site upgrade?
Hosting an industry conference? Ask us about including it in this ticker?

When it Comes to Fiduciary Liability, 401k Plan Sponsors Must Determine if Bigger is Better… or Worse

When it Comes to Fiduciary Liability, 401k Plan Sponsors Must Determine if Bigger is Better… or Worse
September 13
01:45 2016

There’s an old business adage stipulating “No one ever got fired for hiring IBM.” This has been interpreted in several ways. Most obvious, it means going with the biggest player entails less risk. There’s less risk their products will fail (because IBM can’t risk damaging its reputation). There’s less risk the company will fail (face it, the financial behemoth is almost too big to fail). Finally, there’s less risk thousands of other decision makers who opted for IBM will be wrong (in other words, there is safety in numbers).

But is there really safety in numbers? Would you believe research in behavioral psychology suggests the opposite? Not only is there NOT safety in numbers, but risks actually increase when more people are involved. Here’s a simple explanation of this phenomenon: Imagine you’re in a big scary mansion and it’s the middle of the night. We’ll present two different scenarios in this situation. Read them and determine if they each make sense to you (they should).

In the first scenario, you’re all by yourself. Every noise, every creak, every rattle causes you to jump. Now, let’s assume you’re a highly trained Boy Scout leader, fully prepared and able to defending yourself. You don’t sleep. In fact, if you’re smart, you stay on your feet, partly to chase down every suspicious sound, partly to stay one step ahead of the unknown evil stalking you. You can easily imagine yourself in this situation, right?

In the next scenario – still in the same scary mansion – you’re with a group of three dozen people, all highly trained Boy Scout leaders like you. If you hear something out of place, chances are, while it might wake you up, you’ll go back to sleep, comfortable with the fact one of the other people will say something if it’s a real emergency. Moreover, because no one shouts in alarm as a result of the noise, you’re more confident it’s nothing at all. You can easily imagine yourself in this situation, too, right?

Here’s the problem – and the ultimate irony – you may think there are safety in number, but all the other Boy Scout leaders think just like you do. If no one sounds the alarm, the noise must be harmless. But some noises aren’t harmless. They truly signal danger. Since everyone thinks someone else will say something if it’s a true danger, there’s actually a form of peer pressure that prohibits anyone from saying anything. No one wants to be first and risk being wrong.

In this way, the large group presents a greater threat to one’s safety than being alone. Going back to our IBM example, let’s pick another (once) popular computer company. What IBM was to mainframe computer processing, Wang Laboratories was to word processing. Wang was the undisputed king of word processors. At its peak in the 1980s, Wang had more than 33,000 employees and more than $3 billion in revenue. No office manager ever got fired for buying Wang. Until Wang went bankrupt in 1992. It turned out no one needed a dedicated word processing machine when a personal computer could do the same and much more. Office managers who stayed with Wang through the late 1980s and early 1990s probably didn’t stay too long at their companies. That once safe “safety in numbers” decision became fraught with risk.

The Institute for the Fiduciary Standard recently took a closer look at this year’s study of SEC-Registered Investment Advisers (RIAs) by the Investment Adviser Association and National Regulatory Services. Released August 23, 2016, the IAA and NRS’s 2016 Evolution Revolution “contains data on 11,847 firms that manage

$66.8 trillion for more than 36.4 million clients.” The Institute sought to take this underlying data and determine “the degree to which firms minimize conflicts of interest and render financial and investment advice for a fee solely paid by clients.” To that end, according to a Knut Rostad, President of the Institute, the group took a closer look at “the ADVs of 135 RIAs with assets between 250 mm and 164,000 mm AUM and nine of the larger financial services firms.” They sought to “identify areas of commonality and differences among the RIAs and then, separately, between RIAs and the large financial services firms’ advisors.”

The results and conclusions were startling. In nearly all cases, the large financial services firms exposed their clients to a far greater potential for a material conflict-of-interest. For example, roughly a third of the RIAs had either registered representatives of broker-dealers or licensed agents of an insurance company or agency. In comparison, all of the large financial service firms had these types of employees.

Worse, albeit at least circumstantially, this increased exposure to conflicts-of-interest coincides with a greater incidence of some sort of significant fiduciary breach. Specifically, the Institute, citing ADV Part1A item 11 “Disclosure Information”, specifically said, “eight of the nine large firms disclosed that the SEC found the firm ‘involved in a violation,’ imposed a ‘civil fine’ or a federal or state agency found the firm ‘or any advisor affiliate’ ‘to have made a false statement or omission, or been dishonest, unfair or unethical.’ For each of these questions, 1% of the RIA firms disclosed doing so.”

Clearly, as Rostad suggested, while the data cannot for said to confirm previously academic research indicating the ineffectiveness of disclosure, (see “Exclusive Interview with Yale’s Daylian Cain: Just a Sugar Pill? Disclosure’s “Ah-Ha!” Moment,”, October 18, 2010), it, at the very least, offers anecdotal support. What’s more, it may also confirm the “safety in numbers” approach (i.e., selected a larger firm) may offer greater risks to 401k plan sponsors than their own intuition might suggest.

Barbara Delaney, Principal and Founder of StoneStreet Advisor Group in New York City, says, “deep pockets” represents the only advantage when hiring large firms. She sees large firms as less focused due to the complexity of their often competing business products and models. Large firms “tend to be silos with no real connection on getting clear answers,” says Delaney. “Everyone has their own profit center to deal with and client’s best interest may get lost in the mix.”

But there may be one bigger warning light for 401k plan sponsors who are tempted to go the “safety in numbers” route. When the time comes for class action attorneys to scan the field for prospective litigation opportunities, they start from the biggest classes and work their way down. This may be the greatest danger inherent in relying on a “safety in numbers”-based decision.

Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s (including information on the new wave of plan designs) every 401k plan sponsor and service provider wants and needs to know. Alternatively, would you like to help plan participants create better savings strategies? You can buy Mr. Carosa’s latest book Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort right now at your favorite on-line or neighborhood book store.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


No Comments Yet!

There are no comments at the moment, do you want to add one?

Write a comment

Only registered users can comment. Login is sponsored by…

Order Your 401k Fiduciary Solutions book today!

Vote in our Poll


The materials at this web site are maintained for the sole purpose of providing general information about fiduciary law, tax accounting and investments and do not under any circumstances constitute legal, accounting or investment advice. You should not act or refrain from acting based on these materials without first obtaining the advice of an appropriate professional. Please carefully read the terms and conditions for using this site. This website contains links to third-party websites. We are not responsible for, and make no representations or endorsements with respect to, third-party websites, or with respect to any information, products or services that may be provided by or through such websites.