Taking the right steps as investment fiduciaries.

Responsibilities of investment fiduciaries have been brought to the forefront by recent misfeasance and malfeasance in the investment community. In response, The Center for Fiduciary Studies and the AICPA have published Practices & Standards for Investment Fiduciaries, which defines prudent standards and processes for investment fiduciaries--those who manage property for the benefit of others; exercise discretionary authority or control over assets; and act in a professional capacity of trust or render comprehensive and continuous investment advice.

There are more than five million people in the United States who fit this definition. Financial reviews or audits based on these practices will become more widespread for those charged with the management of endowment and foundation assets; ERISA retirement plans; public retirement plans; private family trusts; and high net-worth individuals.

CPAs and their clients can find themselves functioning as investment fiduciaries and not realize the duties and standards that they are being held to. Practices & Standards for Investment Fiduciaries provides that guidance to CPAs, personal financial specialists, certified financial planners--and their clients--by providing tools to evaluate and analyze the roles and responsibilities of the investment fiduciary. The publication also serves as a guide to determine whether there are deficiencies in an investment strategy or process.

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PRACTICE MAKES PERFECT

The publications recommends 27 practices that are applicable to all types of portfolios, regardless of intended use or size. The basis for most of these practices comes from the Employee Retirement Income Security Act, The Uniform Prudent Investor Act (UPIA) and The Uniform Management of Public Employee Retirement Systems Act (MPERS).

Investment fiduciaries can be held personally liable if their conduct is deemed imprudent, so it's important that they fulfill their responsibilities by consistently following a defined process. And keep in mind that liability is not determined by investment performance, but rather by whether or not prudent investment practices were followed.

The prudent investment process was developed by applying standards from the Practices & Standards for Investment Fiduciaries to a five-step investment management process: analyze the current position; diversify and allocate portfolio; formalize investment policy; implement investment policy; and monitor and supervise.

1: Analyze Current Position. Fiduciaries need to know the standards, laws and trust provisions that pertain to investment management. They also must define the goals and objectives so that they are consistent with the portfolio's resources and the constraints of applicable documents and statues. Fiduciaries and parties-in-interest must not be involved in self-dealing. Contracts should be in writing and should not contain provisions that conflict with standards of care. Additionally, assets need to be protected from theft or embezzlement. CPAs who supervise or advise investment committees can use these standards to educate their clients to their duties.

2: Diversify and Allocate Portfolio. The second standard of care is to diversify assets to the client's specific risk/return profile. An important decision in this process is the investment time horizon. Once a time horizon and risk/return profile has been established, the fiduciary then can make decisions on what asset classes are appropriate, the mix between those classes and whether or not there should be subclasses.

What is the basis for the asset allocation process? What money manager or mutual funds might be selected? Practices & Standards for Investment Fiduciaries provides CPAs who function as investment advisers with procedures for developing an asset allocation strategy. As a trusted professional rendering comprehensive and ongoing advice, the client's expectations are raised, so it is beneficial for the CPA to apply and promote the best practices of a prudent investment fiduciary.

3: Formalize Investment Policy. The investment policy statement is the most important function fiduciaries perform and should be considered a tool to manage the investment process in a consistent manner. The policy statement defines the duties and responsibilities of all parties involved; defines diversification, rebalancing guidelines and due diligence criteria for selecting investment options; and defines the monitoring criteria for investment options and service vendors, as well as the procedures for controlling and accounting for investment expenses.

An effective policy statement should contain all material investment facts, assumptions and opinions, and should be used to direct and communicate the portfolio's activities. It also establishes a rational basis for measuring the fiduciaries compliance. CPAs can use the policy statement as a guide for reviewing the investment committee's practices to determine whether the policy's guidelines are being followed and if there are deficiencies in the policy.

4: Implement Investment Policy. The fourth standard of care is to use prudent experts and document due diligence in the implementation of the policy statement. Although fiduciary law does not expressly require the use of professional money managers, a fiduciary will be held to the same standard of care as a professional.

The suggested due diligence and "safe harbor" criteria include performance relative to peer group; performance relative to assumed risk; correlation to specific index; diversification of assets under management; holdings consistent with investment style; expense ratios and fees within industry ranges; and the organization's stability.

The policy statement should describe the process--which is managed by the investment fiduciary--and how it is to be documented. The money managers make investment decisions; it is the fiduciary's duty to make sure practices are in place so that the overall process can be evaluated and monitored. The CPA needs to ask if a due diligence process has been followed.

5: Monitor and Supervise. The fiduciary needs to monitor and supervise the investment process to control and account for investment expenses, monitor the activities of the prudent experts and avoid conflicts of interest and prohibited transactions.

The monitoring function should occur across all policy and procedural issues, and not just as a function of investment performance. Periodic reports should compare investment performance with an appropriate index, peer group and to the policy statement's objectives. Periodic reviews should be made of investment decision makers, specifically, whether there have been any organizational philosophy changes to the specific money managers or if there have been any legal or regulatory proceedings that may affect management.

COMPLIANCE BENEFITS

By consistently following prudent practices, CPAs can differentiate themselves from others and may decrease their potential for litigation. CPAs can use Practices & Standards for Investment Fiduciaries as an educational tool for their clients; to outline the duties and responsibilities of a fiduciary; help uncover areas of procedure shortfalls; identify ways to improve long-range investment performance; and establish benchmarks to measure the progress of an investment committee and adviser.

CONCLUSION

CPAs and investment advisers should review, or have a qualified independent investment fiduciary auditor review, their firm's procedures. This review and subsequent establishment or strengthening of practices can assist CPAs and investment advisers in marketing to endowments and foundations, ERISA and state retirement plans, private family trusts and high net-worth clients.

Also, clients of CPAs and investment advisers should establish oversight of its consultants and investment advisers to assure their practices are adequate. This can be done by its own staff or by using an independent qualified investment fiduciary auditor.

RELATED ARTICLE: prudent INVESTMENT PRACTICES

Step 1: Analyze Current Position

* Investments are managed in accordance with applicable laws, trust documents and written investment policy statements.

* Fiduciaries are aware of their duties and responsibilities.

* Fiduciaries and parties-in-interest are not involved in self-dealing.

* Service agreements and contracts are in writing and do not contain provisions that conflict with fiduciary standards of care.

* There is documentation to show timing and distribution of cash flows, and the payments of liabilities.

* Assets are within the jurisdiction of U.S. courts; protected from theft and embezzlement.

Step 2: Diversify & Allocate Portfolio

* Identify risk level.

* Identify an expected, modeled return to meet investment objectives.

* Identify an investment time horizon.

* Selected asset classes are consistent with the identified risk, return and time horizon.

* The number of asset classes is consistent with portfolio size.

Step 3: Formalize Investment Policy

* There is detail to implement a specific investment strategy, or IPS.

* The IPS defines the following: duties and responsibilities of all parties involved; diversification and rebalancing guidelines; due-diligence criteria for selecting investment options; the monitoring criteria for investment options and service vendors; procedures for controlling and accounting for investment expenses; and appropriately structured, socially responsible investment strategies (when applicable).

Step 4: Implement Investment Policy

* The investment strategy is implemented in compliance with the required level of prudence.

* The fiduciary is following applicable "safe harbor" provisions (when applicable).

* Investment vehicles are appropriate for the portfolio size.

* A due diligence process is followed in selecting service providers, including the custodian.

Step 5: Monitor and Supervise

* Periodic reports compare investment performance with appropriate index, peer groups and IPS objectives.

* Periodic reviews are made of qualitative and organizational changes of investment decision makers.

* Control procedures are in place to periodically review policies for best execution, soft dollars and proxy voting.

* Fees for investment managers are consistent with agreements and the law. "Finders' fees," 12b-1 fees or other forms of compensation that may have been paid for asset placement are appropriately applied, utilized and documented.

Liz L. Flores CPA, AIFA is based in Aptos. She is affiliated with The Oversight Group, which coordinates AIFAs in various parts of the United States to provide reviews and audits of and for investment fiduciaries. You can reach her at [e-mail].