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By Robin R. Ganzert
The fiduciary duty is a legal relationship between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, where the highest standard of care is imposed at either equity or law.
A fiduciary is expected to be extremely loyal to the person to whom they owe the duty; they must not put their personal interests before the duty; and they must not profit from their position.
The fiduciary relationship is highlighted by good faith, loyalty and trust, and the word itself originally comes from the Latin fides, meaning faith, and fiducia.
The investment fiduciary is defined as a person who is “managing the assets of another person, and stands in a special relationship of trust, confidence and/or legal responsibility” according to the Foundation for Fiduciary Studies guide entitled Prudent Practices for Investment Stewards (2006).
In contrast to the investment fiduciary, the investment manager makes the security selection decisions.
The investment advisor manages comprehensive and continuous investment decisions.
As a steward of a nonprofit organization, either in a leadership or trustee role, the role of the fiduciary is crucial.
The steward must be able to demonstrate that the nonprofit has implemented prudent investment processes in a structured, demonstrable manner.
To reduce the fiduciary liability, the investment steward must be able to demonstrate the process, not just the performance results.
The investment steward is responsible for managing the investment strategy, which includes:
* Asset allocation decisions
* Implementation with investment managers
* Monitoring the strategy on an ongoing basis.
The investment steward has responsibility for seven common practices, referred to as Global Fiduciary Precepts, based on legislation, case law and regulatory opinions.
According to Fiduciary 360 and the Foundation for Fiduciary Studies, the practices include:
* Know standards, laws and trust provisions.
* Diversify assets to specific risk/return profile of client.
* Prepare investment policy statement.
* Use prudent experts and document due diligence.
* Control and account for investment expenses.
* Monitor the activity of the prudent experts.
* Avoid conflicts of interests and prohibited transactions.
The practices are adaptable to all nonprofit investment pools, and help to document a prudent investment process.
Such documentation is critical in protecting the investment steward from personal liability issues when exercising their roles and duties. Procedural risks are identified and investment performance in the long-term can be potentially improved through diversification, fee evaluation, transparency, and selection/termination of investment managers. Benchmark and comparison of best practices are also valuable for the investment steward in the documentation of the investment fiduciary process.
Several key steps are essential in adapting the Global Fiduciary Precepts, and include the following process steps:
Process Step 1: Organize
To review whether or not a prudent investment process is in place at the nonprofit organization, the investment steward should start with a careful collection of all applicable documents and the investment policy statements.
A careful review of applicable state law is critical, and an understanding of the status of UPMIFA (Uniform Prudent Management of Institutional Funds Act) in the applicable state.
Written documentation of the investment process is an essential first step. Such documents include:
* Custodial statements
* Investment performance reports
* Applicable trust documents
* Service agreements
* Investment policy statement
* Board and committee minutes.
In reviewing at the documents, the investment steward should ensure that roles are clearly defined for the board, investment advisor and manager; that conflicts of interest and self-dealing situations are avoided; and that there is objectivity in the process.
The service agreements should reviewed by legal counsel.
Relationships should be submitted out to bid every three years as consideration.
Process Step 2: Formalize
In reviewing the investment assets, the organization should state a clear defined purpose for the investment pools, with an identified investment time horizon.
Risk tolerances should be identified with quantitative and qualitative factors such as risk posture, and an identified worst case scenario.
Once a time horizon and risk tolerance position has be identified, the expected modeled return, asset class preference, and tax status should be addressed.
The most important function of the investment steward is the creation of the formal investment policy statement.
The IPS balances the need for specificity, with the risks of oversight burden and inflexibility.
The investment policy statement should incorporate the following:
* Define the roles and duties of all parties (steward, advisor and manager).
* Define diversification and rebalancing parameters.
* Define monitoring, due diligence and benchmarks.
* Identify specificity around socially responsible investments if applicable.
* Review and define procedures around the ongoing review and control of investment expenses.
Process Step 3: Implement
When the investment policy statement is defined, the investment steward must ensure implementation and execution, and that the strategy is executed in compliance with required level of prudence.
According to the Foundation for Fiduciary Studies (2006), “prudent stewards are strongly encouraged to delegate investment decisions to professionals when lacking the required expertise.”
Minimal due diligence in the evaluation of an investment manager by the investment steward includes the following points:
* Regulatory oversight
* Track record
* Stability of organization
* Assets under management
* Composition consistent with asset classes
* Style consistency
* Expense ratios relative to peers
* Risk adjusted performance relative to peers.
Process Step 4: Monitor
The final step is the ongoing monitoring of the performance and rebalancing.
Monitoring includes reviewing the performance to benchmarks, rebalancing, watch lists and the news about managers.
The effectiveness of the fiduciary practices should also be periodically reviewed to foster continued improvement at the organization. Assessments can be conducted to determine whether policies are effectively implemented and maintained, and that the investment policy statement is up-to-date.
According to the Foundation for Fiduciary Studies (2006), “assessment of fulfillment of fiduciary practices necessarily requires an objective evaluation of evidence pertaining specifically to the requirements of the practices.
While there is no legal or regulatory requirement for regular documented fiduciary audits, an investment fiduciary would be hard-pressed to demonstrate a genuine commitment to fulfill fiduciary obligations without a program or regular and comprehensive review.”
With the increasing scrutiny on nonprofits from a management effectiveness and efficiency perspective, the role of the investment steward is highlighted.
Discharging those duties impartially, and in keeping with the view that nonprofit assets are invested within the public trust, the steward not only protects themselves from personal liability, but also ensure that there are more funds to enhance the mission and vision of the organization.
By following the Global Fiduciary Precepts and the process steps, the investment steward avoids financial paralysis, removes noise from the daily markets and enhances overall performance by focusing on the investment process.
This communication is not a covered opinion as defined by Circular 230 and is not intended or written to be used, and cannot be used, or relied on, by the taxpayer, for the purpose of avoiding federal tax. This communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed in the written communication; and the taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.