What if the Department
of Labor ("DOL") showed up at your doorstep to audit your qualified
plan and asked to see your IPS? Do you have one? Is it up to date?
Do you even know what an IPS is? If not, you're not alone. But what
you don't know can hurt you. Without an IPS you risk the potential
for breach of fiduciary duty.
So what is an IPS? It is an Investment Policy Statement...a
written guideline which outlines the process for selecting,
reviewing and changing the plan's investments. Although the Employee
Retirement Income Security Act of 1974 ("ERISA") does not
specifically require an IPS, it is one of the first things that the
DOL will ask to see when they audit a plan and will want proof that
it was followed.
In today's litigious society, it's not only the giants like Enron
that have the potential for litigation for failure to meet fiduciary
responsibilities. Small companies can be affected as well if
fiduciaries do not monitor investments on a continuing basis. Poor
investment performance is not necessarily a breach of fiduciary
responsibility. On the other hand, offering participants investment
choices that consistently perform well below their peers may be.
Who Are the Responsible Fiduciaries?
Many employers offer qualified plans to their employees without
being fully aware of their fiduciary responsibilities and the
potential liability. ERISA defines a fiduciary as anyone who:
- Exercises discretionary authority over plan assets;
- Renders investment advice for a fee; or
- Has discretionary authority in the administration of the plan.
When an employer establishes an ERISA plan, it is the initial
fiduciary. The employer needs to decide whether to appoint
individuals or committees to be responsible for those duties. If a
plan committee is appointed, then the committee members are
fiduciaries and must perform their duties under ERISA's "prudent
expert" standard. If the employer keeps some or all of those duties,
its officers or principals who perform those duties are ERISA
fiduciaries.
Further, the appointment of a fiduciary is itself a fiduciary
act. So, whoever appoints the officers or committee members has a
duty to prudently select those persons and to periodically review
their work to make sure they are doing their job. Typically, it is
the board of directors or corporate president who appoints the
fiduciaries. As a result, the board members or the president are
also fiduciaries.
As fiduciaries, the officers, directors and committee members
must perform their duties in a knowledgeable, careful and skillful
manner. Those duties include:
- Operating the plan according to its terms;
- Overseeing the plan's investments;
- Making sure participants receive the information required by
ERISA; and
- Filing the necessary government reports.
This requires a knowledge of the rules governing retirement plans
and the technical skills needed to comply with those laws.
Fortunately, the fiduciaries can rely on competent outside advisors
to help with those jobs.
Risks of Being a Fiduciary
Many plan fiduciaries are not aware of the extent of their
liability. A breach of fiduciary duty can result in unlimited
personal liability to make up any plan losses and lost opportunity
costs, as well as paying the participant's attorney fees.
Lack of knowledge of the fiduciary requirements can result in
serious consequences. In Springate v. Weighmasters Murphy, Inc.
Money Purchase Pension Plan, the court held the plan
fiduciaries, who were completely ignorant of their fiduciary
responsibilities, personally liable to restore plan losses for
breaching their fiduciary duties of prudently investing the plan
assets. According to one court, "A trustee's lack of familiarity
with an issue does not excuse a fiduciary breach" (Katsaros v.
Cody). Another court noted that acting in good faith is not
sufficient: "...a pure heart and an empty head are not enough" (Donovan
v. Cunningham).
Fiduciaries can limit their legal exposure by engaging competent
advisors who possess the expertise and experience in performing
these duties.
Participant-Directed Accounts Provide
Limited Protection
Most 401(k) plans permit participants to exercise control over
the investment of their account balances. Many employers are under
the misconception that if their plans permit participants to direct
the investment of their own accounts and are designed to comply with
ERISA section 404(c) safe harbor requirements, they have no
fiduciary liability. However, this is not the case since the plan
fiduciaries are still liable for selecting and monitoring the
investment alternatives offered to the participants.
Under ERISA section 404(c), plan fiduciaries may be relieved of
fiduciary liability for investment choices made by the participants
if the plan satisfies certain requirements. Choosing to have a plan
comply with section 404(c) regulations is voluntary. In order to be
afforded 404(c) protection, over 20 requirements must be satisfied
that fall into the following three categories:
- Permitting participants the ability to exercise control of
their investments;
- Offering a broad range of investment alternatives; and
- Providing participants with specific information disclosures
to help them make informed investment decisions.
If all of the requirements of section 404(c) regulations are not
satisfied, fiduciaries may become liable for employee investment
losses.
Why is an IPS Important?
ERISA sets high standards for plan fiduciaries and requires that
they act with the care, skill, prudence, and diligence that would be
exercised by a prudent person familiar with the matter and acting
under similar circumstances. An IPS can provide important
documentation that demonstrates the employer is meeting its
fiduciary responsibilities by establishing prudent and diligent
written policies solely in the interest of participants and
beneficiaries.
The IPS is essential in providing guidelines for the selection of
appropriate investments or, in the case of participant-directed
retirement plans, the selection of investment alternatives. It also
serves as a yardstick for evaluating and monitoring performance.
In the case of Liss v. Smith, a federal district court
judge held that failure to maintain a written investment policy
constituted a breach of fiduciary duty. The judge concluded that if
an IPS had been in place, the fiduciaries would have had procedures
for selecting and monitoring appropriate investments, and the
investment losses could have been avoided. The fiduciaries were held
personally liable for restoring the losses to the plan.
What's Included in an IPS?
Since an IPS is not specifically required by ERISA, the DOL has
not issued specific guidelines regarding its content. An IPS can
vary depending on the type of plan involved but often includes the
following sections:
Plan's Purpose and Objectives
In general, the main purpose of a retirement plan will be to
provide participants the opportunity to supplement their retirement
income. Objectives might include:
- Provide investment options that meet the needs of the majority
of the workforce;
- Attract and retain outstanding employees; and
- To comply with ERISA section 404(c).
Responsible Parties
The parties responsible for the management and operation of the
plan should be identified along with a description of the scope of
their responsibilities. These parties would include:
- Plan sponsor
- Trustee
- Investment committee
Minimum Investment Standards
This section of the IPS should include the criteria to be used in
the selection of investments such as risk tolerance, time horizon,
asset-class preferences and expected returns. For example, the
minimum investment standards for mutual fund selection might
include:
- Historical performance compared to an appropriate index or
peer group;
- Investment manager's tenure;
- Risk level compared to its peer group;
- Overall expenses compared to its peer group; and
- Size of the mutual fund.
Selection and Monitoring of Investment
Options
The selection of investments for participant-directed 401(k)
plans requires that the officers or committee members answer the
following questions:
Is each investment option prudent and suitable for the
participants?
Do the funds, in the aggregate, constitute a broad range of
investment options?
Is the investment package suitable for the abilities of the
particular workforce--or, if not, can it be made so through
offering investment education or advice to the participants?
Fiduciaries have a duty to monitor the funds and to remove any
funds that don't perform well. Some investment providers (such as
insurance companies, mutual fund companies and banks) help
fiduciaries by giving them performance, expense, benchmark and other
information and by removing underperforming funds from their
investment packages.
Other advisors, such as investment consultants, can help the
fiduciaries evaluate the investments being offered to the
participants.
Participant Communications
Generally, this section of the IPS outlines how and when
educational materials will be provided to participants to assist
them in establishing retirement goals and building a diversified
portfolio.
Ongoing Responsibilities
Fiduciary responsibility doesn't end with the creation of an IPS.
At the very least, investments and service providers should be
monitored on an annual basis to ensure that they continue to be
appropriate choices. Details of these periodic reviews should be
documented in writing and carefully filed in case it is ever
necessary to demonstrate that actions and decisions were made in
accordance with the IPS.
In addition, the IPS itself should be reviewed periodically to
make sure it continues to be appropriate for the plan and the
participants.
Conclusion
Retirement plan lawsuits are becoming more common. Failure to
develop and keep an IPS up to date can lead to breach of fiduciary
rules and subject fiduciaries to personal liability for plan losses.
In today's litigious society, it is in the best interest of the plan
fiduciaries to have written guidelines in the event of a claim of a
fiduciary breach. An up-to-date IPS can be extremely valuable in
protecting fiduciaries from liability.
It is our recommendation that you review your IPS to make sure it
is up to date. If you do not currently have an IPS, please contact
us, and our benefit professionals will help you develop an IPS for
your plan.
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