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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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