Introduction
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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The information contained in this newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is provided with the understanding that our company is not engaged in rendering legal or tax advice. Legal or tax questions should always be referred to a qualified tax advisor such as an attorney or CPA.
Copyright 2004 Benefit Insights, Inc. All rights reserved.
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