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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