As most retirement plan sponsors and administrators know, the Employee Retirement Income Security Act (ERISA) doesn’t technically require a plan to have an investment policy statement (IPS), but the U.S. Department of Labor (DOL), which has enforcement authority for ERISA, has said that having one is consistent with the fiduciary obligations set by the law.
An IPS is a useful tool to help retirement plan fiduciaries—for both defined contribution and defined benefit plans—demonstrate that a prudent process has been followed with plan investments.
“A well-constructed IPS is considered a best practice and establishes guidelines for selecting and monitoring plan investments while providing a framework for making critical fiduciary decisions,” according to a March 12 blog post by Joshua P. Itzoe, partner and managing director at Greenspring Advisors, a Maryland-based retirement plan consulting firm.
Small Plans Less Likely to Use
While usage of IPSs is on the rise, it remains less prevalent among smaller plans, where best practices tend to get adopted much less frequently, according to Itzoe, who leads Greenspring’s Institutional Client Group.
But just having an IPS may not be protection enough. “[B]ased on our experience, many plans that have an IPS are using one that likely creates more risk for their fiduciaries, rather than less risk. This is because many plans take what I call the ‘check the box’ approach to IPS management,” Itzoe said in the post.
This occurs when someone at the employer who’s involved with the retirement plan reads an article that says an IPS is recommended, then proceeds to find a boilerplate version of one and fill it out to be included in the plan’s file. The risk in doing so lies in the potential failure to follow the terms of the generic IPS on file.
The widely reported ruling a few years ago on alleged excessive fees from Tussey v. ABB Inc., 2012 U.S. Dist. LEXIS 45240 (W.D. Mo., March 31, 2012), is a good illustration of this, Itzoe said. In that case, ABB had actually implemented an IPS but failed to follow the terms of the document, which led, in part, to its initial loss in court and a judgment in favor of the plan participant plaintiffs. Although appealed (and still ongoing) after nearly 13 years of litigation, ABB was originally slapped with a $36.9 million judgment, Itzoe noted.
“ABB’s IPS included language that directed the plan fiduciaries to select the lowest-cost share class of any mutual fund selected when multiple share classes of the fund were available. However, the court found that when the ABB’s fiduciaries selected share classes for the plan, they chose higher-cost ones that provided more revenue-sharing to the recordkeeper for the plan,” Itzoe wrote. (See 2014 case update story.)
“Remember that a well-constructed IPS is simply a tool in the fiduciary’s toolbox,” Itzoe said. “Like any tool, if it’s in the hands of an expert, it can be used for great benefit, but, in the hands of a novice, it’s likely to do great damage.”
Pro Tips for Using an IPS
To avoid such IPS pitfalls, Greenspring Advisors offers the following strategy tips:
- Develop an IPS customized to your plan.
- Make sure your investment reporting aligns with the criteria in your IPS and establish a watchlist process.
- Consider hiring an ERISA 3(21) adviser to assist your committee with investment decisions or delegate this responsibility to an ERISA 3(38) “Investment Manager.”
- Document investment decisions and why they were made in meeting minutes or another format.
Defined contribution plans in particular should think about these steps:
- Simplify your investment architecture and streamline the number of funds in your plan.
- Select low-cost, passive investments such as index funds.
- Minimize overlap by using one fund per asset class.
- Make sure your target-date fund (TDF) selection process aligns with DOL guidance.
- Comply with ERISA Section 404(c), which gives plan sponsors and other fiduciaries liability protections on participant-directed retirement plans, like a 401(k), if the plan satisfies the regulation’s conditions.