Two major court cases in 2015 highlighted the increased scrutiny that employees and their legal representation are placing on plan sponsors and advisers. Last May, the Supreme Court ruled in Tibble v. Edison that plan advisers have a “continuing duty … to monitor and remove imprudent trust investments.” In November, Boeing paid $57 million to settle a lawsuit related to excessive fees and an improper fund selection process in its 401(k) plan.
How can plan sponsors and advisers avoid being the target of similar lawsuits?
A detailed investment policy statement, or IPS, is key to establishing and documenting a prudent process. It demonstrates that the investment-selection process was envisioned diligently and with regard for plan participants, and it serves as a guide for all future plan decisions.
So what should you include in an IPS? We put together a checklist that plan sponsors and advisers should consider when crafting a statement that will help them better run the plan and stand up to outside scrutiny.
1. Investment criteria. Perhaps the most important section of the IPS is the documentation of how investments are selected.
Be as specific as possible. It’s not enough to say that funds should perform in line with benchmarks, fees should be reasonable or funds should have proper diversification. You need to define those terms so that everyone involved is applying the same metrics. What is the maximum expense ratio you’re willing to accept?
This section also adds cohesion and institutional memory to a plan. As committee members or advisers come and go, each new person brings his or her personal opinions on what constitutes reasonable fees or proper diversification. Creating a detailed statement at the start clarifies these important criteria.
2. Investment monitoring. Setting investment criteria is only half the battle. You need to document how you’ll proactively monitor investments to ensure they continue to meet criteria, and what you’ll do if they don’t.
Who will be part of this monitoring process? How often will the funds be reviewed? Is that a monthly, quarterly or annual process?
Once you’ve answered these questions, it’s important to document the review process. If you are ever in a position to prove you conducted a review, simply saying you did it is not enough. In an audit or lawsuit, considerable emphasis is placed on the process, rather than on the plan’s investment results. A plan with mediocre performance that can demonstrate the fiduciaries’ adherence to a prudent process may be in better shape than one with better performance but no process, or one that has a process that was not followed.
3. Asset classes. The document should include a list of asset classes offered to participants. In addition, the qualified default investment alternative should be spelled out. The QDIA should be reviewed annually to ensure it is still the most appropriate default option for participants.
4. Roles and responsibilities. Just as you need to define investment criteria, you must define the roles of those involved in plan strategy and execution. Who are the advisers, committee members and trustees? How are these individuals or companies selected? And for which parts of the plan are they responsible?
5. Plan and investment objectives. While this might seem basic, sponsors and advisers need to clearly state specific plan and investment objectives. Why is the investment menu designed the way it is? This document needs to be reviewed at least annually and updated when appropriate. If the plan sponsor changes objectives, this needs to be communicated to the adviser, and the IPS needs to be amended.
6. Review of expenses. It is the plan sponsor’s responsibility to know the true and total cost of the plan, and know that those fees are reasonable in light of the services being received. The IPS should address that expenses will be reviewed and benchmarked. Also, it’s a good idea to address how revenue-sharing or expense budget accounts are being administered, if they exist.
7. Education. How will the plan sponsor educate participants? Will materials be shared through written, electronic or face-to-face communication? Who is responsible for putting an education plan into practice?
This checklist isn’t meant to tie your hands. It should provide a specific framework that you can customize for your plan and organization. The more detailed you can be, the more defined the process is for the parties involved. Along with documentation showing you’ve followed the IPS, this will help protect you from litigation and keep you on the right path.
Tara Mashack-Behney is president of Conrad Siegel Investment Advisors Inc., chair of the investment committee and a member of Conrad Siegel Actuaries’ business development committee.