Why You Need an Investment Policy Statement
By: Gregory S. Jacobs and Russell J. Boehner
Like many employers, associations often offer their staff members company retirement plans, such as a 401(k), as an employee benefit. Unlike "defined benefit" plans, which promise a fixed amount of income at retirement, these "defined contribution" plans pay benefits based solely on the value of a participant's account.
In times of good performance for investment vehicles, participants' 401(k) accounts tend to grow, and employees are less inclined to question plan decision makers. In more turbulent market conditions, as experienced in the past few years, accounts may perform poorly, causing participants to question the decisions of the plan's sponsor or managers. These disputes sometimes result in litigation, wherein plan participants allege that the sponsor failed to meet the fiduciary obligations for employee benefit plans established by the Employee Retirement Income Security Act of 1974.
Under ERISA, the person or committee vested by the sponsor with the responsibility to oversee retirement plan management (called "named fiduciaries") are required to act prudently and solely in the interest of the plan's participants and their beneficiaries. These named fiduciaries are required to make reasonable, informed decisions regarding plan assets, subject to their discretion based on a prudent review of the information reasonably available to them at the time the decision was made. In the event that a particular investment decision is later questioned, the fiduciary will, in most situations, be able to defend itself against allegations of imprudent conduct if it can demonstrate the process behind its decisions and why it believed it was acting in the participants' best interests.
To aid the deliberative process and enable sponsors to demonstrate "procedural prudence" behind investment decisions, associations with retirement plans should seriously consider adopting an investment policy statement. When established and administered correctly, an IPS will be strong evidence of procedural prudence and serve as an important protection for plan fiduciaries.
Here are six recommendations for establishing and implementing an IPS:
Clearly state the scope of the IPS. The IPS should begin with an "overview" or "purpose" section that establishes the document's coverage and states that the IPS will be the governing document for all decisions regarding the investment of assets within that coverage.
Establish plan objectives. The IPS should state the plan's goals that the guidelines are intended to facilitate. One common objective is to maximize employee participation and/or voluntary contributions to the plan so as to supplement the basic retirement program.
Provide plan investment guidelines. At the heart of the IPS are the guidelines that managers are to follow in administering the plan. Articulating realistic performance standards for each investment class will provide significant protection to plan fiduciaries if their decisions are questioned.
For participant-directed plans, meet the guidelines for ERISA section 404(c). Many plans allow participants to select from a menu of investment options, allowing employees at different life stages to choose options consistent with their investment goals. But when the participant is making the key investment decisions, how is the plan sponsor protected from liability for losses? ERISA section 404(c) provides guidelines that, if followed, relieve the named fiduciaries from responsibility for investment losses caused by a participant's investment decisions. Under section 404(c), the named fiduciary's major obligations lie in selecting appropriate and diversified investment options; reasonably appointing, monitoring, and terminating, if necessary, investment managers and options; and providing sufficient information to participants to enable them to make informed decisions.
Provide criteria for selecting an investment advisor. It is often necessary to hire a professional investment advisor to assist in selecting investment options and/or managers and effectively communicating those options to participants. In many cases, an IPS will state certain criteria for selecting advisors—for example, independence from any investment managers or fund families, number and type of clients, years of experience, performance, investment philosophy, and fees.
Continuously monitor performance. A plan fiduciary must actively monitor the performance of the plan's investment options and make adjustments where prudent. An IPS will often provide a timetable for periodic review and objective benchmarks against which performance will be measured. For example, the IPS might require a manager to be put on the "watch list" if the manager demonstrates below-median performance against a benchmark and peer group for three consecutive quarters.
Retirement plans can be a key factor for associations in attracting and retaining talented employees. At the same time, sponsoring a retirement plan involves risk, especially in an uncertain economy. Associations that develop and implement a prudent IPS can achieve a significant degree of protection, even when those plans do not perform as well as hoped.