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Step 1: Analyze Current Plan

Section 404(a) (1) (B) of ERISA provides that a fiduciary shall discharge his duties with respect to a plan “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”  Implicit in this provision are two tests, one relating to procedural prudence, the other to substantive prudence.

Procedural Prudence, which is measured at the time an investment decision, is made, without regard to the “20-20” nature of hindsight focuses on the fiduciary’s methodology in selecting a particular investment.  Accordingly, whether a fiduciary breaches his duty to the plan is not necessarily a function of the investment’s performance, but turns instead on the steps the fiduciary took or failed to take in reaching and implementing the investment decision.

Substantive Prudence, on the other hand, focuses on the actual merits of the fiduciary’s decision (also at the time the investment decision is made).  According to the Department of Labor, this means that the scope of the fiduciary’s duty of prudence is “limited to those factors and circumstances that a prudent person having similar duties and familiar with such matters would consider relevant, whether the context is one of plan investments or otherwise.” In practical terms, this means that a fiduciary must give “appropriate consideration” in making investment decisions. As long as there are no conflicts of interest that would impair the fiduciary’s exercise of independent judgment, a fiduciary who considers the substantive factors (substantive prudence) and does so using proper (procedural prudence) will satisfy the prudence requirement in most cases.

Based upon the foregoing, and given the very special characteristics of employee benefit plans, “ERISA’s prudence standard is not that of a prudent lay person but rather that of a prudent fiduciary with experience dealing with similar enterprises.” In fact some courts and commentators have explicitly stated that the standard is that of a prudent “expert”.
Source: Trustees Handbook, Fifth Edition, Marc Gertner Editor, Published 1998 The International foundation of Employee Benefit Plans

A Prudent Process as explained in a leading case:  “[ERISA’s] test of Prudence…is one of conduct, and not a test of the result of performance of the investment.  The focus of the inquiry is how the fiduciary acted in his selection of the investment, and not whether his investment succeeded or failed.”  Donovan v. Cunningham 716F.2d 1455, 1467 (5th Cir 1983)
Section 402(b) of ERISA states that:

“Every employee benefit plan shall provide a procedure for establishing and carrying out a funding policy in a method consistent with the objectives of the plan.” 

The existence of an investment policy statement provides evidence of a prudent investment decision making process and, in doing so, can serve a risk management role as the first line of defense against potential fiduciary liability.

The Profit Sharing Council of America - believes that the adoption of a formal written investment policy process, and following and documenting that process, will assist sponsors in the prudent management of their defined contribution plan assets and will help them avoid unnecessary fiduciary liability.  Without such a written policy statement, how can a sponsor demonstrate that there is a “procedure for establishing and carrying out a funding policy consistent with the objectives of the plan?”

Implementing an investment policy statement also has practical advantages for the plan sponsor.  For example, an investment policy statement:

    1.  Helps clarify the plan’s investment objectives.
    2.  Provides a framework for evaluating investment performance.
    3.  Aids in clear communication of the plans investment policy to participants.
    4.  Supports continuity in the decision-making as plan fiduciaries change.
    5.  Assists the sponsor from inadvertently making capricious or arbitrary decisions.
    6.  Helps the sponsor manage pressure for change generated by participant’s vendors or the media.

Source: Profit Sharing Council of America, Volume 52, Number 2, March/April 2004.  Prudent Investment Practices – A handbook for Investment Fiduciaries, Published in 2003 by the Center for Fiduciary Studies (www.cfstudies.com)  which operates in association with the University of Pittsburgh Katz Graduate School of Business.  2003 Foundation of Fiduciary Studies (www.ffstudies.org), library of Congress Catalog Card Number: 2003100923, ISBN 0-9728739-0-2

The Investment policy statement should be viewed as a business plan and the essential management tool for directing and communicating the activities of the plan.  It should: possess sufficient detail that a third party would be able to implement the investment strategy; be flexible enough that it can be implemented in a complex and dynamic financial environment; and yet not so detailed that it requires constant revisions and updates.

Opposing View of the Minority - Some attorneys believe that plan fiduciaries might not properly execute the process specified by the written investment policy statement, or that the execution of the process , even if proper, might not be sufficiently documented by plan fiduciaries.  They believe that this would subject the plan to greater risk than if an investment policy statement had not been adopted. 

 


WRITING AN INVESTMENT POLICY STATEMENT

  1. Why Do 401(k) Plan Sponsors Need an Investment Policy Statement (IPS)
    1.  Documents that there is a defined process by which the 401(k) is being managed.
    2.  Assists fiduciaries in avoiding capricious investment decisions during market turbulence.
    3.  Is a great communication tool for trustees, service providers, and investment committee members.
    4.  Defines the roles and responsibilities of the trustees, advisor, custodian, and investment managers.
    5. Clearly identifies the plan fiduciaries.
    6. Delineates how to hire, monitor, and replace investment managers, as needed.
    7. IS THE MOST IMPORTANT TASK THAT A FIDUCIARY PERFORMS FOR THE 401(K) PLAN PARTICIPANTS!

 

  1. How To Get Started – Gather the Plan Documents
    1. As the fiduciary for the plan, it is imperative that you take the time to understand the specific needs and any applicable laws affecting the plan. Gather the following list of documents for review:
      1. trust documents, including all amendments.
      2. summary plan descriptions and all plan documents.
      3. written minutes of committee meetings.
      4. service agreements with all current vendors and bids/proposals submitted by prospective vendors.
      5. investment performance reports from investment managers, custodians, and consultants.
      6. enrollment activity reports.
      7. participant education materials.
      8. loan activity reports.
      9. procedure manuals.
      10. IRS Form 5500 and all related schedules.
      11. independent audit report, if applicable.
    2. WITH ALL THESE DOCUMENTS IN ONE PLACE, PUT TOGETHER THE BEGINNINGS OF A FIDUCIARY AUDIT FILE!

 

  1. Review the Documents and Answer These Questions
    1. Do the plan documents identify the trustees and named fiduciaries?
    2. Is the plan intended to be 404© compliant?
    3. Is there clear understanding of plan expenses and whether they are reasonable based upon the services being provided?
    4. Is there a formal process for making investment-related decisions?
    5. Is there a clear paper trail of the process being deployed?
    6. Who has the authority to make investment decisions?
    7. Do the trust documents prohibit certain asset classes?

 

  1. Develop the Investment Policy Statement to Include
    1. Executive Summary and Background - the overall objective is to provide sufficient detail to allow a third party to implement the strategy, but flexible enough to allow implementation in a complex and dynamic investment environment.
    2. Purpose of the IPS - provide the purpose and intent of the IPS not only for incumbent committee members but for successors as well.  Include in this section whether the plan is intended to be 404(c) compliant.
    3. Duties and Responsibilities - identify the various parties involved with the plan investments and summarize their responsibilities.  Include retirement plan committee, investment managers, consultant(s), and custodian.
    4. Asset Class Guidelines - describe the process by which asset classes being offered to the participants were chosen and identify the appropriate index and peer group. Note: fiduciaries for 401(k) plans must ensure that a diversified menu of investment options is available!
    5. Investment Manager Selection - outline the considerations and guidelines to be followed in the selection of investment managers.
    6. Develop the Investment Policy Statement to Include - Continued
    7. Executive Summary and Background - the overall objective is to provide sufficient detail to allow a third party to implement the strategy, but flexible enough to allow implementation in a complex and dynamic investment environment.
    8. Purpose of the IPS - provide the purpose and intent of the IPS not only for incumbent committee members but for successors as well.  Include in this section whether the plan is intended to be 404(c) compliant.
    9. Duties and Responsibilities - identify the various parties involved with the plan investments and summarize their responsibilities.  Include retirement plan committee, investment managers, consultant(s), and custodian.
    10. Asset Class Guidelines - describe the process by which asset classes being offered to the participants were chosen and identify the appropriate index and peer group. Note: fiduciaries for 401(k) plans must ensure that a diversified menu of investment options is available!
    11. Investment Manager Selection - outline the considerations and guidelines to be followed in the selection of investment managers.
    12. Investment Manager Monitoring – clearly state how investment managers will be monitored on a quarterly basis. Describe how underperforming managers will be placed on a “watch list” and what steps will be taken to further evaluate and replace a manager, if needed.
    13. Controlling and Accounting for Investment Expenses – a key fiduciary requirement under ERISA is to account for and control investment expenses. Define the process by which plan expenses will be reviewed for reasonableness.
    14. Investment Policy Review and Monitoring – the IPS should be reviewed
      annually for material changes.

Source: TH541 Thornburg Securities Corp., Distributor 119 East Marcy Street, Santa Fe, NM 87501 - 1.800.847.0200

BACKGROUND: 
The Department of Labor regulations under Section 404(c) list approximately 20 requirements for shifting the legal responsibility for investment direction from the plan fiduciaries to the participants.  Plan sponsors should understand that the only way for investment fiduciaries (e.g., plan committee members, corporate officers etc. who select or participate in the selection of investments) to avoid responsibility for participant investment decisions is to comply with ERISA 404(c).  This is true even if the fiduciaries prudently select and monitor the investments options.

20 Steps to 404 (c) Compliance

  1. The participant has an opportunity to obtain written confirmation of his instructions
  2. The person to whom the instructions are given is an identifies plan fiduciary who is obligated to comply with the instructions
  3. The participant is provided by an identified plan fiduciary with the following:
    An explanation that the plan is intended to be a 404(c) plan;
  4. An explanation that the fiduciaries of the plan may be relieved of liability for losses;
  5. A description of the investment alternatives available under the plan;
  6. A general description of the investment objectives and risk and return characteristics of each designated alternative;
  7. Identification of any designated investment managers;
  8. An explanation about giving investment instructions;
  9. A description of any transaction frees and expenses which affect the participant’s account balance;
  10. The name, address, and phone number of the plan fiduciary responsible for providing information;
  11. Specified information regarding employer securities;
  12. A copy of the most recent prospectus provided to the plan for investment alternatives subject to the Securities Act of 1933;
  13. Any materials provided to the plan relating to the exercise of voting, tender or similar rights.
    The participant is able to obtain upon request:
  14. A description of the annual operating expenses of each designated investment alternative;
  15. Copies of any prospectuses, financial statements and reports provided to the plan;
  16. A list of the assets comprising the portfolio of each designated investment alternative;
  17. Information concerning the value of shares or units in designated investment alternatives;
  18. Information concerning the value of shares or units in designated investment alternatives held in the account of the participant.
  19. Plan permits participants to give investment instructions with a frequency which is appropriate in light of market volatility.
  20. The core investment alternatives, constituting a broad range, permit instructions at least once within any three-month period

           
Source: Reish Luftman McDaniel & Reicher at – www.reish.com/pa/benefits/20steps.cfm