The answer is that it can be both. But it doesn’t need to be risky. Risk can be reduced or eliminated by drafting the IPS in a thoughtful and careful manner ... with an eye to eliminating possible pitfalls.

The benefits of an IPS are obvious. It provides a roadmap to help fiduciaries engage in consistent processes to prudently select and monitor a plan’s investments. However, the risk is that the terms of the IPS will not be followed, and that losses will happen because of that. But, through careful drafting the risk can be mitigated.

So, while ERISA doesn’t require that a plan have an IPS, if it is properly drafted, an IPS can be both a best practice that supports fiduciary compliance and a good risk management tool.

Unfortunately, many investment policy statements are based on forms that were drafted from an investment perspective, but without enough thought given to the legal risks.

Here are some tips on how to avoid problems with an IPS:

 

Guidelines or Requirements

Many investment policy statements “require” that plan fiduciaries (who this article refers to as the “committee”) take certain steps. If the IPS is drafted in a way that a reasonable reading is that the committee must do certain things, there is the risk of a breach for failure to follow its terms.

My preference is for the IPS to be a set of “guidelines”. To do that, the IPS should say that the provisions of the IPS are guidelines to the committee to help them engage in a prudent process to select and monitor the plan’s investments, and are not mandatory. Instead, the committee is expected to exercise its judgement and discretion in making decisions about the plan’s investments. In that case, where in the committee’s discretion, it is preferable to proceed in a manner different than the process described in the IPS, the committee can exercise its independent judgment.

As this suggests, the purpose of this approach is to avoid an inadvertent breach for failure to follow the terms of the IPS.

 

Amend or Change through Action

Most investment policy statements have an amendment provision. It usually requires that a written amendment be prepared, approved by the plan committee, and signed by a member of the committee. But, what happens if a change is made in the investment approach (by the financial professional or the committee) and the IPS isn’t amended? The answer is that committee decisions could be a fiduciary breach. It doesn’t have to be that way.

 

An IPS can also be a teaching tool for new committee members. 

 

I prefer to draft the IPS to say that it can be amended in writing or by an act of the committee. Then “act” is defined as any decision by the plan committee that is different than the provisions of the IPS. While there are advantages to a written record of changes to an IPS (e.g., an amendment to the IPS or a recorded decision in the committee minutes)--because that supports a consistent approach going forward, I would rather use this flexible approach to avoid inadvertent breaches. 

 

Plan Reports and the IPS: Consistency

As a practical matter, most plan committees rely heavily on their financial professionals’ reports to make investment decisions. And, since those reports are in writing, they become part of the records of the committee. As a result, and hopefully this goes without saying, those reports and the IPS provisions should be in alignment. In other words, if the IPS says that certain criteria are to be used to evaluate the plan’s investments, then the reports from the financial professional should use those criteria to evaluate the funds. If the reports and the IPS use different criteria, then the financial professional should consider recommending that the committee amend the IPS. 

Those kinds of accidental conflicts can potentially lead to problems down the line ... but the conflicts are easily avoidable.

 

On the Table or in the Drawer 

In my experience, many plan committees don’t regularly review their IPS. Instead, it is in a drawer collecting dust. That is unfortunate and creates some risk that its terms will be forgotten (and, as a result, that the committee might make decisions that conflict with the IPS). It is a best practice and good risk management to have it “on the table” at any committee meeting that considers a plan’s investments. Then, during the discussion, the plan’s financial professional should explain why the recommendations (e.g., keep in the plan, watch list, remove) are consistent with the terms of the IPS. That approach supports committee members in engaging in an informed process that is consistent with the IPS. 

In addition, it would be helpful to review the IPS with the committee members at least once a year. That would be both good risk management and a “teachable moment” in which the financial professional could explain what the IPS says ... and why it says that. 

An IPS can also be a teaching tool for new committee members. A plan’s financial professional should consider having one-on-one meetings with new committee members to discuss their responsibilities. That could include, for example, a review of the IPS and the plan’s summary plan description.

 

Committee Minutes: More or Less

Let’s turn to committee minutes. While they are obviously different than an IPS, they record investment decisions made by plan committees and the discussion preceding the decisions. Unfortunately, they are not always consistent with a committee’s obligations and with the IPS. For example, several years ago, I reviewed committee minutes in which a member suggested adding a “hot” mutual fund category to the plan. But, as you might expect, “hot” wasn’t one of the criteria in the IPS.

While that is an extreme example, the point is that committee discussions may sometimes conflict with the terms of the IPS or with sound fiduciary processes. Hopefully, other committee members will correct the inappropriate comments. From a risk management perspective, committees should consider whether those inappropriate comments should be included in the minutes at all, particularly if the committee members determined that they would not be considered as a part of the committee’s deliberations.

Closely related to that, a reason for a “less” approach in the information recorded in the minutes is that the minutes and those comments may be reviewed by plaintiffs’ attorneys years after the fact. If a committee member is recorded in the minutes as making a particular statement, they could be examined on that in a deposition or at trial, five, six or more years later. Why subject someone to that?

As a result, for risk management purposes committee minutes should, in my view, be drafted with a minimalist approach. For example, a decision to remove a fund from a 401(k) plan might be described in the minutes along the following lines:

“The plan’s financial professional provided the committee with information about the XYZ fund and its underperformance as compared to its benchmark. The financial professional then explained the reason for the underperformance and the possibility that it would continue into the future. A discussion by the committee ensued, with questions to and answers from the financial professional. At the conclusion of the discussion, it was moved and seconded, and unanimously approved, that the XYZ fund be removed from the plan.”

In other words, there are advantages from a risk management perspective to recording minutes with a minimalist approach . . . no names, no “he said, she said”, nothing but the facts and the decision (and including any underlying documents, e.g., the financial professional’s report with the minutes in the due diligence file).

Concluding Thoughts

As a practical matter, most plan committees won’t get sued. The problem is that we don’t know which ones will and which ones won’t. As a result, it makes sense to take reasonable steps to reduce risk—and particularly risk that may be unnecessary. A well-drafted IPS, with an eye to risk management, does just that.