In that brief, the DOL argued that plan fiduciaries—members of a committee—violated their fiduciary duties by failing to follow the terms of their investment policy statement (IPS). As that demonstrates, an IPS is a critical document for plan governance and shouldn’t be viewed as an off-the-shelf form. Instead, it should be drafted to support best practices and to reduce the risk of lawsuits.

This article discusses several important best practices for accomplishing those results.

An IPS Should Be a Roadmap, Not a Set of Requirements

On a practical level, an IPS should be a map for fiduciary compliance in the selection and monitoring of investments and investment service providers and not a set of rules that mandate behavior.

An investment “map” will provide fiduciaries with a step-by-step approach to compliance, but will also allow flexibility. After all, ERISA expects that fiduciaries will exercise discretion in acting in the best interest of the participants…it is principles-based, not rules-based. In addition, as products, services and concepts evolve, the application of fiduciary principles and prudent processes will require new approaches and consideration of additional or new factors.

One approach to build flexibility into an IPS is to say that, as circumstances change, the fiduciaries may need to consider factors in addition to or different than those specified in the IPS. An IPS could also specifically say that it isn’t intended to be binding on the fiduciaries, but instead is a set of guidelines for them to consider. In that case, the IPS could go on to say that, instead of being bound by the terms of the IPS, fiduciaries are expected to exercise their discretion prudently and in the best interest of the participants.

For even greater protection, the IPS could say that, when fiduciaries make a decision that’s inconsistent with any of the terms of the IPS, that decision is considered to be an amendment of the IPS.

The point of this discussion is that, so long as fiduciaries are making prudent and loyal decisions, the IPS shouldn’t limit their ability to make decisions or expose them to potential liability. Instead, it should be a set of guidelines to help them with their responsibilities, but not to hinder that work.

Share Classes and Revenue Sharing

One of the most common claims in fiduciary breach lawsuits is that the fiduciaries selected the wrong (and more expensive) share classes of the investments (e.g., mutual funds or CITs). To help the fiduciaries avoid problems with those matters, the IPS should have guidelines on selection of share classes and revenue sharing.

A good starting point would be to have the fiduciaries (1) decide whether they want to use revenue sharing to pay for the costs of operating the plan, and (2) determine the share classes and expense ratios of the investments that would pay that revenue sharing. Those costs could be compared to the lowest cost available share classes of the same investments. Then a decision as to which option is in the best interest of the participants should be made.

As this suggests, there’s nothing inherently wrong with using revenue sharing share classes of investments—so long as the revenue sharing is applied to the benefit of the participants. For example, it benefits the participants if plan expenses are paid from that revenue sharing since those expenses would otherwise be charged to their accounts.

On the other hand, it could be better for participants to have access to lower cost share classes and have the operating expenses charged to their accounts. If the fiduciaries engage in an analysis of the costs and benefits, and it’s clear that non-revenue sharing investments are in the best interest of the participants, the fiduciaries would be walking on the thin ice of exposure to risk.

If revenue sharing share classes are used, it would be a good practice to have the IPS specify that fact and how the revenue sharing will be used to benefit the participants. A common approach is for revenue sharing to be paid into an expense recapture account and to pay plan expenses from that account. 

In my experience, it isn’t common for IPS’ to have specific language about revenue sharing. However, revenue sharing payments are a recurring subject of fiduciary breach litigation, and the inclusion of a thoughtful approach in the IPS would help protect the fiduciaries.

Target Date Funds and the IPS

Target date funds (TDF) have become a target for plaintiffs’ attorneys—both for performance and expense ratios.

Why is that? As Willie Sutton said: “Because that’s where the money is."

As TDFs accumulate more of the money in 401(k) and 403(b) plans, they have become subject to increased scrutiny. As a result, the fiduciary processes—and therefore the IPS terms—should become more detailed.

As a starting point, here are three considerations for the selection and monitoring of a plan’s TDFs:

• Are the share classes and expense ratios appropriate? The issues here are the same as for a plan’s other investments. That is, does the selection of share classes and expense ratios reflect a thoughtful process in the best interest of the participants?
• Is the TDF’s glide path “to retirement” or “through retirement?”  A “to retirement” glide path ends on the target date. A “through retirement” glide path continues to grow more conservative after the target date. Fiduciaries should know which design they have selected and why they selected that design. Both plaintiffs’ attorneys and the DOL have identified this as a significant issue.
• How do the asset allocation and glide path align with the demographics of the covered participants? For example, do the demographics of the covered workforce suggest that a lower volatility TDF suite would be appropriate…or a glide path with higher volatility? 

Those issues and others are discussed in the Department of Labor’s Target Date Funds - Tips for ERISA Plan Fiduciaries.

The IPS as an Educational Tool

A good practice would be for a plan committee, with the help of their financial professional, to review the IPS at least once a year. This is important for several reasons.

First, the committee members are legally required to monitor a plan’s investments on a regular basis. The process for doing that review should be spelled out in the IPS and committee members should be reminded of that process. Similarly, when an investment needs to be removed, the committee should follow the terms of the IPS to select the replacement investment. An annual reminder of those terms will help the committee members do their jobs properly.

Second, the IPS is evidence of the value of the financial professional. Typically, an IPS contains concepts and terminology that aren’t familiar to most committee members. By going through the IPS and explaining the terminology and concepts, the financial professional educates committee members about the expertise that they bring to the table.

Third, a review of the IPS should be part of the fiduciary education of any new committee members. It’s a good way to onboard those new members.

Fourth, an IPS may need to be amended from time to time to reflect changes—in investments, services or information. An annual review—with the guidance of the financial professional—will help the committee identify when changes should be made.

Concluding Thoughts

Investment policy statements should be “friends” of the plan fiduciaries—by providing a map to compliance. However, they shouldn’t create compliance “traps” by being written as “rules.” A financial professional can help plan committees draft an IPS that walks that fine line.