7 Steps to a Well-Constructed Investment Policy Statement

Although the ERISA doesn’t necessarily require an investment policy statement, the law does make it clear in Section 402(b)(1) that plans must “provide a procedure for establishing and carrying out a funding policy in a method consistent with the objectives of the plan.”

Further, the DOL has stated in Interpretive Bulletin (IB) 2016-1 that “a statement of investment policy designed to further the purposes of the plan and its funding policy is consistent with the fiduciary obligations set for in ERISA Section 404(a)(1)(A) and (B)” which obligate plans fiduciaries to fulfill a duty of prudence to participants and beneficiaries.

It also happens to be one of the first items requested when the DOL conducts an audit of a retirement plan.

So, the law doesn’t technically require an IPS, but the DOL (which has enforcement authority for ERISA) has stated that having one is consistent with the fiduciary obligations set forth under the law. Nothing like a Catch-22 when it comes to managing legal risk.

Either way, an IPS is a useful tool to help retirement plan fiduciaries demonstrate that a prudent process has been followed when selecting and monitoring plan investments.

A well-constructed IPS is considered a best practice and establishes guidelines for selecting and monitoring plan investments while providing a framework for making critical fiduciary decisions.

While the usage of investment policy statements is on the rise, not every plan uses one, especially in the small plan space where best practices tend to get adopted much less frequently.

However, based on our experience, many plans that have an IPS are using one that likely creates more risk for their fiduciaries, rather than less risk. This is because many plans take what I call the “check the box” approach to IPS management.

This often happens when someone at the company who is involved with the plan (e.g., a CFO or VP of HR) reads an article that says they need an IPS for their 401k or 403b plan. And so, they Google the term “IPS,” and they find a boilerplate version and download it, or they ask their broker/advisor, recordkeeper or TPA, one who is happy to oblige, who also sends along a generic template.

In both cases, what typically happens is the person who decided they needed an IPS sticks it in the file (often without reading it or verifying what it says will be done can actually be done) and “checks the box.”

In fact, I’d venture a guess that many of the companies who answered affirmatively to the survey above have a “check the box” IPS.

Unfortunately, any ERISA attorney in the country will tell you that it’s better to have no process at all than to have one you don’t follow.

Tussey v. ABB

A case in point is the 2012 ruling from Tussey v. ABB Inc. In that case, ABB had actually implemented an IPS but failed to follow the terms of the document which led, in part, to its initial loss in court and a judgment in favor of the plaintiffs (i.e., the plan participants).

Although appealed (and still ongoing) after nearly 13 years of litigation, ABB was originally slapped with a $36.9 million judgment.

ABB’s IPS included language that directed the plan fiduciaries to select the lowest cost share class of any mutual fund selected when multiple share classes of the fund were available.

However, the court found that when the ABB’s fiduciaries selected share classes for the plan, they chose higher cost ones that provided more revenue sharing to the recordkeeper for the plan.

7 steps

As an alternative to the common “check the box” approach, here are seven tips for creating a well-constructed IPS:

1. Make sure your IPS includes a description of purpose, the roles and responsibilities of those involved with the plan (e.g., committee members, recordkeepers/TPAs, investment advisors, etc.), factors that will be used to select and monitor investments and expenses, and the process for reviewing/replacing underperforming investments (often referred to as a “watch list”). Also, make sure the IPS is signed.
2. Beware of drafting the IPS with language that is either to broad (which can effectively render the document useless) or too strict (which can make it extremely too difficult to comply with as highlighted in Tussey v. ABB Inc.). Ideally, you want enough detail/structure to provide a clear process to follow but enough flexibility to maneuver when making decisions. A properly constructed IPS should be a “framework for making decisions, not a mandate.”
3. Words like “always” or “never” or “required” should be avoided. Also, whenever possible, replace words like “annually” with “regularly.” For instance, instead of saying “The IPS will be reviewed on an annual basis” (which creates a strict frequency of review) you can modify to say “The IPS will be reviewed on a periodic basis” (which creates some flexibility as to the frequency of review).
4. Select and monitor investments using quantitative criteria but make decisions using a qualitative process. At Greenspring Advisors, we use quantitative criteria to score and rank plan investments. When an investment fails a certain number of criteria, it goes on the watch list, and our firm conducts further due diligence to identify what caused the failure, and we make our recommendation. We describe the quantitative criteria as something like the check engine light in your car—it tells you something is wrong but not what the problem is. The qualitative process is like taking the car to a mechanic who then plugs the vehicle into the computer and pulls the error codes to determine whether the issue is a minor or major one.
5. Make sure you have the right tools and technology in place to monitor the criteria stated in the IPS. We consistently read through existing investment policy statements that obligate plan sponsors to monitor or measure investments using specific criteria but without any tools to do so or evidence the process has been followed (e.g., reports). Remember, not having a process at all is far better than having a process that isn’t followed.
6. When an underperforming fund qualifies for the watch list, make sure to clearly document the factors that influence why a decision is made to either keep or remove/replace the fund. This should be reflected in the meeting minutes or other written format.
7. On a periodic basis (usually every couple of years), have the committee read through the IPS and discuss the various sections to ensure everyone understands what it says and determine if any modifications are warranted due to a change in process or procedure. Realistically, your IPS should not change very frequently.

Remember that a well-constructed IPS is simply a tool in the fiduciary’s toolbox. Like any tool, if it’s in the hands of an expert, it can be used for great benefit, but, in the hands of a novice, it’s likely to do great damage.

Josh Itzoe is a founder of Greenspring Advisors and leads the firm’s Institutional Client Group. He specializes in developing and managing corporate retirement plans by providing independent advice on fiduciary oversight, investment due diligence, fee-benchmarking, plan design and vendor management. He is also the author of one of the retirement industry’s most well-known books on fiduciary responsibility for defined contribution plans, Fixing the 401(k): What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully.