CEFEX Perspectives
A series of articles on fiduciary practices leveraging the training and experience of CEFEX Analysts.
CEFEX certifies over 125 retirement plan advisors in the US and our assessment includes the sampling of plan sponsor files. Fortunately, plan sponsors and their corporate counsel are generally sufficiently enlightened to maintain documentation, but we still come across plans that lack an IPS and other documentation supporting the investment process.
So, it is worth taking a look at what documentation a 401k plan and its investment advisor should develop and maintain to establish and demonstrate the prudence of the plan’s investment process.
The IPS has been written about extensively in the past, so I’ll pass on repeating its relevance. The CEFEX assessment looks for this document to be signed by both the advisor and the plan sponsor. This best practice assures all parties, whether involved in the past, current or future of the plan, that the IPS is referred to as the business plan for managing the investment portfolio.
What other documents, then, should plan fiduciaries maintain in carrying out their fiduciary responsibilities?
The US Supreme Court in Tibble[1] reminded us that plan fiduciaries are subject to a “continuing duty of some kind to monitor investments” but the Court did not define the scope of that duty. We do know from the DOL, however, that documentation is key to that process: “It is the view of the Department that compliance with the duty to monitor necessitates proper documentation of the activities that are subject to monitoring.[2]” This obligation is reflected in best practices pronounced throughout the retirement plan community[3] but it is an obligation to which lip service is all too often applied.
The generally accepted interpretation of DOL regulation[4] is that, in regard to a particular investment course of action, plan fiduciaries should determine what information is relevant, they should then examine and understand that information and they should then make an informed and reasoned decision. Thus, the documentation that plan fiduciaries should maintain is that documentation which demonstrates that they have undertaken these steps.
Documentation sufficient to demonstrate that a prudent process has been followed, leading to a substantively prudent decision, is reviewed in the CEFEX assessment. This includes documents that should be presented to the investment committee, such as due diligence reports, investment performance reports, watch-list records, RFP responses, survey results, benchmarking reports, vendor agreements and rebalancing records.
Then, following the investment committee’s evaluation and discussion of the information presented, the investment committee must make a reasoned decision based on that information and the results of their discussion.
Completion of all of these steps should then be recorded in investment committee minutes. Writing minutes is an area of significant potential improvement for most investment committees, who often fail to record what was discussed and what reasons the committee relied upon in making its decisions.
This is not a difficult task. Minutes should record the topic discussed, the information reviewed and relied upon, brief observations of relevant discussion, the committee’s decision and the committee’s reasons for that decision. All of these materials should be retained in the plan’s fiduciary file.
Why is this important? Quite simply, without a record of prior decisions, the reasons for those decisions and the materials relied upon to support those decisions, adequate monitoring cannot be reasonably performed. Committee membership turnover diminishes institutional memory and without an adequate historical record of prior decisions, committees become exposed to unnecessary fiduciary risk in their attempts to perform prudent monitoring.
The importance of sound documentation is taking on increased importance as a result of the Brotherston case[5]. In this 401k plan fiduciary breach lawsuit, the Court of Appeals for the First Circuit made two important determinations. The Court decided that: (1) once a fiduciary breach and a loss are established, it falls to the plan fiduciaries to prove that the loss was not caused by the breach; and (2) comparison between a plan’s investment returns and the returns of appropriate index funds is sufficient to establish a loss.
Brotherston is now before the US Supreme Court, but the Solicitor General has filed an amicus brief recommending that the Court not accept the case for further appeal, arguing that the lower court had already reached the right conclusions.
If the Court of Appeals’ decision stands or survives an appeal, plan sponsors and their investment advisors may now find themselves having to affirmatively justify their investment decisions and the process by which they were reached.
Further, where actively managed funds are used, the documentation will need to demonstrate that the selection was justified by realistically evaluated return expectations, considering the added costs and risk that an active strategy may involve[6]. Note that Morningstar has recently adjusted its forward-looking Analyst Rating system in a manner that addresses this. According to Jeffrey Ptak, Morningstar’s Global Director of Research Management, Morningstar has “… moved to simply subtracting a fund’s expenses from our estimate of how much value it can add before fees. If there’s nothing left for investors, then we won’t recommend the fund.[7]”
This sets a higher bar for an active fund, which won’t earn a Gold, Silver or Bronze rating, unless it can beat both its benchmark index and its peer group average after fees, adjusted for risk. Taking this and the Brotherston decision into account, documentation of the investment process will fall under increased scrutiny, reinforcing that plan sponsors and investment advisors should continue to review their investment process and supporting documentation to verify conformity with prudent practice.
About CEFEX
CEFEX, Centre for Fiduciary Excellence, LLC, an Fi360® company, is an independent certification organization. CEFEX works closely with industry experts to provide comprehensive assessment programs to improve the fiduciary practices of investment stewards, advisors, recordkeepers, administrators and managers.
This article series is based on the experience from hundreds of assessments conducted since 2006. Connect to CEFEX at www.cefex.org or via Twitter or LinkedIn.
[1] Tibble v. Edison Int’l, 135 S. Ct.1823 (2015) [2] DOL Interpretive Bulletin 2016-1, 29 CFR Part 2509, page13 [3] See, for example, Fi360 Prudent Practices for Investment Advisors©2016-2019 Fi360; ERISA fiduciary issues, A practice guide for advisors, Broadridge Matrix; A Defined Contribution Retirement Plan Handbook, Second Edition, April 2017, Russell Investments; Best Practices for plan fiduciaries © 2016 The Vanguard Group, Inc., [4] See for example: 29 CFR § 2550.404a-1 – Investment duties [5] Brotherston v. Putnam Investment, LLC, 907 F3.d 17 (1st Cir. 2018) [6] See Restatement (Third) of Trusts, § 90, comment f (American Law Institute). Also, note that while the Brotherston decision supports the use of index funds as a “safe haven”, actively managed funds do not become per se imprudent. However, there will need to be documented evidence of the evaluation that lead to selection of an actively managed investment strategy, as discussed. [7] See: Introducing the Enhanced Morningstar Analyst Rating for Funds, Jeffrey Ptak, CFA , Morningstar, November 5, 2019 – https://www.morningstar.com/funds/introducing-enhanced-morningstar-analyst-rating-funds
Roger Levy, LLM, AIFA®, is CEO of Scottsdale, Ariz.-based Cambridge Fiduciary Services, LLC. and a Senior Analyst for CEFEX. He is a member of the 401(k) Specialist Advisory Board and the co-author of Your 401K – The Danger Within. He has provided expert testimony in several 401k fiduciary breach lawsuits.