Statement of Purpose

Experts say two of the most critical functions a retirement plan adviser can provide are to ensure that a plan has an investment policy statement (IPS), and actually follows the document.

“[An IPS] is like a blueprint; you don’t build a good house without it,” says John Barry, a registered principal with JMB Wealth Management/National Planning Corp., a firm with more than $300 million in assets under management, in Torrance, California.

It seems simple, yet many plans do not have an IPS. According to PLANSPONSOR’s most recent Defined Contribution Survey, 29.5% of plans that are without the services of an adviser do not have an IPS in place, and nearly as many—25.6%—of those plans that do employ the services of an adviser still lack an IPS (See “Why Have an IPS?” below) The lack of an IPS can open the door to advisers seeking new business. It’s a good prospecting tool to gain new clients, notes Bill Harmon, National Sales Director and Vice President of 401(k) for Great-West Retirement Services in Denver. If the plan does not have an IPS in place, or has one it cannot locate, it opens the door for the adviser to pitch his services.

The second best practice is to follow the IPS. Many plans have an IPS in place, but are not monitoring investments in accordance with the policy, notes Gary Josephs, Managing Partner at Castner Josephs Retirement Group, in Costa Mesa, California, which advises on more than $1.9 billion in retirement plan assets. One way in which advisers can help to ensure clients follow the IPS is to keep a signed copy of a sponsor’s IPS in their files, says Barry.

For the most part, says Barry, clients expect the adviser to draft the IPS. Vendors have made it easy for advisers to draft an IPS by making model forms available. However, there’s no perfect template for drafting an IPS that is appropriate for every situation, says Josephs. In fact, one can argue that IPS documents always should be customized, he adds.

The adviser should draft the IPS for the company with its goals and objectives in mind and in compliance with the Employee Retirement Income Security Act (ERISA) section 404(c), because that is the section that absolves sponsors from fiduciary liability if participants self-direct, says Josephs. Advisers can go to recordkeepers and get a boilerplate IPS, says Barry, and then tailor that for specific clients. At a minimum, the methodology determining if a fund fails to meet the standards outlined in the IPS, and what will be done if that happens, should vary from client to client, agrees Harmon.

For example, if the standardized IPS provides that underperforming funds will be eliminated, advisers can revise it to provide that the funds will be placed on a watch list. The document also can be changed to provide that the investment committee ultimately will make the determination to watch or eliminate the fund.

For guidance in learning how to customize IPS documents, Josephs recommends Best Practices for 401(k) Plan Investment Committees, by Rocco DiBruno and the Fiduciary 360 Web site (www.fi360.com). Advisers also may want to consult ERISA attorneys and legal counsel for guidance on customizing IPS documents, adds Harmon.

When drafting the IPS, flexibility should be built in to deal with changing market conditions and events, says Josephs. For example, says Barry, if a mutual fund is underperforming, participants who were dollar cost averaging into the fund while it was going down will lose out if the plan simply switches funds. So, if the IPS says every underperforming fund must be replaced, it does not allow the investment committee to take into account whether some participants may be better off for their money to remain invested in that particular fund.

Moreover, while flexibility is important, so is simplicity. For example, keep the methodology for picking and eliminating investments uniform, counsels Barry. Advisers also should avoid drafting an IPS so detailed that it complicates managing the plan, such as putting in overly specific benchmarks, says Josephs. Markets change, he explains. A broad benchmark such as requiring managers to be in the upper 50% of their universe is a good IPS benchmark, he says. However, requiring equity managers to outperform their benchmark by 75 basis points is bad, he adds, because it is too specific and does not give the investment committee much flexibility.

“If the IPS is so complex that no one follows it, it’s almost worse than not having one at all,” agrees Harmon. That complexity can extend to the process itself. If the IPS requires that a 15-person committee will meet monthly, he says, it will be almost impossible to coordinate that many schedules to schedule a meeting every month.

Once the document has been drafted, advisers should monitor the plan and the IPS to assure ongoing compliance, says Josephs. If the plan is out of compliance, then the adviser should make recommendations to either bring the plan into compliance or change the IPS to conform to actual practices. However, while revisions are sometimes necessary, Barry warns that revising the IPS too frequently may not be a good thing. “There’s no consistency in what you’re doing if you’re constantly revising the document,” he says.

Thereafter, say the experts, the adviser should lead the plan sponsor in ongoing monitoring of the plan and the IPS, at least annually—and more often if circumstances warrant. Advisers should lead a review of all investment materials to determine if any changes are needed to conform to the IPS, and also should lead a review of the plan investment options, making recommendations or changes as needed. It is important that advisers keep written records of both reviews and actions taken, documenting the reasons for the changes, says Barry.

Barry says things change, perceptions change, or fiduciaries change, and they may have a different reading on how to do things now than they once did. For example, if a sponsor replaces its chief financial officer, the new CFO may have a totally different idea of how investments should be chosen and what should be in the IPS, says Barry. That could necessitate a revising of the IPS.

Why Have an IPS?

The main reason to create and implement an IPS is to satisfy the plan sponsor’s fiduciary duty under ERISA to select and monitor investment options prudently. The IPS demonstrates that the plan sponsor has thoughtfully developed a plan for selecting investments and investment retention in accordance with ERISA. There is, however, no explicit requirement in ERISA that retirement plans have an IPS. A well-developed and monitored IPS can insulate the sponsor from liability in the event of litigation, says Barry, because it gives clear explanation as to how investments were chosen. What is more, the IPS, say the experts, is also the first thing that the Department of Labor (DoL) asks for when it audits a plan. However, the second thing it looks for is evidence that the plan is following the IPS. If the DoL audits a plan and an investment is questionable, the IPS justifies how and why the investment choice was made, notes Barry. Furthermore, if participants sue over an investment choice, the sponsor is more open to liability in the absence of an IPS, he says. The IPS also gives the plan’s investment committee clear guidance as to how and why to select investments. One of the main objectives of an IPS is to outline the processes that a plan sponsor will use in selecting and monitoring plan investment options. “The IPS is the cornerstone of the investment committee’s decisionmaking process,” says Josephs. “It details why they did what they did.”

Illustration by John Hersey