Retirement plan sponsors aren’t required by the Employee Retirement Income Security Act (ERISA) to have an investment policy statement (IPS), but it is considered a prudent practice.

However, Bruce Ashton, a partner in the Faegre Drinker Biddle & Reath LLP Employee Benefits and Executive Compensation Practice Group, says he’s heard some plan sponsors say they don’t want an IPS because it will increase their liability. “I don’t think that’s true,” he says. “The issue is what’s in the IPS and whether plan fiduciaries are following it. For example, if the IPS has a policy in it that is not a prudent process and it gets followed, that could increase liability significantly. Likewise, if it prescribes an array of prudent processes and fiduciaries don’t follow them, it can increase liability.”

Ashton points to litigation in which a retirement plan’s committee was sued for not following the policy it had laid out. Although it wasn’t the principle issue in the lawsuit, in the long-running case of Tussey v. ABB, a court of appeals found that the members of the plan committee had violated their fiduciary duties by failing to follow the terms of the IPS. The court said, “Under longstanding interpretive guidance by the secretary, a statement of investment policy issued by a named fiduciary … is a plan document that fiduciaries are required to follow unless doing so would violate ERISA. Accordingly, the District Court correctly determined that the … fiduciaries violated their fiduciary duties when they failed to comply with the plan’s own requirements, as expressed in the investment policy statement.”

Natascha George, a partner in the ERISA and Executive Compensation Group at Goodwin, says an IPS is a plan sponsor’s declaration in written form of how plan fiduciaries intend to select, monitor and make decisions about investment options offered to plan participants.

Defined contribution (DC) plans have a wide array of investment choices, including a qualified default investment alternative (QDIA) and, possibly, brokerage windows, George notes. The goal of an IPS is to set forth the investment objectives of the plan. “Usually the goal is to provide a diversified menu of options so participants can construct a diversified portfolio based on their personal goals,” she says.

George says she tells clients it is far better to not have an IPS than to have one they are not compliant with. “Having an IPS is not required by ERISA or the DOL [Department of Labor], but the DOL has issued guidance saying that maintaining one is consistent with fiduciary duties,” she notes. “I tell clients to be sure they are comfortable with what’s in the IPS, because if they adopt one and don’t comply with it, that is a bad situation. It’s important as a fiduciary to have a clear understanding about what the IPS says and be willing to do whatever that requires.”

Ashton says if plan sponsors have a prudent policy that is properly drafted and plan fiduciaries follow it, they are in a better position to reduce liability. They can always get sued, but with a proper IPS, they have a much better defense.

“A properly drafted policy, in my view, should be one that lays out a guideline for the plan committee or fiduciaries of the structure plan investments should follow,” Ashton says. “It should be clear that it is only guidance and not prescriptive and state in the policy clearly that the committee may deviate from the guidelines in the exercise of its discretion.”

For example, the IPS might say an investment that doesn’t meet certain criteria for two consecutive quarters must be put on a watch list and if it doesn’t improve after two more quarters, it will be removed. However, Ashton says, there may be good reasons to not remove the fund, so the IPS should state that plan fiduciaries are able to exercise discretion.

Ashton adds that he had a client that had a fixed income investment in the plan that didn’t perform quite as well as its benchmark suggested it should, but one of reasons was that it had more government securities in the fund than the benchmark typically did. “The investment was actually safer because it had more conservative underlying funds, so the committee decided in its discretion that it was a good thing to keep the investment rather than get rid of it because of its performance,” he says.

Don’t Get Locked In

George says an IPS will usually set forth categories of assets the plan intends to offer, but it won’t specify particular funds. “It will probably say the plan will offer equity investments, including large cap, growth, small cap, international and emerging markets,” she says. “On the fixed income side, it will likely say the plan will offer cash or cash equivalents and bond funds.”

Plan sponsors might broadly say they want a fund that tracks the S&P 500, for example, but they shouldn’t specify particular funds, George adds. The IPS will say that within the different categories, the investment committee will evaluate specific funds that have the best risk/return profile, select those and review them periodically.

One thing Ashton says he likes seeing in an IPS is a discussion of the role of investment advisers hired by the plan sponsor. “If it is clearly laid out in the IPS what the adviser is supposed to do on a periodic basis and they follow it, that can be helpful in protecting the committee from liability,” he says.

He doesn’t like a lot of detail about which investment categories and strategies should be included in the plan. “it shouldn’t lay out specific investments to include. That has a tendency to lock people in,” Ashton says.

“The value of having an IPS is to set procedures for how funds are selected and monitored,” George says. “For example, if there is a manager change, is a fund put on the watch list for a while? In addition, if there is a style drift—a large cap equity fund looks like it’s venturing too far from its stated mix of investments—the IPS can provide a framework for guardrails for plan fiduciaries to use in determining whether the fund is no longer a fit.”

However, issues regarding watch lists can get plan fiduciaries in trouble, George warns. “If the IPS says the committee will get rid of a fund that is on the watch list for two quarters, that removes discretion from the committee,” she says. “The fund may just have a manager change and the committee wants to keep it on the list to make sure the new manager keeps in line with the stated mix of investments.”

Some policies in the IPS should not be hardwired, George says. She adds that removing funds can be disruptive; plan fiduciaries have to find a replacement fund and notify participants, “so there needs to be a really good reason for replacing funds.”

“The IPS should be specific enough to give fiduciaries guidelines but not so stringent that they are locked into courses of action that may not be appropriate considering all facts and circumstances,” George says.

“As a rule of thumb, be very careful about the use of ‘shall,’ ‘must’ and ‘will’ statements,” Jim Phillips, president of Retirement Resources, previously told PLANSPONSOR. “For example, let’s say your IPS says a fund will be removed if it underperforms its benchmark for three consecutive quarters.  If you haven’t followed your IPS, you could be financially responsible for any losses incurred subsequent to the point at which the IPS required that fund to be removed.”

Adopting and Maintaining an IPS

There is no one-size-fits-all approach to an IPS, George says. “It’s risky for sponsors, particularly of smaller plans, to just go online and grab one from the internet,” she warns. “And they also shouldn’t just take one from a fiduciary investment adviser and rubber stamp it.”

George says, most of the time, she sees a plan sponsor adopt an IPS after assets have gotten large enough to hire investment advisers. “They create an investment committee, a committee charter and an IPS and hire investment advisers usually at same time,” she says. “Perhaps they will use an IPS provided by an investment adviser to begin with, but they should scrutinize it. Are they really going to meet quarterly or just periodically? Do they want to stick to a strict watch list?”

An IPS is especially good to have for first-time committee members who are dipping their toes into fiduciary responsibility, George says. “It’s good to have guidelines.”

Ashton says the IPS should be reviewed periodically to see if modifications are needed.