The law holds sponsors of retirement plans to very high standards. In fact, the courts themselves have commented that ERISA establishes the highest standard of care under American law.
At the same time, ERISA doesn't offer a lot in the way of specific guidance. That puts plan fiduciaries in a tough spot—particularly when it comes to performing due diligence on investments.
One way many fiduciaries address this challenge is by forming an investment committee. However, in many cases, these committees tend to be informal groups of executives with no specific procedures to follow.
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That kind of casual approach can be risky, leaving plan fiduciaries vulnerable to accusations that they failed to fulfill their duties. Without a documented process, it can be hard for plan fiduciaries to prove that they acted properly and met the high standards required by ERISA.
Financial professionals can be well positioned to help plan sponsors overcome these challenges. By educating plan sponsors on how to form an investment committee, create an investment policy statement and select and monitor investments, financial professionals can demonstrate their expertise while also helping plan sponsors minimize their risks.
Here are a few best practices to consider.
Forming an investment committee
- Start by forming a written charter. This lays out the responsibilities of the committee and its members.
- Keep the committee small—and use an odd number of members. Aim for three to seven members. An odd number helps avoid tie votes.
- Look for people with the right experience, attitude and availability. Some background in finance or investments is a good idea, but there may be limited availability, especially in smaller organizations.
- Consider potential issues with company stock. When company stock is a plan investment option, the presence of senior executives on the committee may create a conflict of interest.
- Impose staggered term limits. Rotating three- or four-year terms may make the best use of committee member experience and still keep enthusiasm and involvement at a high level.
Creating an investment policy statement
A written investment policy statement (IPS) helps to document the employer's practices—a good source of protection in the event of an audit. While every plan sponsor's IPS will vary, consider including these sections:
- Statement of purpose. This states the employer's commitment to run the plan for the benefit of its participants under the Exclusive Benefit clause of ERISA .
- Investment objectives. The general objectives regarding performance, costs, diversification and other matters can be spelled out in this section.
- Investment guidelines. This section details the investment categories for which plan investment options will be provided. The types and numbers of investments to be offered in each category will also be detailed, as will matters such as benchmarks and other expectations.
- Selection of investment managers/options. This part describes the factors to be considered in selecting an investment manager or option, such as the investment manager's organization, philosophy and process, resources, performance and fees.
- Monitoring of investment managers and investment options. Due diligence also applies to ongoing investment monitoring. Factors to consider include performance evaluation criteria, style drift monitoring, handling of changes in ownership of the investment management firm, or change in a portfolio manager.
- Elimination of investment managers and investment options. Here, the ability and process to remove investment options and replace investment managers – along with the criteria and procedure for doing either – is explained in detail.
- Policies on the service of committee members. This section details matters such as how many members the committee will have or how often it will meet.
Establishing good processes for investment committees and investment policy statement formulation are often-overlooked issues. By educating yourself on this critically important process, you can demonstrate the depth of your expertise and carve out a potentially lucrative niche. Financial professionals can find more information in our white paper on Investment Committee Best Practices.
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