Canada: Does Your 401(K) Plan Have An Investment Policy Statement? That's Great, But Do Your Fiduciaries Follow It?

Although investment policy statements are not required by the U.S. Employee Retirement Income Security Act (ERISA), it is highly recommended that every 401(k) plan have one. An investment policy statement (IPS) can protect the plan committee or other fiduciary responsible for investments by setting out procedures for fulfilling fiduciary responsibilities.

Although a good IPS can be a defense in a lawsuit asserting breaches of fiduciary responsibility, a recent court decision, Tussey v. ABB. Inc., reminds us that it is a double-edged sword-that is, there can be liability if you adopt an IPS but do not in practice follow it.

This case involved plan fees and particularly the way in which "revenue sharing" – the application of part of the expense ratio of plan investment funds to pay for record-keeping services - impacted other decisions made by the plan fiduciaries. Although the court made it clear that revenue sharing was not in itself an ERISA violation, the decision was premised on departures from the standards set out in the IPS. In this case, the departures occurred when fiduciaries agreed to overpay for record-keeping fees, selected the classes of fund shares made available to participants, and replaced one investment fund with another fund, motivated by the desire to increase revenue sharing. It also found the record-keeper liable for not applying the float on plan contributions for the benefit of the participants.

The court stated that an IPS is one of the instruments governing the plan (see Section 404(a)(1)(d) of ERISA) that must be followed when fiduciaries administer the plan in accordance with its terms. It found that breaches of the IPS were breaches of the duty of prudence. The employer investment policy statement required that:

  • Revenue sharing should at all times be used to offset or reduce record-keeping costs. The court interpreted this language to require that the employer know how much it was paying for record-keeping services and, by using benchmarks for the competitive market for comparable funds, to know that it was overpaying for record-keeping. There was an obligation to negotiate for rebates of the overpayment from the record-keeper. The employer was found liable because it did none of these things and did, in fact, benefit by application of excessive revenue sharing to subsidize corporate services the record-keeper supplied to the employer. The defendants were ordered to reimburse the plans $13.4 million.
  • The committee should examine a fund's performance over a three to five year period before deciding to place a fund on a "watch list" and perhaps proceeding to remove a fund from the investment lineup. The court determined that this process was not followed when the highly regarded Vanguard Wellington Fund, which had only one year of poor performance, was replaced by Fidelity's Freedom Funds, lifestyle funds which did not perform well during the period in question. The motivation was to replace the Wellington Fund with funds that generated more revenue sharing to reduce the employer's portion of the costs. The defendants were ordered to pay $21.8 million dollars to make up for participant investment losses resulting from the mapping of the Wellington Fund to the Fidelity Freedom Funds.
  • In addition, the employer was found to have violated the IPS and apparently also Section 5 of its plan, which required that the employer "select that share class that provides participants with the lowest cost of participation," and the fiduciary duty of loyalty, by instead selecting share classes with higher expense ratios that generated greater revenue sharing.

In addition to the monetary relief, the court also ordered the employer to engage in a competitive bidding process for plan record-keeping services within 18 months. The current record-keeper was permitted to participate.

While it could be argued that this employer and the other fiduciaries would have been held liable for fiduciary breaches based on their behavior even if a written investment policy had not been adopted, the investment policy played a role in the court's quick rejection of the defenses presented.

There is an important lesson in this case: it can be very expensive to depart from your investment policy. We find that many employers adopt "canned" investment policies that they received from their outside service provider without much explanation or analysis. The best defense against the kind of award won by the plaintiffs is for investment fiduciaries to make sure that they have read and understand the IPS and determined whether it is appropriate for them, and, where appropriate, made any changes to customize a canned IPS.

It may be helpful for the IPS to contemplate that departures from its general guidance may be appropriate at times. And, it goes without saying, the best defense is to actually follow a good IPS, your plan provisions, and sound fiduciary procedures in practice.

Carol has practised in the employee benefits field for over 30 years, advising clients on all aspects of employee benefits and retirement plans, including questions relating to 401(k), defined benefit and employee stock ownership plans, welfare plans, fiduciary responsibility, prohibited transactions and plan asset issues arising in investment fund formation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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