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Are You A Sitting Duck?

If you are a partner, stockholder, or owner of a business which provides retirement benefits to employees, and you are a plan trustee or participate in the selection of retirement plan investments or managers, then you are probably an investment fiduciary. As such, you have personal liability for employee investment losses unless you have a signed contract with a qualified advisor accepting that liability. Even then, you have an oversight responsibility. How many small firms meet the oversight requirements or have a contract that effectively protects them from liability? Probably less that 1%. The issue is serious. Many people think that investment fiduciary liability could become the malpractice issue of the next decade.

What is the problem? The Employee Retirement Income Security Act (ERISA) defines procedural steps that must be taken in selecting retirement plan investments or managers. The steps are very wisely conceived, and if followed, will probably lead to a good investment outcome. ERISA holds fiduciaries responsible for losses IF they fail to adhere to prudent procedures. These rules apply to every retirement plan even if employees have the right to choose from a menu of mutual funds. ERISA defines losses as the difference between actual plan earnings and what a prudent person with the care, skill, and experience appropriate to such matters would have earned in like circumstances. In my opinion this means that if you are not comparing costs and returns on a regular basis and making sensible changes you could have a problem. For example, if an attorney demonstrated that an investment fiduciary failed to follow these procedures and the plan underperformed the markets or incurred excess cost, the investment fiduciary could be liable for the comparative difference. Small differences can amount to big money: the difference between a 7% and 8% return on $50,000 over ten years is $20,000. Multiply this by the number of plan participants and it could add up to real money.

Prudent Procedures: ERISA outlines six investment supervision requirements:

  1. An investment policy statement must be established and should be in writing.
  2. Plan assets must be diversified in such a way as to reduce risk.
  3. Investment decisions must be made with the skill, care, diligence, and prudence of a competent person familiar with such matters.
  4. Investment performance must be monitored.
  5. Expenses must be controlled.
  6. Prohibited transactions must be avoided.

The key words in these requirements have professional definitions which may not be apparent to the lay person. They establish a level of competence which is normally associated with a highly skilled investment advisor. Additionally, as the amount and complexity of quantitative information increases, the standards of due diligence rise.

Investment Policy Statement (IPS): The IPS and supporting documentation is the heart of the oversight function and is required even if an outside trustee or investment management firm has been hired. The function of the IPS is to put in place a methodology to compare performance, costs, and risks to acceptable standards, and to select investments appropriate to participant needs. This is particularly important where a bank, insurance company or family of mutual funds has a conflict of interest in using their own funds as investments. Basically they are not in a position to objectively evaluate their own performance or cost. An independent trustee or advisor should be retained to develop the IPS, assist the plan sponsor in keeping it current, and to evaluate investment choices and manager performance.

How to Minimize Personal Liability:The simplest way to minimize personal liability in retirement plan matters is to:

  1. Get specialized legal advic
    e and obtain a Letter Ruling to assure that your plan meets IRS regulations.
  2. Retain a qualified investment advisory firm to accept investment oversight responsibility for your plan as provided by Section 3(38) of ERISA.
  3. With your advisor, establish an Investment Policy Statement and review it each year. Keep relevant journals and notes.
  4. Be sure that risks and returns are quantified, costs are defined, and that all of these factors are compared to credible performance standards each year.
  5. Be sure that there is sufficient investment diversification to reduce risk and meet participant needs.
  6. Separate the product sales and lending functions from the investment advisory function. Be aware of all conflicts of interest.

Many sponsors believe that by giving employees a choice between several different investment options, they have dodged the bullet. Wrong. For example: What if the investment options themselves are not a good "menu of choices?" You are a sitting duck!

There is a lot more to retirement plans than personal liability issues. Equally important is how to achieve excellent investment returns. For more information please contact Randy Tisch at 734/994-1188.