Avoid these Common Due Diligence Shortfalls

TJ O'Meara

by TJ O’Meara

Tort lawyers are feasting on retirement plan fiduciaries for common due diligence shortfalls. Yes, that’s a blatantly alarmist opener. However, many people are being sued and not infrequently those suits involve individuals who believed they had employed appropriate fiduciary procedures. What makes this matter particularly concerning to us is that the issues noted in this first wave of lawsuits are common to retirement plans that do not employ appropriate investment, legal and administrative professionals. This blog aims to help employers to evaluate and, if necessary, update their fiduciary processes to meet modern standards and best practices.

As with any process, success starts with proper planning and infrastructure. The first step in your evaluation should be to appraise your internal governance structure: who is in charge? At least one employee must take on the role as fiduciary and decision-maker. However, it is advisable to form a committee, if your company’s infrastructure permits. We suggest designating at least one committee of three-to-six financially savvy employees (though not necessarily experts) that are willing to collaborate to make sound fiduciary decisions for the company’s retirement benefits. Some firms prefer a single committee to make all the decisions, and some prefer a two-committee structure with one for administrative decisions and one for investment due diligence.

With a good governance structure in place, the next step is to determine where outside help may be needed. The investment committee should start by taking an inventory of their skills and available resources. Like great business managers, the best investment committees “know what they don’t know,” and they engage professionals in areas where expertise is lacking. For retirement plan fiduciaries, such wisdom is not optional; fiduciaries are obligated to seek outside help if they don’t have in-house experts to help them make prudent and objective decisions.

Few employers have specialized retirement plan investment, legal, and/or administration experts on staff. As a result, most committees hire an investment advisor that specializes in retirement plans as well as an attorney who specializes in Employee Retirement Income Security Act (ERISA) matters. If your committee hires an investment advisor, there are essentially two types of fiduciary specialist advisors: co-fiduciaries and discretionary fiduciaries. A co-fiduciary advisor assists committees in making investment decisions, while a discretionary advisor takes full responsibility and discretion for all investment manager selection and monitoring. Either can be a great choice, depending on the desired level of involvement among investment committee members in monitoring individual fund managers. We recommend investigating both options.

With the required experts in the fold, the next step is to formalize the investment policy for the retirement plan, usually by drafting an Investment Policy Statement (IPS). There is no legal requirement under ERISA to have an IPS, and for liability reasons you’re better off having no IPS than a poorly-written one. However, for retirement plan committees, the IPS is often the key differentiator between those that render arbitrary decisions and those that deliver sound and consistent ones. That is because a good IPS facilitates healthy discussion among committee members by articulating meaningful criteria for investment manager selection and monitoring processes. Successful committees have much easier jobs because they built a solid foundation in their IPS.

The IPS is especially key for committees that perform due diligence directly or with a co-fiduciary advisor. When a discretionary investment advisor is engaged, the IPS still serves an important role in supporting the committee when making peripheral investment decisions, such as selecting investment share classes. With a discretionary relationship, make sure the advisor has clearly articulated investment policies that guide their decisions. These policies should be integrated into your IPS.

With the governance structure, expertise, and investment policy in place, your investment committee has the most difficult parts of the process complete. From there, the job focuses primarily on maintenance. The investment committee should meet at least annually, even if they hire a discretionary investment advisor. Those meetings should focus on ensuring the funds in the plan are meeting the expectations of the IPS.  If a fund is not in compliance, it may need to be placed on a watch list or removed, depending on the nature of the violation and the policies specified in the IPS.

Finally, the best policies and procedures can’t help you in court if you can’t prove you were executing them. So document every important decision made by the committee, including decisions not to act. With each item, include the rationale behind the decision, and detail the actions that are to be taken, if any.

By following this guide, your investment committee will be armed with the tools needed to make sound fiduciary decisions. And, regardless of the outcomes of those decisions, the prudence of your processes should keep the tort lawyers at bay.