InStep® 3: Formalize

After you have gone through the audit and organization steps it’s time to document some of those decisions and formalize them in a written policy. The Investment Policy Statement or IPS is the cornerstone of the rest of this program. Having a written, authoritative statement on how you govern the plan will prevent litigation and insulate the sponsor, company, and plan from harm and malfeasance. It is the single most important component to managing a plan. If you don’t have one, run, don’t walk to remedy this. 

Simply put, the IPS is the foundational document that formalizes the overall strategy for investment fiduciaries. And while ERISA doesn’t require its presence, case law on the subject makes clear its importance.

Liss v. Smith

Divane et al v. Northwestern University

401k Formalize

Benefits of an IPS

Creating an IPS is essential for governance and due diligence. As a result, InStep® clients adopt one as a plan resolution. Then they can afford the following benefits:

  • Risk mitigation during an audit or litigation. The IPS can provide a papertrail for the process as well as management due diligence.
  • The IPS will help manage ex-post criticisms. In other words, the IPS documents how the portfolio was being managed from the beginning and that the process was agreed upon by everyone involved. The IPS will help clarify matters for any inductee to the investment committee, and document the decision with what was known at the time.  
  • During market volatility, the IPS is a natural response to pricing concerns. This helps insulate the decision makers from the whims of the market and draws focus to the process itself.
  • There is no replacement for experience and due diligence in investment decisions, the IPS can capture both of these elements regardless of the familiarity the investment committee may or may not have with asset behaviors. 
  • Fiduciary excellence can only be achieved through prudent processes that are consistently applied. The IPS is the governing document that allows for the consistency in that prudent application.

Eight Essentials for Formalizing an IPS

The AIF® process has developed eight quintessential components you should include in your Investment Policy Statement. However you begin drafting the IPS start by documenting these parts first:

  • Plan purpose including governing law
  • Duties and responsibilities
  • Risk, return and time horizon parameters
  • Diversification and rebalancing guidelines
  • Due diligence criteria for selecting investment options and service providers
  • Procedures for controlling and accounting for investment expenses and service providers
  • Monitoring criteria for investment options and service providers
  • Signatures from all the parties involved (and adjoining committee members)

Using the IPS to Limit Liability

The Investment Policy Statement is drafted for two main purposes, the first of which is the governance of the plan over time and the second is to mitigate the liability of the plan sponsor. InStep® clients get this document reviewed by an attorney who ideally has some familiarity with the laws and regulations associated with the applicable portfolio. 

Once the policy statement is in place, you need to implement said policy by following the written guidelines. When the investment committee is selecting and monitoring plan investments, the service providers can use the plan document as support for decision making and deliberation. 

Remember, the IPS is yours and the advisor’s tool for making investment selections before investment performance unfolds. InStep® clients are encouraged to document that the IPS is being followed during annual reviews, investment changes, and updates the IPS if necessary.

How can you ‘formalize’ right now?

If you are being added to a Plan as a participant and an Investment Policy Statement exists, review it. If you are being asked to serve on the investment committee, review it twice. If you are a plan sponsor review it twice and make sure your attorney knows you signed it. It’s that important. 

Every IPS document could be improved or updated, it’s not a crime to make these changes and keep your process in a constant state of improvement. So, understanding the key components of IPS construction can open doors and provide opportunities for the plan and its participants.

Once the IPS is adopted and understood, selecting and monitoring plan assets is easier and lowers the plan’s administrative risks. Understanding the important aspects of the IPS is a vital fiduciary function for existing clients but it also creates a new business opportunity for advisors to demonstrate their worth as educators and experts for prospects.

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