6 STEPS TO ERISA COMPLIANCE

It is extremely important for retirement plan fiduciaries to understand the scope of their responsibilities and the potential penalties for shirking these responsibilities under ERISA (The Employee Retirement and Income Securities Act). A fiduciary can be held personally liable for breach or violation of these responsibilities, even to the extent of having to restore lost profits to the plan.

Anyone who is a trustee, sponsor or otherwise exercises any authority or control over any type of employee benefit plan is a fiduciary. A person who renders investment advice to a plan for a fee is considered a plan fiduciary. In addition, other parties can be included as fiduciaries by reason of their functional relationship to the plan.

With this in mind, it is important to design an approach that will not only ensure complete compliance with the standards of ERISA, but also provide a prudent investment strategy for all participants.

Step One. Write an Investment Policy Statement. This statement should provide specific instructions to an investment advisor and cover such topics as target rates of return, risk tolerance, anticipated withdrawals or contributions, regulatory issues and desired holding periods of asset classes.

An Investment Policy Statement may range from the very simple to the very elaborate. As the name indicates, it sets forth the objectives, guidelines and requirements of the qualified plan. Typically, the Investment Policy Statement is written by a trustee, a plan sponsor and/or an investment manager. Although the investment manager may not be a named fiduciary, his assistance in developing an Investment Policy Statement can make him a “functional fiduciary” and create fiduciary liability. A written Investment Policy Statement will assist fiduciaries in meeting the plan’s objectives, help promote effective communication with investment managers and aid in satisfying the regulatory requirements of ERISA by establishing investment and funding procedures. 

The plan document does not have to be overly complex, as long as the objectives are specific enough to meet plan needs and goals. Some very comprehensive Investment Policy Statements have been contained within three pages. Written objectives are as integral to a twenty-person plan as they are to massive employee plans. Fiduciaries in both cases will be held to standards defined by ERISA, as well as those defined by plan documents.

Step Two. Select an investment advisor who constructs portfolios using Institutional Asset Class Funds and who is compensated on a fee basis. Advisors who work on commission may be more likely to recommend more frequent transactions in your portfolio. Asset class investing offers an academically sound approach to investing. On the other hand, market-timing and individual stock selection have been shown to be unreliable management techniques. Using institutional asset class funds will also help meet the reasonable expense requirement of ERISA.

Step Three. Determine the appropriate time horizon for the plan. Use at least a five-year time horizon for investing. Historically, past experience indicates the stock market goes down one year out of every four years. No one has ever been able to accurately predict a down year. For that reason, use a five-year horizon and design your portfolio so that, when a down year occurs, the storm can be weathered.

Step Four. Determine your level of risk, particularly on the down side. For example, a three percent loss might be sustainable while an eight percent drop in a single year might be too aggressive for you. Don’t set yourself up for failure. Recognize there will be down years and be in a position to ride through those years. If down years bring a level of risk you’re uncomfortable with, you should not be in the equity market.

All investments involve some risks. Therefore, the duty of a trustee does not call for the avoidance of risk, but rather for the prudent management of risk. This requires that careful attention be given to a particular risk tolerance; that is, to its susceptibility to volatility.

Asset allocation decisions are an integral part of a sound investment strategy and a starting point in formulating a plan of diversification. Trustees have a duty to diversify unless, under the circumstances, it is clearly prudent not to do so. This is fundamental to the management of risk, regardless of the level of safety an individual investment offers.

Step Five. Set target rates of return that you will need on your entire investment portfolio to achieve your objectives. An investment advisor can show you different models and mixes of investments suitable to achieving your goals on historical information.

Step Six. Monitor your investment performance and rebalance your portfolio periodically. If an asset differs by more than 5% from its original target allocation, then either buy more or sell some of the assets until the target percentage is restored.

  

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