Defined contribution plan sponsors are ignoring one of their fundamental fiduciary duties if they fail to establish formal written investment policy guidelines, according to industry experts, yet most plans have no well-defined investment guidelines.
Essentially all defined benefit plan sponsors long ago adopted investment policy guidelines to assist with investment and performance evaluation and define goals and objectives, and industry experts say defined contribution plans have the same need for legal protection and to serve as a road map as the plan grows.
The Employee Retirement Income Security Act does not mandate the establishment of a formal written investment policy statement, but does state employee benefit plans must "provide a procedure for establishing and carrying out a funding policy in a method consistent with the objectives of the plan."
Investment policy is needed
More than a few defined contribution experts have interpreted that as strongly suggesting the need for an investment policy.
"If you have a written policy for your defined benefit plan, you need one for the defined contribution plan," said Joe Valletta, principal with HR Investment Consultants, Baltimore. "(M)ost case law involves investment policy statements for defined benefit plans or trustee directed assets. But 401(k) plans are still relatively new and there hasn't been anything out there to act as a model for defined contribution investment policy."
While there seems to be no hard data on the number of defined contribution plans with investment policy statements, interviews with investment consultants, fund managers and plan sponsors lead to the conclusion the number is relatively few. Also, there seems to be little interest among plans in having one.
One of the first to sound the alarm about potential fiduciary problems in the absence of a written policy was William McHugh Jr., treasurer at Novartis Corp., Tarrytown, N.Y. Mr. McHugh said some plan sponsors might be sidestepping their fiduciary responsibilities under ERISA regarding the selection of 401(k) investments, the appointment of investment managers, the establishment of appropriate investment guidelines and monitoring investment activities by ensuring they are in accordance with "pre-established" investment guidelines (Pensions & Investments, Feb. 17.)
Mr. McHugh said there has been a growing trend over the past few years in the use of full-service or bundled providers and that it is not uncommon for plan sponsors to base selection decisions on name recognition, administrative ease and "whether or not the service provider's investment funds are listed in the daily newspaper."
Nathaniel Duffield, director-trust investments at Halliburton Co., Dallas, said each of the four investment options of the $3.8 billion Halliburton plan has a detailed investment policy statement which is reviewed at least annually. Mr. Duffield said each Halliburton fund contains specific guidelines for asset allocation limitations, whether the fund may participate in securities lending activities, performance objectives and liquidity requirements.
"We manage our defined contribution plan in exactly the same way as a defined benefit plan, with specific guidelines that we monitor regularly to make sure investment managers stay within their areas," said Mr. Duffield. Halliburton uses external money managers to structure its three core investment options.
"Defined contribution, defined benefit, what is the difference with regard to the need for an investment policy," asked Mr. Duffield. "The reason other (plan sponsors) aren't writing them is because they aren't doing anything."
Officials at Rowe Decision Analytics, Chicago, estimate the number of defined contribution plans with an investment policy around 5%.
Software devises plans
Rowe has developed a software package, Investment Policy/Asset Allocation Manager 2.0, designed to assist plan sponsors in generating investment policy statements customized to the plan. A spokesman said current IPAAM modules are available for 401(k) and 403(b) plans, money purchase, profit-sharing and other defined contribution plans. A module for endowments and foundations will soon be available. A spokesman declined to identify plans using the software.
Henry Saveth, principal and attorney at William M. Mercer Inc., Washington, said plans are not legally required to have a policy statement, but having a written policy is"helpful and protective."
Labor Department regulations issued in 1994 encourage plans to develop policy statements but do not require it.
"There is one type of employer who would be better off without a written investment policy statement," said Mr. Saveth, "And that type of employer is one who doesn't follow its own policies."
Some just aren't interested
Part of the reason for the lack of interest might be because of the complexity of developing a policy for participant-directed plans as opposed to trustee-directed defined benefit plans.
But experts say policies are being written covering the same areas as defined benefit plans. According to HR's Mr. Valletta and other sources, defined contribution investment policies should establish the purpose of the plan, its objectives, cash flow, asset mix portfolio limitations, diversification, restricted investments, investment guidelines and performance review and evaluation procedures.
"How do you know when it's time to terminate a manager and how often do you review the investment options? That has to be written somewhere. Whether you call it an investment policy or a business plan, I don't know how you can manage without one," said Mr. Valletta.
Curt Manning, president of Northwest Benefit Consultants, Chicago, a third-party administrator for more than 185 small and midsized 401(k) plans, said he has been encouraging his clients to develop investment policy statements to no avail.
"Most 401(k) plans do not have an investment policy statement," he said. "Because the plans are participant directed, the conception is that there is no need for one. I don't think we have one plan with an investment policy statement."
Steve Butler, president of Pension Dynamics, Lafayette, Calif., consultant and third-party administrator for nearly 500 defined contribution plans, said only a few of his clients have written investment policies.
"There are very few plans actually doing it. It's relatively easy to do, and everyone should do it," said Mr. Butler.
It is a relatively simple matter, however, to find others who are skeptical.
Keeping it simple is hard
"I think to some extent focusing on the need for a formal written investment policy statement can detract you from the real issue," said Dave Barry, managing director at Bankers Trust Co. "We all have a tendency to overcomplicate the problems a plan fiduciary has. We can all get distracted by technicalities, but if you focus on doing the right thing you won't be getting into trouble."
"If you have an investment policy and do the wrong thing, you will be in trouble. If you don't have an investment policy and do the right thing, you won't get into trouble," said Mr. Barry.
He said plan sponsors should focus on "picking the right funds and make sure the money managers are doing what you hired them to do."
Mr. Barry pointed out that a major problem facing plan sponsors in the monitoring of investment managers is style drift from the stated objective, a point others believe should be addressed in the investment policy.
"If your equity manager is a retail mutual fund trying to beat the S&P 500, the manager is trying to figure out how to beat the S&P and may try to make his performance look good. He may not be providing what the fiduciary hired them to do if he goes 30% into cash or into emerging market bonds," he said.
That situation is exactly what an investment policy statement is designed to prevent, according to those who espouse them.
"Some people say that if you don't know where you are and where you are going then you can't get lost," said Mr. Valletta.