When you manage a 401(k) plan, it’s how you play the game

By Neil H. Alexander, JD, CFP, AIFA

The recent volatility of the stock market should serve as a good reminder to companies with 401(k) plans that they are required by federal law to review their plan’s investment options on a regular basis.

The Employee Retirement Income Security Act (ERISA) is the federal law that governs how company officials, or “plan fiduciaries” as they are called under ERISA, manage and administer corporate retirement plans.

ERISA imposes numerous duties on plan fiduciaries, one of which is to prudently select and monitor the investment options offered within a 401(k) plan. If plan fiduciaries violate this duty, they may be held personally liable for the losses that plan participants suffer as a result. Under ERISA, plan fiduciaries include anyone who exercises discretionary authority over a plan or a plan’s assets, such as a business owner, a company’s board of directors, the corporate officers, the plan trustees and the members of the investment committee.

If challenged, either during an investigation by the Department of Labor (the federal agency that enforces ERISA) or during a civil lawsuit by an employee, plan fiduciaries must be able to document an investment management process that promotes the prudent selection and monitoring of investment options. The following factors should be kept in mind when creating or managing an investment management process:

• Draft a written Investment Policy Statement that defines the duties and responsibilities of involved parties, the guidelines for selecting investment options, the criteria for monitoring the investment options and service vendors, and the procedures for controlling and accounting for investment expenses. Because this document is usually the first document that a regulator or a plaintiff’s attorney will ask to see, it is important to adhere to the investment policy once it is created. The only thing worse than not having an Investment Policy Statement is to have one and not follow it – a clear violation of a plan fiduciary’s duty.
• Identify asset allocation alternatives that allow participants to allocate their contributions across asset classes, investment styles, capitalization size and domestic and foreign markets. The market performance of the late 1990s and the subsequent bear market showed that many plan sponsors relied on short-term performance, which led to growth-heavy investment options that ultimately collapsed with the popping of the technology bubble.
• Select the actual investment options that conform to the identified asset classes, the plan sponsor’s Investment Policy Statement and the due diligence criteria for the selection of mutual fund managers, such as the funds’ performance relative to their peer group and assumed risk.
• Lastly, monitor the plan’s investment options on an on-going basis. The cornerstone of this process is the annual performance report detailing how the investment options compare against appropriate index, peer group and investment policy objectives. Although this is the last step in the investment management process, it is the most problematic for plan fiduciaries and is where most fiduciary lapses occur.

Most plan fiduciaries are business owners or corporate executives who help administer the company’s retirement plan in addition to their primary responsibilities. While these individuals may be qualified to oversee the administration of their company’s 401(k) plan, they most likely do not have the experience, time or training to review the selection and monitoring process of their plan’s investment options.

Accordingly, plan fiduciaries should consider seeking the opinion of a third party to ensure their procedures will stand up to scrutiny. If ever called upon to defend their actions, a written review from an independent financial professional will provide plan fiduciaries a valuable tool in documenting that they have met their fiduciary duty under ERISA.

It is important to remember that a plan fiduciary is not responsible for selecting investment options that only increase in value. Rather, they must ensure that the selection and monitoring process is an objectively prudent one. In other words, it’s not whether you win or lose, it’s how you play the game.

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