An investment policy statement is essentially the business plan for a portfolio. For 401(k) fiduciaries, the IPS serves as a critical governing document, one that should be carefully crafted, periodically reviewed and updated, and diligently followed.
The last point is particularly important—the only thing worse than not having an IPS is having one that is not followed. Two recent lawsuits against plan sponsors—Tussey versus ABB and White versus Chevron—powerfully illustrate this valuable lesson.
In both cases, the IPS was a central point of contention. Plan participants in each lawsuit alleged breach of fiduciary responsibility associated with the selection, monitoring and replacement of investment options when performance faltered.
The court decisions offer a contrasting tale of two investment policy statements: one a tale of woe and neglect, with resulting negative repercussions for the fiduciaries, and the other a textbook case of overreaching by the plaintiffs and ultimate court dismissal.
TUSSEY VERSUS ABB
Tussey versus ABB was filed in 2006 and had a long, torturous history of litigation starting in a Missouri district court. It included a bench trial in 2010, and subsequent appeals to the 8th Circuit and Supreme Court. After the trial, the district judge awarded participants $21.8 million in damages for ignoring the IPS. It was only this past October that the ABB fiduciaries finally exhausted their appeals; the 8th Circuit has remanded the case back to the district court to reconsider the judgment in the case and recalculate any damages associated with the IPS breach.
ABB's investment committee adopted its IPS late in 2000, at the recommendation of staff. The plan was big, with $1.4 billion in assets and 14,000 participants. According to the court, the IPS described "the underlying philosophy and process for the selection, monitoring and evaluation and, if necessary, removal of investment options."
Unfortunately for ABB, the district court found that plan fiduciaries did not follow the prescribed procedures of the IPS when it decided to remove the Vanguard Wellington Fund from the fund lineup and replace it with a new target-date fund.
According to court filings, ABB's investment committee took little time to switch out Wellington with the Fidelity Freedom target-date funds, chosen after only briefly reviewing three other choices and without examining historical performance of the Wellington Fund in a manner consistent with IPS guidelines for removal of funds. In fact, in the same meeting that the IPS was adopted, ABB staff recommended removing the Wellington fund, according to court documents.
WHITE VERSUS CHEVRON
White versus Chevron is a much different story, and with a much shorter litigation history. Chevron's plan is also big, with $19 billion in assets. Participants filed suit in February 2016 in a California district court alleging, among other things, that Chevron's fiduciaries violated the IPS by failing to switch its only conservative investment option from a money market fund to a stable value fund.
Participants argued Chevron should have known better, in light of the run on money markets in 2008 and the low interest-rate environment afterward. Participants also alleged Chevron retained a small-cap option for far too long, after 15 out of 17 quarters of underperformance when compared to its benchmark.
The California court noted the Chevron IPS required at least one fund to provide "a high degree of safety," which was represented by the money market fund. It also noted that the IPS required all plan options to be liquid and valued daily.
According to the court, Chevron's fiduciaries complied with the IPS. Moreover, the judge agreed with the defendants' justification of the small-cap option: that retaining poorly performing investments as part of a long-range strategy is common.
The lesson to be drawn from these two cases is simple. Draft carefully, be prepared to follow what the IPS says you are going to do, and document your decisions. This process applies equally to both institutional and retail clients.
Courts do not have the luxury of debating best drafting procedures. They must address real-life situations. And that is why case law is invaluable in learning what works and what doesn't when the IPS is at center stage in the courtroom.
Blaine F. Aikin is executive chairman of fi360 Inc.