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The Fiduciary Audit File

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One of my favorite stories concerns a horse that was found wandering in the countryside. No one knew where it had come from, since the animal had no distinguishing markings or tattoos. But those who found the wanderer couldn’t imagine keeping the horse for themselves–it needed to be returned to its rightful owner.

A farmer decided to bring the horse home, mounting it, leading it to the road, and then allowing the horse to pick its own direction. Only when the animal left the road to eat grass or to walk into a field would the farmer firmly guide it back to the road.

After some time the horse returned to its home, surprising its owner, who asked the farmer how he had known where to bring the horse. “I didn’t know, the horse knew!” said the farmer. “All I did was to keep him on the road.”

Here is a method designed to help your clients who themselves serve in fiduciary roles to stay on the right road, while at the same time adding value to your relationship with the client.

Let’s say you have a number of clients that sit on their companies’ 401(k) investment committees. Here is a common problem facing such a fiduciary client: Many committee members, while they realize they have a fiduciary obligation, are under the impression that their bundled service provider or third party administrator will protect them. Unfortunately, all too often, this is not the case.

As a fiduciary, their obligations are defined under Title I of ERISA, and as investment committee members they have responsibilities to oversee tasks often done by several individuals from more than one organization. In addition, they also have overall review responsibility for plan documents, selection of investment options, remittance of plan contributions, quarterly benefit statements, employee communications, and government and regulatory filings, to name just a few of their responsibilities. Keeping track of this paperwork is often the last thing committee members want to do. But this continues to be an important area where you can help the “horses” find their way home, and where you can distinguish yourself by adding value to your relationship with those clients.

First and Last: Document, Document, Document

A retirement plan fiduciary’s primary efforts should be focused on establishing a procedurally prudent investment process including the setting of investment policy, selecting the professionals to implement the process, and monitoring the results of the process. Given this mandate, it is critical that plan fiduciaries maintain ready access to documents that demonstrate they are following a “prudent” process that has been properly established and adhered to, and that significant decisions affecting the plan have been adequately documented.

Documentation is critical in fulfilling the role of a retirement plan fiduciary and may span a wide array of both internal and external reporting requirements. Internal records should be maintained to build an audit file that is readily available and can be quickly produced for review or audit purposes, and to verify compliance with applicable rules and regulations. External reports are required to satisfy plan participants, their beneficiaries, and regulatory authorities that assets are being properly administered and prudently invested. All these can be kept in an easy to access notebook or other simple filing system.

Building a Comprehensive Audit File

The Nobel Prize winning physicist Murray Gell-Mann said that he thought the most valued personal trait in the 21st century will be the facility for synthesizing information–to decide what information to heed and what information to ignore, and the information that can reveal non-obvious relationships within big-picture complexity. All the needed pieces of information may be at hand, but they may be hidden from plain view.

To gain that synthesis, collect and keep the following documents, at a minimum, in a fiduciary notebook for your client. Imagine how your client is going to feel when you show up with a simple system such as a binder with several folders that can hold a series of tabs for each required document. This notebook can be labeled “Fiduciary Audit File” with the name of your client on the cover. Inside the notebook can be tabs labeled Summary Plan Description, Investment Policy Statement, Trust Documents, Service Agreements, Money Managers Information, and other topics specific to the plan or sponsor. This one notebook will be the system that locates all documentation in one place in an organized fashion and in a form that is easy to maintain.

It is important to note that this checklist was developed as a general guide and that each plan may have unique internal and external reports that must be retained. My caveat: You should consult your compliance department or have this list reviewed by your retained retirement plan counsel and get their blessing before you show it to your clients.

The remainder of this article is divided into nine sections as listed below, which represent the major tabs in the Fiduciary Audit File. Here’s what should be included in each of those tabs:

Tab 1: The Plan Documents

All plan trust documents–plus a summary of any material modifications–along with all amendments, addenda, and attachments go behind this tab along with your adoption agreement if you have a prototype plan. Include a copy of summary annual reports and trustee reports for the past seven plan years and your “Plan Summary Description,” including all amendments and attachments that summarize the specific features of your plan; eligibility, benefits, contribution limits, vesting schedules, and distribution rules. In essence, this tab contains the “formalities” of the plan, with the required signatures evidencing the actions taken to establish and administer the plan.

Tab 2: Government/Regulatory Requirements and Communications

Keep a copy of Internal Revenue Service Form 5500 and your audited financial statements that accompany the 5500s and any applicable notes. Include here as well any letters or other communications from the Dept. of Labor, attorneys, new rules, or regulatory releases from the appropriate regulatory/legislative bodies.

Tab 3: Journals and Ledgers

Here is where journals, ledgers, account statements (including bank and trust statements), appraisals and other evidence to support all assets/investments are stored. This would include annual plan financial statements, cash flow statements evidencing contributions and withdrawals–essentially any document evidencing activity within the plan of a financial nature. Records and minutes of meetings could also be included in this section.

Tab 4: Section 404(c) Compliance

In order to comply with ERISA Section 404(a)(1)(c) your plan must be diversified. As a result, included in this section should be a list of investments offered to plan participants (must include a minimum of three diversified core investment choices); a description of the frequency of the participant’s ability to transfer assets among investment choices (quarterly is minimum); a copy of the statement to participants of intent to be 404(c) Compliant; a description of investment alternatives and copies of the applicable prospectuses; and your record/log of plan participant and information request forms and how they are fulfilled. You should also include the instructions to participants on how to obtain further information. In light of new proposed DOL regulations (as of this writing), information concerning the “default” investment options should also be included in this section. Under current proposals, investments that qualify for this option will be broadly diversified, multiple asset-class lifestyle and lifecycle type funds, as well as balanced and other specific diversified investment options.

Tab 5: ERISA Fidelity Bond

Place a copy of the bond and include a quick reference to the amount of your plan’s “Fidelity Bond Policy.” The amount of the bond must be at least 10% of the value of the plan assets, but not less than $1,000. While not required, the ERISA bond may exceed $500,000.

Tab 6: Participant Communication Documents Regarding 401(k) Education/Enrollment/ Meetings

Keep here all 401(k) plan promotional materials, including copies of all marketing materials that document and describe all investment options and related changes since the inception of the plan. Also keep any participant communications from the plan administrator or plan sponsor. Make sure there is a record of the distribution dates of updated prospectuses and other investment information that is provided to plan participants. In other words, any material relating to the investment options provided to your participants should go into this section. You could also include a sample of a participant account statement. In light of new Internet communication capabilities, records of activity, communications, messages, and other such information should be maintained here. Your plan sponsor or TPA should be able to provide you with documentation of these communications. If outside advisors are used to provide participant education, records of their credentials, outlines of their presentations, and other pertinent information concerning their presentations should be maintained here. A list of participants who attended these sessions should also be kept.

Tab 7: Investment Policy Statement

A copy of the Investment Policy Statement (IPS), written minutes, and/or files from investment committee meetings should be maintained in this section.

The Investment Policy Statement (IPS) is used as the basic business plan and establishes the communication systems and schedules for directing the activities of the investment program (for details on the necessary ingredients for a plan IPS, see the “IPS Essentials” sidebar, page 124.)

Tab 8: Third Party Service Providers

Here is where you should save copies of all investment management agreements and related correspondence to current, former, and potential managers as well as other service providers. Documentation of the due diligence process that was used to select investment managers, meeting notes from manager presentations, as well as notes of committee discussions concerning the hiring and firing of investment managers should also be housed behind this tab. Once a manager is hired, manager reports on performance, fees, and compliance to investment guidelines should be retained here. Notes of periodic reviews and documentation of monitoring of outside investment manager performance are also included here. Copies of all service agreements including those with custodians, money managers (and their ADVs), actuaries, accountants, and attorneys should also be included.

Also, keep copies of your Requests for Proposals (RFPs) and any competitive bid documentation along with all related correspondence.

Tab 9: Plan Procedures and Minutes

The final tab should include documentation of anything else that is not included elsewhere. General meeting minutes, administrative procedural matters, notes concerning specific participant situations, and records of ad hoc meetings with interested parties would be included here. Also place copies of approved plan forms such as applications, loan and hardship withdrawal request forms, or distribution or rollover request forms.

This may look like a lot of work, and it is. To comply with the mandates of ERISA, fiduciaries must establish prudent processes for administering retirement plans, including the creation and maintenance of an adequate record-keeping system. Explained here are the basic requirements for plan sponsors and those that find themselves in an ERISA fiduciary status.

No one can afford to take these responsibilities lightly. Huge damages have been collected from Wall Street firms, trust companies, and banks, but even more important are the cases of individual fiduciaries who became personally liable, in some instances, for acts they were unaware of or which they did not know were within their responsibility. Not knowing the provisions of the plan or where the necessary plan governing documents and records are is no defense! Establishment of a fiduciary audit filing system is your best defense, and constitutes what I consider to be a best practice for fiduciaries.

Ken Ziesenheim is president of Thornburg Securities and managing director for Thornburg Investment Management. He can be reached at [email protected].


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