FIDUCIARY PRUDENCE AND INVESTMENTS:

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1 Prepared by the Law Offices of Geoffrey M. Strunk, LLC FIDUCIARY PRUDENCE AND INVESTMENTS: Historical Track Record The interpretation and application of ERISA is dynamic with respect to what is reasonable and prudent. Track record is relevant in the context of prudent fund selection by an investment fiduciary. However, ERISA and the Labor Regulations fail to specifically include a direct track record requirement. Labor Regulations exist which allow an ERISA retirement plan investment fiduciary to select a retirement plan investment regardless of the length of its track record. An investment policy statement (IPS) should clearly grant the maximum permissible flexibility and discretion to an ERISA investment fiduciary. If the IPS is too restrictive with regard to track record or any other component, it should be revised in a prudent and responsible manner so as to avoid potential conflict and clearly authorize this exercise of discretion by the ERISA investment fiduciary. All investments involve risk, including possible loss of principal. IMPORTANT NOTE: The Law Offices of Geoffrey M. Strunk, LLC have prepared this white paper on behalf of Legg Mason & Co., LLC. This paper includes suggested practices that plan sponsors, and the financial professionals who work with plan sponsors, may wish to consider in connection with the selection and monitoring of plan investments. It is important to note that the suggested practices are not the exclusive means of fulfilling fiduciary obligations in connection with the selection and monitoring of plan investments. Other combinations of practices also may be effective. Plan sponsors and other fiduciaries should consult with their own legal counsel concerning their responsibilities under ERISA with respect to the selection and monitoring of plan investments. Future legislative or regulatory developments may significantly impact these suggested practices and the related matters discussed in this paper. Please be sure to consult with your own legal counsel concerning the application of ERISA to the selection of plan investments and your other fiduciary obligations under ERISA. This white paper is intended for general informational purposes only, and it does not constitute legal, tax or investment advice on the part of the Law Offices of Geoffrey M. Strunk, LLC or Legg Mason & Co. and its affiliates. Plan sponsors and other fiduciaries should consult with their own legal counsel to understand the nature and scope of their responsibilities under ERISA and other applicable law. INVESTMENT PRODUCTS: NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

2 I. INTRODUCTION When it comes to the standard of care that a retirement plan fiduciary must exhibit when performing his or her investment-related responsibilities, the starting point is the explicit statutory standards set forth under the Employee Retirement Income Security Act of 1974, as amended (ERISA). In relevant part, ERISA states that a fiduciary must discharge his duties with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use. 1 A large volume of Labor Regulations also address and impact these responsibilities. However, it is interesting to observe the general lack of specificity of such rules. This vagueness necessarily impacts an ERISA fiduciary s compliance with these rules. For example, the responsible application of the vague term reasonable in the context of service providers and investment-related fees is the source of much of the ERISA fiduciary litigation of today. Were the fees reasonable for the services provided? The answer to this question in the context of any specific instance requires a thorough understanding of the facts and circumstances at issue. This is because the application of the rule requires one to attempt to objectify what is otherwise generally considered to be a subjective term, reasonable. Ultimately, what is important about this example of reasonableness for purposes of this white paper is that context is critical to analysis and, as a result, conclusions. Thus, the interpretation and application of ERISA is dynamic with respect to what is reasonable and a practice that may previously have been reasonable may not be so at some point in the future due to the surrounding context. This white paper considers the dynamic aspects of the ERISA fiduciary duty of prudence in the context of investments. As this is such a broad topic, we choose to examine the specific reliance of many ERISA fiduciaries on an investment having a minimum track record as a data point for which many retirement plan investments are held inflexibly accountable. For our purpose, track record is limited to the length of time that a specific investment has been available to investors regardless of such investment s performance. This data point was chosen as a point of focus in part due to the volume of questions that surround this issue but also because, while many ERISA investment fiduciaries unwaveringly subscribe to the unqualified satisfaction of this criteria, neither ERISA nor the Labor Regulations specifically require it. Thus, the analysis and discussion herein examine the track record requirement by considering its origins, its application to the retirement plan industry and whether reliance upon it may need to be tempered through a broader spectrum of other fiduciary concerns. 1 ERISA 404(a)(1)(B). 2

3 II. TRACK RECORD A. Background Investment professionals routinely employ screening techniques in order to sort through and evaluate the large volume of potential investment opportunities for their clients. In the context of participant-directed defined contribution retirement plans, the purpose of these screens is to more easily compare and contrast different investments in order to ultimately create a retirement plan s fund lineup from which participants might invest their individual accounts. Engaging in this due diligence process demonstrates a very basic level of fiduciary prudence under ERISA. The primary prerequisite to the ability to engage in the screening process considered above is the availability of data. Without data, there is a stark inability of an investment professional to compare one investment to others in its peer group. Without an ability to compare and contrast one investment to others, it becomes difficult, if not impossible, to evaluate and ultimately rank different investments. Thus, surely everyone would agree that investment data is very important to the satisfactory performance of the ERISA investment fiduciary s duties. As a result of this logical application of the ERISA prudence duties to the investment selection process, investment professionals generally have adopted a standard when it comes to the minimum amount of data necessary to formulate an opinion about an investment opportunity in comparison to its peers. More specifically, as evidenced by a conversation with almost any financial professional who works in the retirement plan space, as well as the specific requirements of the vast majority of investment policy statements (IPS) adopted in connection with ERISA retirement plans, there is a general expectation that an investment must have at least a three-year track record in order to justify its consideration as a retirement plan investment. This requirement raises the logical question of: Why three years? Why not five years or one year or some other time frame? The answer to this question, while not necessarily intuitive, is not surprising. The process of comparing and contrasting different features of a vast number of different investment options invokes principles of statistical analysis. Within the realm of statistical analysis, there is a rule known as the law of large numbers. The law of large numbers is a principle of probability that is employed to evaluate data in order to help predict outcomes. Essentially, the law of large numbers states that as a sample size grows, the average actual result gets closer to the average expected result. For example, rolling a single six-sided die should produce one of the numbers 1, 2, 3, 4, 5 or 6 with equal probability. Thus, the expected value of a single die roll is 3.5 (( )/6). In general, the law of large numbers proposes that if the sixsided die were rolled 1,000 times, the average value of a single roll is much more likely to approach 3.5 than the average value of rolling the six-sided die only four times. These expectations are a direct result of the variance in sample sizes. Once we understand the law of large numbers in statistical analysis and apply it in the context of investing, our next question becomes: What is the minimum sample size that must be tested in order to attain any confidence that our average actual result can reasonably be relied upon to predict an expected result? Although the larger the sample size, the greater the ability of one s average results to predict an expected result, many academics of statistical analysis also identify a sample size number of 30 as something of a magic number for this purpose. 2 In this regard, it is proposed that a minimum of 30 normally representative samples must be employed in order to be able to predict an expected result and that the marginal benefit of using more than 30 samples declines rapidly beyond that point. When we apply the law of large numbers and the statistical magic number of 30 to our discussion of track record, we see the likely explanation for the standard adoption of a threeyear track record requirement in connection with the analysis of potential investment options. A three-year period of time would allow for 36 monthly samples. A sampling of 36 data points could reach a level of statistical significance such that it could reasonably be relied upon in order to attempt to predict a result. Thus, in the context of a financial professional s attempts to compare one investment to another in its peer group, a three-year track record requirement could be useful in order to provide enough investment data so that a statistically relevant analysis of the investment s performance could be prepared. 2 Although it is beyond the scope of this article, it is noted that, while many statistics textbooks recognize a sample size of 30 as the minimum number necessary to generate reasonable confidence in predicting an average expected result, there are many academics who characterize this number as random in its selection and who might propose a number other than 30 depending on the circumstances and specific analysis being performed. 3

4 B. ERISA requirements The consideration of track record above is interesting and allows one to conclude that an established track record bears a certain level of significance when it comes to an investment fiduciary s performance of his or her duties and responsibilities. However, even though we can recognize a track record s relevance in the context of prudent fund selection by an investment fiduciary, relevance to the analytical process remains distinct from an objective requirement of ERISA and/or the Labor Regulations. Thus, we must delve deeper in order to analyze track record as a required analytic component of a prudent retirement plan investment. As described in the opening paragraph of this white paper, ERISA states that a fiduciary must discharge his duties with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use. 3 This section of ERISA is a statement of the standard of care that a fiduciary must exercise in the performance of his or her duties, including his or her investment-related duties. 4 However, the lack of specificity here forces any analysis of its application to be performed on a facts and circumstances basis. 5 Thus, in general, the facts and circumstances of the action to be considered must be measured against a prudent fiduciary practice in order to determine whether it is compliant. Applying that premise to the concept of track record, the prevalence of the consideration of track record by investment fiduciaries, in and of itself, suggests that it is an important data point that should be examined in the context of fund selection. This is because its prevalence suggests its utilization is a discharge of one s fiduciary duties under the circumstances then prevailing that a prudent man and familiar with such matters would use. 6 Therefore, it would appear to be a mistake to entirely dismiss consideration of an investment s track record. Notwithstanding the foregoing paragraph, it remains impossible to ignore that the statute and resulting regulations do not impose a track record requirement. In fact, not only do ERISA and the Labor Regulations fail to specifically include such a requirement, Labor Regulations exist which allow an ERISA retirement plan investment fiduciary to select a retirement plan investment regardless of the length of its track record. More specifically, the DOL s ERISA retirement plan fee disclosure regulations provide direct accommodations for the mandatory disclosures set forth therein in connection with an investment s track record or lack thereof. Under the participant-level fee disclosure mandates of section 404(a)(5) of the Labor Regulations ( Participant Fee Disclosure Regs ), plan sponsors are required to disclose certain investment-related information to the plan s participants which includes, but is not limited to, performance data and an appropriate benchmark. 7 These disclosure requirements are further qualified to state that the necessary information must be provided over 1-, 5- and 10-calendar year periods (or for the life of the alternative, if shorter). 8 This shows that the Department of Labor (DOL) has created a specific exception 3 ERISA 404(a)(1)(B) 4 Id. 5 See id. 6 See ERISA 404(a)(1)(B). 7 ERISA 404(a); Labor Reg a-5(d)(1)(ii)&(iii). 8 Id. 4

5 under the Participant Fee Disclosure Regs to accommodate investments offered under an ERISA, participant-directed, defined contribution plan that have a track record of less than one year. Thus, this allows us to infer that, in the opinion of the DOL, there is no absolute minimum track record requirement. Similar to the Participant Fee Disclosure Regs, another section of the Labor Regulations obligates certain retirement plan service providers to formally disclose their fees to their retirement plan sponsor clients ( Service Provider Fee Disclosure Regs ). 9 In the context of performance data and benchmarks, the disclosures under the Service Provider Fee Disclosure Regs are identical to those required under the Participant Fee Disclosure Regs. 10 In fact, the Service Provider Fee Disclosure Regs directly cite the relevant provisions of the Participant Fee Disclosure Regs in order to impose an identical disclosure requirement under the Service Provider Fee Disclosure Regs. 11 The Participant Fee Disclosure Regs only apply to ERISA, participant-directed, defined contribution plans. 12 However, the Service Provider Fee Disclosure Regs apply to all ERISA retirement plans. 13 Therefore, by extending this accommodation for investments with less than a one-year track record from the Participant Fee Disclosure Regs to the Service Provider Fee Disclosure Regs, the DOL broadened its acknowledgement that an ERISA retirement plan investment could have a track record of less than one year from only ERISA, participant-directed, defined contribution plans to all ERISA retirement plans. Therefore, a cursory examination of the Participant Fee Disclosure Regs and Service Provider Fee Disclosure Regs (hereafter collectively referred to as the Fee Disclosure Regs ) allows us to conclude that the DOL does not believe that ERISA investment fiduciary duties require adherence to an absolute minimum track record requirement. It also is important to recognize here that the Fee Disclosure Regs are a comprehensive set of rules that are intended to directly regulate ERISA retirement plan fiduciary conduct. Consequently, although surely not promulgated with the direct intent of specifically establishing the DOL s position on a minimum track record requirement for ERISA retirement plan investments, the Fee Disclosure Regs do exactly that as a result of their clear and direct regulation of the same subject matter, ERISA retirement plan investments. Despite the conclusions above, the fact that the DOL, ERISA and the Labor Regulations fail to impose a minimum track record requirement for retirement plan investments does not mean that track record is a data point that should be entirely ignored, either. Track records prevalence in the investment industry shows that the factor has value. However, when considered in connection with the existing statutory and regulatory structure associated with retirement plan fiduciaries, it appears that track record is but one factor in the overall analysis and not an independently controlling factor in and of itself. 9 ERISA 408(b)(2); Labor Reg b-2(c)(1)(iv)(E)(3). 10 Id. 11 Id. 12 ERISA 404(a); Labor Reg a-5(b)(2). 13 ERISA 408(b)(2); Labor Reg b-2(c)(1)(ii). 5

6 C. The relative importance of track record Accepting that track record is only a single piece of a much broader fiduciary process raises the question of how to determine the relevance of track record in connection with a specific investment opportunity. As suggested above, application of fiduciary duties and obligations to a specific situation are extremely fact-dependent. Obviously, an investment fiduciary s consideration of a potential retirement plan investment that has existed for 10 years probably would not raise any question of whether there is a sufficient track record for such investment. Since the rule of thumb followed by many investment professionals and investment fiduciaries imposes a three-year track record for a retirement plan investment to be considered for inclusion, presumably we can agree that any minimum track record requirement would also be satisfied in that context. However, what if the track record of a particular retirement plan investment opportunity is shorter than three years? Shorter than one year? How short is too short? Unfortunately, the factual dependence of this type of fiduciary analysis fails to provide us with an explicit rule to follow. However, by considering some examples we can try to determine circumstances where offering a retirement plan investment with a track record of less than three years might still be a prudent fiduciary decision. Let s start with situations that more clearly indicate that a track record should have little influence on a fiduciary decision to include or exclude such investment. One example of a situation where track record might not be a significant consideration could be when an investment is comprised of other investments for which a track record does exist. For example, a newly issued mutual fund which only invests in other mutual funds, a fund of funds where each of the underlying investments have at least a three-year track record and the fund s manager or management team has a prior record of experience and stability. With respect to an investment fiduciary s consideration of a track record criteria, this would appear to be a clear example of a situation where the absence of a specific track record is irrelevant. This is because, despite the fact that the investment option is new and has yet to establish an independent track record of its own, track record data could be aggregated from the underlying investments in order to reasonably satisfy this consideration. As suggested above, it would appear that the experience of the fund manager should also be carefully considered in this context in order to allow one to reasonably conclude that the anticipated allocation efforts and approach of such fund manager is appropriate. The prior sentence is not intended to suggest that the investment manager s experience and stability should ever be ignored. However, it would likely take on a slightly greater importance in the situation considered here. To be clear, consideration of an underlying fund s track record and management team as a potential method of satisfying a newly issued fund s track record requirement is predicated upon a careful analysis of each of the underlying funds and such funds independent ability to qualify as a reasonable and prudent investment selection of an ERISA investment fiduciary. In this context, a normal review of the underlying investment would need to be performed to the satisfaction of the ERISA investment fiduciary and would presumably include consideration of many factors, such as investment strategy, performance, fees, etc. This is interesting and noteworthy here because it suggests that a newly issued fund with a satisfactory management team might reasonably satisfy the track record requirement by mirroring the investment strategy, fees, etc. of another single fund (as opposed to a fund of funds) that reasonably satisfies the track record requirement. Taking this idea a step further in the context of the growth in popularity of collective investment trusts (CITs), it is plausible that a newly issued CIT that mirrors the investment strategy of an existing mutual fund subject to the Investment Company Act of 1940 could leverage the available data associated with such mutual fund in order to build an argument that the CIT is a better investment than the mutual fund from which such analogous data emanates. Obviously, there are many factors to consider within this example, but if we were, for the sake of argument, to limit our consideration to only investment strategy and fees with respect to two investment options that each have the same investment strategy, fees become the controlling piece of the analysis as to which investment might be better suited for inclusion within a retirement plan fund lineup by an ERISA investment fiduciary. If we are to further assume that the CIT is less expensive than the analogous mutual fund as a result of the lower marketing, overhead and compliance costs generally associated with CITs, it is reasonable to envision a situation where the CIT is a better investment option than the analogous mutual fund which was selected for consideration in order to assuage concern about the CIT s lack of track record. Another example of when a track record for a particular investment might be both unavailable and irrelevant involves the initial launch of a new share class of target-date or lifestyle funds (hereafter collectively referred to as (TDFs) intended to benefit a new generation of individuals who are just entering the workplace. More specifically, upon the future release of a new TDF intended to benefit individuals with an anticipated retirement date of 2070, such fund will, at least initially, have no measurable track record. Despite the absence of a track record, an investment fiduciary s examination and satisfaction with the track record of the new TDF s underlying funds and fund manager s experience could reasonably warrant the offering of such fund. Although far from conclusive, 6

7 additional support for this fiduciary decision presumably could be derived from the investment fiduciary s selection and satisfaction with other TFDs from the same fund family. To take this example a step further, the acceptance and utilization of TDFs in conjunction with retirement plan investing has become widely accepted. Thus, it would not be difficult to envision a plaintiff s attorney alleging a fiduciary breach if an ERISA investment fiduciary failed to offer a newly released share class of an existing TDF intended to benefit the youngest generation of workers solely due to an inability to satisfy a minimum track record requirement. Consequently, it is possible to envision a circumstance where a failure to include a newly released TDF could result in a fiduciary breach claim despite the absence of any track record at all. With this consideration of TDFs and track record, it also is interesting to note the DOL s general approval of TDFs as demonstrated by the qualified default investment alternative (QDIA) regulations. 14 As we know, the DOL has established through the QDIA regulations that a TDF is an appropriate, permissible and responsible form of default investment election to be made by an ERISA investment fiduciary on behalf of nonelecting retirement plan participants. 15 As with the performance of any ERISA-imposed duty or obligation by an ERISA investment fiduciary, their decision making must result from a careful, responsible, investigative process. 16 However, within the QDIA regulations the DOL once again had the opportunity to directly impose or at least indirectly reference minimum track record in the context of an ERISA fiduciary satisfying his or her investment obligations. 17 Notwithstanding, the DOL imposed no such requirement in this context either. The examples above appear to readily demonstrate circumstances whereby an ERISA investment fiduciary could follow a careful, prudent fiduciary review process that reasonably concludes that the lack of a three-year track record, or any track record at all, for that matter, is irrelevant or outweighed by other factors. However, as we all know, the challenges presented to us in the real world often are not so clear. Thus, it is necessary to consider a situation where the conclusion is not as clear. What is the importance of track record in the context of the creation of an entirely new asset class? For example, how important is track record with regard to the emergence of crypto currencies such as Bitcoin? In the context of crypto currencies, the market has experienced a significant degree of speculative investment and, as a result, wild volatility. Thus, the wild swings associated with this asset class suggest that extreme care should be taken by an investment fiduciary considering it as a retirement plan investment. Consequently, in the context of the speculation and wild volatility generally associated with crypto currencies, it would appear much more difficult to discount the importance of track record. Again, in order to fulfill his or her ERISA obligations, an ERISA investment fiduciary must follow a careful, responsible, and professional investigative process when making any decision. In this regard, in addition to the general requirement that an ERISA fiduciary discharge his duties with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use, ERISA also requires that an investment fiduciary [diversify] the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. 18 When these ERISA fiduciary duties are taken together, track record may take on greater importance for an asset class that has shown such extreme volatility over the course of a short existence. This is because even though we all know that past performance is not indicative of future results, in the context of a new asset class, track record might still help to establish a reasonable expectation of future market trends when little else is available to consider. As a result, it is difficult to envision that an ERISA investment fiduciary could substantiate that investing in a brand-new, highly volatile investment opportunity without a significant track record is prudent and would minimize the risk of large losses. However, as we see here, the conclusion proposed in this context was not merely due to the absence of a significant track record. It also considered the relative volatility of such investment and that volatility s impact on the ability of a fiduciary to minimize the risk of large losses. Thus, again, we see that track record appears to be a relevant but not controlling data point that is only a part of the investigatory process that must be performed by ERISA investment fiduciaries. It bears repeating that the analysis of an ERISA fiduciary s satisfaction of his or her duties and obligations is extremely fact-dependent. Thus, if we were to assume that a new asset class was created that was more conservative in nature than crypto currencies, it could be that track record once again becomes less important due to the examination and consideration of other factors in the context of a thorough fiduciary examination process. 14 See ERISA 404(c)(5); Labor Reg c-5(e)(4)(1). 15 Id. 16 See White v. Chevron, Case No. 16-cv-0793-PJH (N.D. Cal. Aug. 29, 2016); quoting Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983); Tatum v. RJR Pension Inv. Comm. 761 F.3d 346 (4th Cir. 2014) quoting DiFelice v. U.S. Airways, Inc., 497 F.3d 410, 420 (4th Cir.2007); see also Pension Benefit Guar. Corp. ex rel. St. Vincent v. Morgan Stanley Inv. Mgmt., 712 F.3d 705, 716 (2nd Cir. 2013). 17 See ERISA 404(c)(5); Labor Reg c-5(e)(4)(1). 18 ERISA 404(a)(1)(B) & (C). 7

8 D. Oracle lawsuit At least one recent lawsuit has attempted to focus on the importance of track record in the context of retirement plan investment selection and ERISA fiduciary duties. 19 In this pending case, plaintiffs have alleged that the inclusion of two different funds were imprudent due at least in part to the absence of an adequate track record at the time of their inclusion. 20 The framing of these issues within the plaintiffs complaint is interesting in that, although reference is made to track record within the recitation of facts of such complaint, the actual allegations set forth therein refer instead to a more general failure of the fiduciaries to engage in a prudent process for the selection and retention of Plan investment options. 21 In addition, the real substance of the allegations appear to actually focus upon the fiduciaries failure to review and monitor the funds after they were initially offered. 22 This is demonstrated by the plaintiff s recitation of facts within the complaint. 23 Specifically, the complaint states that one fund underperformed its benchmark by anywhere from two to 10 percent for the entirety of the five consecutive year period that it was offered by the plan and the other fund underperformed compared to another plan offered fund in the same asset class by approximately seven to 30 percent over a three-consecutive-year period. 24 As a result of the considerations above, it appears that the Troudt complaint s specific mention of track record is only intended as a component of the broader allegation of fiduciary imprudence and not a separate allegation in and of itself. This broader allegation encompasses not only reference to track record but also allegations of excessive revenue sharing and management fees for the funds offered within the plan. Thus, it appears that both the plaintiffs claims and the judicial examination of any such allegations will review track record as no more than a single data point among many others which should be considered by an ERISA investment fiduciary during the fund selection and monitoring process. The aforementioned expectations of how plaintiff s claims will progress in the Troudt case support the general premise of this white paper, which is that track record is an important data point but no more than a single component of the broad spectrum of data that must be considered by an ERISA investment fiduciary. Regardless, it will be interesting to monitor the progress of this case in order to determine whether any additional guidance on the importance of track record can be obtained. 19 Troudt v Oracle Corp., No. 1:16-cv (D. Colo. Jan. 22, 2016) [hereafter Troudt]. 20 Id at Troudt at Troudt at Troudt at Troudt at 22, 24. 8

9 III. IPS As initially discussed within the Background section of this white paper, ERISA retirement plan IPSs often set forth plan minimum track record requirements for investments. In this regard, many, if not most, IPSs tend to indicate that any investment should or must have at least a three-year track record in order to be considered for inclusion in the plan s fund lineup. If for no other reason than the popularity of offering TDFs within retirement plans, it is fair to say that such a restriction is overly broad. As alluded to above, a new TDF share class generally is issued every five years, and if such share class were to immediately be offered under an IPS that required a minimum three-year track record, it would violate the terms of the IPS. This is important because the IPS is a written memorialization of the duties and obligations of the ERISA investment fiduciary. Thus, a failure to follow the terms of the IPS could be used to allege a fiduciary breach. Due to this concern, it is advisable for every ERISA retirement plan sponsor to, at a minimum, review the terms of its IPS in order to ensure that it tempers any track record restriction with the practical reality of the periodic release of new TDF funds. It is further proposed that, as a result of the other track record issues considered within this white paper, any IPS that includes an absolute minimum track record requirement within an IPS be revised. Such revision should emphasize a minimum track record as an important data point for consideration by every ERISA investment fiduciary. However, the IPS should also grant discretion to the ERISA investment fiduciary in order to allow him or her to look beyond this data point in any situation where it clearly remains prudent to do so. Regarding some of the specific items that an ERISA investment fiduciary should consider in reviewing an IPS with respect to the track record issues discussed within this white paper, the attached checklist at the end of this document sets forth multiple questions and concerns. An IPS should be a dynamic tool that is routinely reviewed and, when necessary, revised to ensure that it remains both current and relevant. Thus, with regard to either a new or an existing IPS, each of the issues on the checklist should be considered in order to ensure that the IPS clearly grants the maximum permissible flexibility and discretion to the ERISA investment fiduciary. If the IPS is too restrictive in this regard, it should be revised in a prudent and responsible manner so as avoid potential conflict and clearly authorize this exercise of discretion by the ERISA investment fiduciary. 9

10 IV. CONCLUSION In order to satisfy ERISA, fiduciary decision making must always be the result of a detailed, thorough and prudent process. However, the answer to what ultimately is appropriate is extremely fact-sensitive and, as a result, dynamic. As we know, the investment industry is particularly dynamic and constantly evolving. Therefore, in order to be prepared for future developments, it is important to attempt to anticipate changes and ensure that ERISA investment fiduciaries are granted the level of discretion necessary to accommodate and incorporate such changes into their actions while continuing to comply with their ERISA fiduciary obligations. When examining these principles in the context of an investment fiduciary s consideration of the need for a potential investment to satisfy a minimum track record requirement; the weight of ERISA, the Labor Regulations and current litigation strongly indicate that minimum track record is a relevant data point. However, those same resources also strongly indicate that track record is only one component of the overall fiduciary analysis and that minimum track record is not a controlling or decisive factor in that analysis. Notwithstanding the foregoing, many IPSs contain rigorously defined minimum track record requirements. As a result, many IPSs could force an investment fiduciary to ignore certain investments due exclusively to such investments failure to satisfy such criteria. However, such restrictions are too broad. Thus, retirement plan sponsors employing an IPS with such a restriction should consider revising it to emphasize minimum track record as an important data point for consideration but such IPS should also grant discretion to the ERISA investment fiduciary in order to allow him or her to look beyond this data point in any situation where it clearly remains prudent from an ERISA perspective to do so. Again, the checklist at the end of this white paper is intended to provide guidance on evaluating an IPS to ensure that it avoids potential conflicts and grants permissible discretion. 10

11 Investment policy statement review checklist The following is intended to provide an ERISA investment fiduciary with a convenient method of determining whether revisions may be necessary to an investment policy statement (IPS) as a result of the considerations raised within this white paper. Investment Manager hiring/monitoring checklist 1 Is there an IPS that memorializes the process by which retirement plan investments, investment professionals and other relevant parties are evaluated, selected, monitored and retained or replaced? 2 Are the terms of the IPS periodically reviewed in order to ensure that they are adequate with respect to the ERISA fiduciary processes set forth therein? 3 Are the terms of the IPS periodically reviewed in order to ensure that they are accurate with regard to the actions actually taken by the ERISA fiduciaries who are charged with enforcing the terms of the IPS? 4 Does the IPS include a direction to retirement plan fiduciaries to consider a minimum track record requirement for retirement plan investments? a. If the IPS imposes a minimum track record requirement for retirement plan investments, does the IPS avoid applying a specific, inflexible time frame that every investment selected under the terms of the IPS must invariably satisfy? b. If the IPS imposes a minimum track record requirement for retirement plan investments, does the IPS allow for deviation from this requirement in the context of newly released target date or lifestyle fund (TDF) share classes? c. If the IPS imposes a minimum track record requirement for retirement plan investments, does the IPS allow for deviation from this requirement in the context of the development of a new asset class in situations where it clearly remains prudent from an ERISA perspective to do so? d. If the IPS imposes a minimum track record requirement for retirement plan investments, does the IPS allow for deviation from this requirement at the discretion of the ERISA investment fiduciary in situations where it clearly is prudent from an ERISA perspective to do so? Yes No A review of a well-drafted IPS that grants the maximum permissible level of flexibility and discretion to an ERISA investment fiduciary should result in a confident yes in response to each of the questions above. To be clear, this includes answering yes to the question of whether the IPS includes track record as a consideration (as opposed to an inflexible obligation) when evaluating potential investments for inclusion in the fund lineup of an ERISA retirement plan. Again, the point here is not to ignore track record but, instead, to temper its usual consideration as an absolute requirement in favor of a broader overall ERISA investment fiduciary review process. If you answered no to any of the questions above, it is strongly recommended that you consult with qualified retirement plan professionals in order to review and, if necessary, revise your or your clients IPS. Such a review should ensure that your or your clients IPS permits ERISA investment fiduciaries to exercise their duties in a manner which satisfies their ERISA fiduciary duties without unnecessarily restricting their discretion. Any such review also should confirm that no conflicts exist between the terms of the IPS and the actual practices of the ERISA investment fiduciaries. The investment industry is dynamic and evolving and an IPS must be drafted correctly in order to allow ERISA investment fiduciaries to take advantage of appropriate opportunities as they arise. 11

12 Brandywine Global Clarion Partners Legg Mason is a leading global investment company committed to helping clients reach their financial goals through long-term, actively managed investment strategies. ClearBridge Investments EnTrustPermal Martin Currie QS Investors RARE Infrastructure Over $744 billion* in assets invested worldwide in a broad mix of equities, fixed income, alternatives and cash strategies A diverse family of specialized investment managers, each with its own independent approach to research and analysis Over a century of experience in identifying opportunities and delivering astute investment solutions to clients Royce & Associates Western Asset LeggMason.com About Geoffrey M. Strunk Geoffrey M. Strunk, Esquire, is the principal of the Law Offices of Geoffrey M. Strunk, LLC, a boutique ERISA law firm located in Glen Mills, Pennsylvania. Since 1998, Mr. Strunk has continuously maintained a private legal practice focused exclusively on the field of employee benefits. In that role, he routinely handles contested and procedural employee benefit matters, including the direct representation of plan administrators and fiduciaries before the IRS and the DOL. These responsibilities extend to the provision of compliance services involving government submissions and negotiations. In addition, he designs, drafts and consults on all forms of employee benefit pension plans, with specialties in tax-qualified defined contribution plans and all forms of non-qualified plans. Mr. Strunk also fulfills a compliance consulting role for certain recordkeepers and thirdparty retirement plan administration companies. In this context, he serves as a legal resource for marketing/sales staff and retirement plan administrators in order to help ensure the compliant design, maintenance and operation of their client s retirement plans. Mr. Strunk received his Juris Doctor from Villanova University School of Law and his undergraduate degree from the Pennsylvania State University. He is licensed to practice law in the states of New Jersey and Pennsylvania. Mr. Strunk was recognized in the legal community as a New Jersey Super Lawyer-Rising Star for five consecutive years. In addition, Mr. Strunk frequently writes and presents on numerous topical employee benefit matters. * As of June 30, Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, a forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. All investments involve risk, including loss of principal. Legg Mason, Inc., its affiliates, and its employees are not in the business of providing tax or legal advice to taxpayers. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties or complying with any applicable tax laws or regulations. Tax-related statements, if any, may have been written in connection with the promotion or marketing of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. Legg Mason, Inc. and the Law Offices of Geoffrey M. Strunk, LLC are not affiliated companies Legg Mason Investor Services, LLC. Member FINRA, SIPC. Legg Mason Investor Services, LLC is a subsidiary of Legg Mason, Inc RETX /18