FINANCIAL MANAGEMENT/Selecting a pension plan custodian

Choosing a custodian for an employee pension plan is a key task for local governments. City and county pension plan administrators should understand the criteria on which to base that choice and evaluate candidates critically.

For pension plan management, the custodian is one leg of a three-legged stool. The other two are the investment manager, who purchases and sells assets based on guidance from the pension plan’s board of trustees, and the investment consultant, who advises the board on the investment manager’s performance. All three are accountable to the trustees and the plan administrator.

The custodian holds title to a plan’s assets in the government’s name. It makes benefit payments, processes purchases and sales of securities, collects income and securities, provides tax services, and issues reports and statements.

When selecting a pension plan custodian, local governments want to be sure the custodian can perform those functions adequately. Additionally, they should evaluate potential custodians based on the following criteria:

• Financial wherewithal. Custodians should be financially strong and adequately insured. Those qualities can be checked by obtaining a bank rating and by asking for financial statements. Plan administrators can ask an independent expert, such as a rating service, for an assessment of the company’s ability to deliver on its commitments — both during good and bad times.

• Commitment to the custodial line of business, including ongoing investment in superior accounting and trust systems. By now, plan administrators have a right to expect 24-hour access to their accounts over the Internet. They also should expect their custodians’ systems to integrate with those of the investment managers.

• Availability of flexible reporting, including “cost-to-market” and “market-to-market” accounting. The custodian should be able to report both so that local governments can evaluate the performance of the security or account using different methods.

• Commitment to tracking performance measures based on the size of the account/pension fund. Plan administrators can determine whether a custodian has the resources to oversee large accounts by asking direct questions. What specific resources will the custodian use to serve the local government’s needs?

• Effective coordination with investment managers. In most cases the investment manager is hired before the custodian. The investment manager and the custodian will interact regularly and depend on one another; plan administrators should be sure the investment manager is comfortable with the custodian.

• Competitive rate of return on sweep funds. Often, five percent or more of a pension plan is left liquid for payment of distributions, fees and taxes. The custodian should offer a choice of sweep investment vehicles to ensure that money is invested wisely.

• Competitive fee structure. Custodians typically charge an annual fee based on the plan’s average assets, plus transaction fees. Plan administrators should develop a matrix and compare the fee structures of several proposed custodians.

• Knowledge, depth, accessibility and dependability. Plan administrators should expect top-quality service and expertise from their custodian’s contacts, such as upper-level management and the administrative staff. To ensure those requirements are met, plan administrators can make specifications in the request for proposals.

• By establishing criteria to evaluate a potential custodian, administrators can ensure that the custodian is well equipped to manage plan assets. To make the most informed decision, local governments should consider the custodian’s financial strength, its reputation, and its trading and reporting services.

  The author is president for Deerfield Beach, Fla.-based Salem Trust.