In today’s world of retirement plan fee transparency and litigation over a multitude of plan expense-related issues, business owners and executives (plan sponsors) are becoming increasingly aware of the fiduciary liability they possess – liability that results from the investment decisions they make regarding their company’s retirement plans. We’re observing that many plan sponsors are eagerly seeking ways to mitigate if not eliminate this liability.
As a business owner or executive with responsibility for your company’s retirement plan, it is important for you to understand the different levels of fiduciary liability your retirement plan’s investment advisor can assume. Most plan sponsors we work with want to insulate themselves as much as possible from fiduciary liability associated with their actions and decisions regarding the investment options in their retirement plan.
Properly appointing the right type of investment advisor can help reduce liability with respect to these investment decisions. The two most commonly discussed investment advisor fiduciary terms are 3(21) Investment Fiduciary and 3(38) Investment Manager. The differences are critically important regarding the fiduciary responsibility associated with the investment decisions inside your plan.
The table below outlines the major differences:
A 3(21) investment fiduciary is a paid service provider that makes investment recommendations, but DOES NOT have discretionary authority to make the actual investment decisions. A 3(21) investment fiduciary typically provides suggestions to the plan sponsor. The plan sponsor is then free to accept or reject those suggestions. If your plan’s investment advisor is a 3(21) investment fiduciary, you ultimately share fiduciary responsibility and the accompanying liability with your investment advisor.
There are also some investment advisors who are not allowed to serve in a fiduciary capacity. Many financial services firms will not allow their advisors to assume ANY type of fiduciary role – so it’s best to ask an advisor to provide a written explanation as to their role as a fiduciary or non-fiduciary. You can also find this information in your financial advisory service agreement. A vast majority of retirement plan investment advisors do not assume any type of fiduciary role OR they assume the role of a 3(21) fiduciary.
Additionally, there are mutual fund and insurance companies who offer a “fiduciary warranty” with their products. Typically, when one reads the fine print, these warranties offer very little fiduciary protection and require the plan sponsor select investments from a short list of proprietary or “house” funds. Making this offering even worse, is the fact that many of the proprietary lifestyle (risk-based) or lifecycle (target date) investment offerings are what are known as “funds of funds” that often include expense laden poor performing funds. Bottom line on selecting any company using a fiduciary warranty as a marketing ploy: read the fine print very carefully.
The highest degree of investment-related fiduciary protection is offered by advisory firms operating as a 3(38) investment manager. A 3(38) investment manager is a fiduciary who has been specifically appointed to have full discretionary authority and control to make the actual investment decisions. The 3(38) investment manager selects, monitors and makes proactive changes to the investment options in your plan. Only specific types of financial institutions may be appointed as a 3(38) investment manager: a registered investment adviser, bank or insurance company. These entities are required to acknowledge their fiduciary status in writing.
Once a plan sponsor has appointed a 3(38) investment manager, the plan fiduciaries are relieved of much of the fiduciary responsibility associated with investment decisions. Keep in mind, however, that the plan sponsor is not completely removed from fiduciary liability with respect to performing due diligence on all of the plan’s providers, including the investment manager, record keeper and third party administration company. The Department of Labor has held that plan sponsors have a continuing responsibility to “establish and follow a formal review process at reasonable intervals” in order to monitor the plan’s providers and ensure that they are handling their respective duties prudently and in accordance with the investment policy statement and service agreement. 1
The ability to transfer the majority of fiduciary responsibility is a key advantage to using a 3(38) investment manager. Many plan sponsors want this extra layer of protection and are moving to 3(38) investment management relationships due to ever-increasing litigation and heightened regulatory scrutiny.
Plan sponsors we have discussed this option with often have two questions. 1) How much will this cost? and 2) Do I have any say in the investment decision-making process? First, if you are considering this move, there may likely be an additional expense for the service of a 3(38) manager. Second, we would recommend you consider a relationship with only those advisory firms who are willing to accommodate reasonable investment-related requests from you that are outside the scope of what they are recommending, and are still willing to maintain their status as 3(38) investment managers.
If you’re a business owner, we encourage you to contact us to better understand how working with a 3(38) investment manager may benefit you. Contact Bryan Webster, CCM Director of Institutional Client Services.
1. Employee Benefits Security Administration – Frequently Asked Questions