The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

All Fiduciaries Are Not The Same-Part I

March 2010

First, let me say that I am not an attorney. So, as I wade into interpretation of ERISA, I gratefully acknowledge my reliance on the previous work and wise counsel of numerous ERISA attorneys who have been kind enough to share their opinions with me.

With that disclosure, I will attempt to shed light in a two-part series on an issue that is receiving an increasing amount of attention in the 401(k) marketplace: The roles of ERISA section 3(21) fiduciary investment advisors and section 3(38) fiduciary investment managers.

The growing awareness of these roles seems to be driven by two key factors:

  1. Numerous 401(k) lawsuits over the past few years have made plan sponsors increasingly aware of their fiduciary responsibility and liability, which they are now keenly interested in limiting.
  2. The investment industry is aware of this growing concern and is seeking to capitalize on the “fiduciary” business opportunity.

While ERISA has always defined the various roles of fiduciaries to retirement plans, most industry practitioners have simply not been aware of the finer points and how those can benefit plan sponsors and participants. Now, however, as more plan sponsors seek out the services of fiduciaries, Wall Street is increasingly marketing itself as such, especially under the “co-fiduciary” label. So it is imperative that plan sponsors, and those that advise plan sponsors, understand the key differences between the various fiduciary roles.

There are a variety of functional fiduciaries in the operation of a qualified retirement plan, including the plan administrator, trustee(s) and members of the investment/benefits committee. Our focus here, however, will be on clarifying the roles of “Investment Advisor” and “Investment Manager.”

In a white paper commissioned by SageView Advisory Group, attorneys Fred Reish and Joe Faucher of the Reish & Reicher law firm explained the 3(21) Investment Advisor and 3(38) Investment Manager roles this way:

Where committee members lack the needed technical knowledge to properly select the investments, they are required to hire knowledgeable advisers. In ERISA, those investment advisers are sometimes referred to as section 3(21) fiduciary investment advisers. However, while the use of knowledgeable advisers is evidence of a prudent process (particularly if the adviser is independent), the committee continues to be the primary investment fiduciary. As a result, it remains the primary “target” for plaintiffs’ attorneys and the U.S. Department of Labor (DOL).

Where committee members desire additional protection, they should consider appointing a discretionary investment manager to select and monitor the investments. In ERISA, those discretionary managers are referred to as 3(38) fiduciaries. Appointing an investment manager insulates the fiduciaries against losses (or inadequate gains) arising out of claims that the investments were not appropriate or prudent. Fiduciaries who appoint an investment manager to control the selection and monitoring of the plan’s investments are responsible only for the prudent selection and monitoring of the investment manager which, for attentive fiduciaries, is a manageable task.

The essence of the difference between these two designations is that a 3(21) advisor makes recommendations and a 3(38) manager makes decisions.

So, if a plan sponsor wants to retain the responsibility for investment selection and monitoring, hiring a 3(21) investment advisor can be part of a prudent fiduciary process. But if a plan sponsor wants to be insulated from the responsibility and liability for investment selection and monitoring, then a 3(38) investment manager should be engaged.

Most groups holding themselves out as “investment advisors” in the 401(k) industry are operating as 3(21) advisors (if, indeed, they are acting as fiduciaries at all.) The 3(38) manager designation requires a greater level of fiduciary responsibility, and only a minority of firms are willing to accept the increased liability that comes with the 3(38) designation.

In Part II, I will provide guidance on how to identify what type of fiduciary you may be working with now.

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