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Considerations for Engaging a 3(21) or 3(38) Fiduciary

Service Providers

Thinking about engaging a 3(21) or a 3(38) fiduciary? A new podcast by CAPTRUST discusses some of the key distinctions in terms of the risks and responsibilities. 

In the latest episode of “Revamping Retirement,” Jennifer Doss, Senior Director and Defined Contribution Practice Leader, along with Scott Matheson, Managing Director of the firm’s Institutional Group, speak with Jenny Eller, Principal and Chair of Groom Law Group’s Retirement Services Practice Group and Fiduciary Practice, about her perspective on plan sponsor considerations for selecting a nondiscretionary or discretionary advisor. 

Eller also shares her perspective on the reasons behind the trend toward 3(38) investment manager discretionary services and how outsourcing investment responsibilities can impact—or even mitigate—risk in the current litigious environment.

Key Differences

When asked by Matheson to describe the key differences between a non-discretionary and discretionary advisor, Eller notes that it’s important to dispel a myth that exists that a 3(21) fiduciary is some sort of a “fiduciary lite” or not a real fiduciary. “The truth is there is absolutely no difference between the legal standards that apply—the care and loyalty standards that applies to a 3(38) fiduciary apply exactly the same to a 3(21) fiduciary or an advice fiduciary.” 

The difference, Eller explains, is in the responsibilities that the different types of fiduciaries are supposed to carry out, and the obligations and expectations that the law imposes on planning committees working with those different types of fiduciaries. The Groom practice leader noted that it comes down to more of a practical difference rather than legal, and a simple explanation is that you either have a “do it with me fiduciary” under 3(21) or a “do it for me” 3(38) fiduciary who exercises discretion.

When clients are weighing the decision on which way to engage a plan advisor, Eller notes that she tries to steer people away from a “theoretical debate” and, instead, have them focus on their current process, where they want to go and what’s best for their organization. “I think it’s important to ask them questions: Is it important to free up time? Is your committee spending too much time evaluating what you think are the wrong things or is your committee super interested in having a hands-on approach or is your committee ready to sort of step back?

“There is no playbook for how to do this, and so, within the bounds of the law, there are a million different variations about how you can run your plan,” Eller emphasizes.  

3(38) Engagement

For plan sponsors that have decided on a 3(38) engagement, Eller stresses that it’s important to recognize that the law provides a special benefit for fiduciaries who hire a 3(38) investment manager. The Groom attorney explains that, as long as the appointing fiduciary has a solid process for selecting and monitoring the 3(38) manager, that appointment fiduciary will not be liable for losses that the 3(38) fiduciary causes the plan, even if the 3(38) fiduciary is imprudent. 

“That is not a common benefit that the law provides, but it’s important that plan committees who are selecting a 3(38) fiduciary do the right thing to maximize that benefit,” Eller explains. She further notes, however, that if you hire a 3(38) fiduciary and then make the decisions anyway, you have lost all the benefits of appointing someone. “I’d say the really important thing is to know what you’re getting into and then to document really well, your process for selecting the 3(38) fiduciary.” Eller also stressed the importance for clients to document their ongoing monitoring, noting that it’s not a “set it and forget it” situation.  

“You have to continue to monitor, but the thing you monitor is not second guessing their decisions, you monitor their process,” and whether they continue to have qualified people involved and the resources they need to engage in their own kind of proven process, she explains. 

One key thing to remember, according to Eller, is that for a 3(38) fiduciary to qualify as an investment manager, they have to actually exercise discretion over the plan’s assets. “So, when you’re thinking about whether to appoint a 3(38), one of the things you have to be okay with is not having that final say, because if you appoint a 3(38), it’s really important for the full benefit to be realized, that they have the actual ability to make final discretionary decisions.”

Discretionary Trends

When asked by Matheson what’s driving an apparent trend that many plan sponsors, even among those in the middle-market, are moving to appoint 3(38) fiduciaries, Eller believes there are a couple of things at work. 

The Groom attorney notes, for instance, that the courts have taken plan fiduciaries and the respective committee members to task for “blindly following” the advice of a 3(21) fiduciary and not considering investment decisions on their own. And so, she notes, plans that have worked with an advisor for a long time come to recognize their experience and the value in getting that advice, and conclude that the advisor may be the best equipped to make these decisions. 

A second trend is the movement toward default funds and the use of target date funds, which, Eller notes, are the fastest growing type of investment funds, and that there are lot of them and they’re difficult to monitor. “I think it really makes committees think that, when they are spending time having a 30-minute discussion about a small cap fund that might capture 6% of the assets in the plan, is that really the best use of their time,” Eller observed.  

And finally, there’s the litigation risk. The Groom attorney noted that the volume of ERISA fiduciary cases continues to grow and they are moving down market. “You still see the litigation being brought against the largest plans, but you also see under a billion or a $500 million plan being sued. And what they are being sued about essentially is their process. And that is something that is really expensive to defend.” 

Eller notes that, on the one hand, clients believe in their process and that they did the right thing, but because it is such a pain to defend, they look to an alternative to insulate them better from the threat of litigation.  

“What we’ve seen is that it’s been much less likely for companies to get sued over company stock when they have an independent fiduciary in place. And then if there is a lawsuit, the independent fiduciary has fared very well because they have standardized their process and they document it really well,” Eller observed.