3 (38) Fiduciary Status - Risk & Confusion

 

To differentiate their practice, select advisors are starting to promote themselves as ERISA 3(38) investment managers. Unlike the traditional 3(21) advice provider role, a 3(38) assumes discretionary control for some or all of a plan's assets.

While the appointment of a 3(38) does not transfer policy discretion or monitoring responsibilities, the investment decisions under this structure are made without the approval of the plan sponsor and/or their internal fiduciaries. Similar to the selection of any service provider, the plan sponsor must employ and document a prudent process for the selection of the 3(38) investment manager. If the 3(38) lacks experience and corresponding performance as a discretionary investment manager, the decision to retain their services could be deemed imprudent.

While new trends always present opportunities and challenges, advisors willing to assume a 3(38) role could be blindsided by an aggressive plaintiff's bar for failure to conduct themselves in a prudent manner during a challenging investment market. This liability could also apply to advisors who manage QDIAs and/or customized Target Funds.

There are at least three different types of 3(38) managers serving 401(k) plans. The skill sets applicable to advisor provided investment counsel and investment management are very different. To avoid liability, advisors who move into the manager space must understand the difference. Advisors are far less skilled than investment management companies in this space and those who become managers without a corresponding change in their support services are increasing their litigation risk.

Additionally, many in the network do not believe 3(38) was intended to apply to investment advisors. Regardless of the business model, advisors who lack the necessary experience should be wary of assuming an expanded fiduciary role. If convicted of a fiduciary breach, ERISA 411 could preclude them from serving retirement plans in any capacity.

To find out if you are better suited for fiduciary appointments as a full scope 3(21) or a named fiduciary under ERISA 402(a), attend the CFDD's Advisor Conference session on What Type Of ERISA Fiduciary Are You & Why It Matters. Armed with experience, David Witz (FRA/PlanTools), Jeff Gratton (SageView Advisory Group), Al Otto (OneFiduciary Group) and Jason Roberts (Reish & Reicher) will take off the gloves while sharing their different views on fiduciary appointments.

In addition, advisors who assume a 3 (38) role should be aware of potential coverage issues within their errors & omissions insurance (E&O). Although an E&O policy can appear to provide affirmative fiduciary coverage, some policies may provide so only in a limited capacity. Some E&O policies provide fiduciary coverage, but contain a specific exclusion for 3 (38) capacity. In addition, contractual exclusions may eliminate coverage for a 3 (38) role. A standard contractual exclusion excludes coverage for liability assumed by contract unless such liability would exist in absence of the contract. The 3 (38) advisor may be contractually accepting liability that would not exist in absence of the contract. Advisors who are considering 3 (38) status should review their E&O coverage with an expert to confirm coverage.