Understanding the 3(38) Investment Manager

The Employee Retirement Income Security Act of 1974 (ERISA) sets forth the requirements under which defined contribution plans, such as 401(k)s and 403(b)s, must be managed for the benefit of the plan participants. The catch-word that has been the subject of various lawsuits is fiduciary responsibility. Employers and plan sponsors who have not taken the proper steps to mitigate their liability with respect to the provisions of Section 404(a) of ERISA run the potential for drawn out litigation and the financial risk associated with failing to adhere to the “Prudent Person Rule.” This requirement may cause you to consider whether you wish to continue to assume the role of a Section 3(21) plan fiduciary or outsource investment oversight to a Section 3(38) investment manager.

3(21) vs 3(38) Fiduciary

A “named fiduciary,” under ERISA, is usually the employer or an officer of the employer (such as the CEO, COO, CFO, etc.). The fiduciary is named in the plan documents submitted to the DOL and is held liable for any breach of their fiduciary responsibility. The law does describe two additional types of fiduciaries: an unnamed Section 3(21) plan fiduciary and a Section 3(38) investment manager.

A 3(21) plan fiduciary, who is not named in the plan document, may be deemed a fiduciary if they engage in any or all of the following activities:

• Provide, for a fee, investment advice (e.g. your investment consultant);
• Express discretionary authority over the management of the plan and/or the disposition of assets;
• Express discretionary authority over the administration of the plan.

By default, the plan’s sponsor, trustee, administrator, or an investment fiduciary who engages in any of the activities described above assume the role of a 3(21) fiduciary and accept the associated liability.

Investment managers under Section 3(38) differ from 3(21) fiduciaries in that they have been granted authorization to act as a fiduciary on behalf of the plan. As authorized, the investment manager acts with discretion to direct, choose, dispose of, and make investment decisions on behalf of the plan and its participants. A 3(38) investment manager assumes fiduciary responsibility from the named fiduciary (subject to any limitation set forth in the plan document) and is typically a bank, investment advisor (registered under the Investment Advisers Act of 1940), or insurance company.

Benefits of the 3(38) Investment Manager

Under ERISA §404(a) (“Prudent person standard of care,” as paraphrased), “a fiduciary shall discharge their duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries; and defraying reasonable expenses of administering the plan:

• with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;
• by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and
• in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of the law (ERISA).

In the case of an eligible individual account plan, the diversification requirement and the prudence requirement (only to the extent that it requires diversification) is not violated by acquisition or holding of qualifying employer real property or qualifying employer securities.”

It is from this basis that you may wish to consider sharing if not shielding yourself from the burdens of complete fiduciary responsibility. This may be done through a risk sharing method involving the hiring of a Section 3(38) investment manager.

Why Sponsors Should Choose a 3(38) Investment Manager

There is a lot of responsibility that comes with providing a retirement plan for your employees. It is an important employee benefit, necessary for the recruitment, retention, and continued productivity of your workforce. Managing the complexities of a plan, including the disposition of plan assets on the behalf of your employees including investment decisions and those duties that are a part of managing and administering those investments may be something best left to a professional investment manager. Hiring a 3(38) investment manager provides an additional layer of protection that, versus the cost of a lawsuit or regulatory inquiry, may make the most sense.

Let PlanPILOT Help

If you are considering outsourcing your investment fiduciary or learning more about your fiduciary responsibilities, PlanPILOT can help. As an independent Registered Investment Advisor, PlanPILOT is not tied to any investment fund or record-keeper. We offer clients unbiased advice and assistance to control their retirement plan risks and deliver benefits effectively. We encourage you to contact us at (312) 973-4911 or info@planpilot.com.

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