Business owners, if you offer a company 401(k), you should know the difference between 3(21) and 3(38) fiduciary services.

Marcos A. Segrera, CFP®
Financial Advisor

In today’s evolving legal, regulatory, and litigation environments, it is vital for qualified retirement plan fiduciaries to understand their roles and responsibilities. The additional time and money needed to cover fiduciary duty may be hard to come by for business owners, who likely prefer to spend those resources growing their businesses rather than learning and worrying about the nuances of a corporate retirement plan. As lawsuits targeting 401(k) plan sponsors proliferate, the need and demand for investment fiduciary services has grown.

The services fall into two distinct levels: 3(21) and 3(38). These numbers refer to specific sections of the Employment Retirement Income Security Act (ERISA) of 1974. The goal of this post is to address the differences and benefits of 3(21) and 3(38) fiduciary services and highlight some of the common areas in which 401(k) lawsuits fall.

To begin, you should be familiar with two fiduciary terms: plan sponsor and plan fiduciary.

The plan sponsor is the company that provides the plan, including 401(k), profit sharing, cash balance, etc., for the benefit of the owners and employees. By default, the company is also a plan fiduciary.

The plan fiduciary is any individual with discretionary authority or responsibility for the administration of the plan, anyone who provides investment advice to the plan for compensation, or anyone who has any authority or responsibility to do so. These individuals are therefore subject to fiduciary responsibilities. Plan fiduciaries include plan trustees, plan administrators, and members of a plan’s investment committee. Business owners are often listed as a trustee, administrator, etc.; therefore, they are plan fiduciaries.

We find three main areas of concern where plan participants and the Department of Labor (DOL), which regulates ERISA plans, brings forth a lawsuit:

  1. Inappropriate investment choices
  2. Excessive fees
  3. Self-dealing

Both 3(21) and 3(38) fiduciary services can help mitigate these issues.

With regard to investment choices, ERISA does not specify which investments are appropriate or inappropriate. Often, the finding for or against a plan’s fiduciaries does not hinge as much on results—i.e., whether investment returns were too low or fees were too high—but whether a prudent process was followed and documented as well as whether the decisions made were in the participants’ best interests. The plan fiduciaries need to demonstrate that the final menu of investment options was determined using prudent decision-making that has been consistent over time. Issues can also arise when plan fiduciaries include the employer’s own stock within the plan investments.

Outside the obvious, ERISA does not specify much when it comes to fees, but it has been the major source of lawsuits during the recent surge in litigation. Again, the emphasis is on showing that a prudent process was used to select investment options and ensuring that the plan pays no more than reasonable fees for needed services. For example, ensuring that your plan offers institutional share classes of mutual funds versus the more expensive retail share class is a simple way to improve investment costs. However, many plan fiduciaries find themselves with retail share classes in their menu of options when an equivalent institutional share class is available. It is important to consistently review your current menu against what is available for your plan. In addition, the costs of plan operation, including third-party administrators, record-keepers, etc., fall under the duty to control plan costs to those reasonable and necessary.

Self-dealing refers to an instance in which the plan fiduciary acts in their own best interests rather than serving the plan and its participants. Self-dealing only accounts for a small share of total lawsuits. Most violations arise from actions taken by very large companies that include proprietary investment products in their plans. Companies are not prohibited from having proprietary products included in their 401(k)s, but issues arise when a plan fiduciary encourages participants to invest in those products. Self-dealing also plays a role in determining which expenses can be paid by the plan, i.e., essentially by the employees, versus being paid directly by the employer. The DOL divides fees into two categories: administrative expenses that are payable from plan assets and settlor expenses that cannot be paid by plan assets.

For more information regarding the causes and consequences of 401(k) lawsuits, you can refer to this study by the Center for Retirement Research.

How can 3(21) and 3(38) fiduciary services support plan fiduciaries? They help by allowing the plan fiduciaries to share in the investment liability—3(21)—or delegate the liability—3(38).

A 3(21) advisor-fiduciary is a co-fiduciary role that provides counsel and guidance. An advisor provides investment advice to the plan sponsor with respect to the investment options available on the 401(k) menu. The advisor only makes recommendations for which it has no legal responsibility because a 3(21) fiduciary has no ERISA-defined “discretion.” The plan fiduciaries retain the discretion to accept or reject the advice. Since the plan fiduciaries are co-decision makers they hold co-responsibility, and generally “the buck stops” with the plan fiduciaries. The investment advisor shares in the liability but does not assume the full liability pertaining to investment decisions. The 3(21) services add a level of investment expertise for an employer and may cost less – than a 3(38) fiduciary, but it does not remove ultimate liability from the plan fiduciaries, including the business owner.

A 3(38) advisor-fiduciary manages the investments on a discretionary basis and holds responsibility for selecting, monitoring, and replacing investments. The plan sponsor enjoys less liability in this relationship because the fiduciary risk is delegated to the advisor. The plan fiduciaries retain the responsibility of selecting and monitoring the advisor. Under ERISA, as long as the plan fiduciaries prudently monitor the investment manager, the plan sponsor will not be liable for the acts and omissions of the investment manager. These services may cost more than the 3(21) services, but they obviously provide greater protection for plan fiduciaries.

Do you know if your company-sponsored retirement plan has 3(21) or 3(38) fiduciary services in place? Unfortunately, many business owners and plan fiduciaries do not know the answer to this question, and they may assume they have a 3(38) relationship by hiring a firm to run the plan; however, simply hiring an advisor does not mean they provide 3(38) services. If you don’t know, now is the time to have a conversation with your plan provider or plan investment advisor. For most employers, the additional plan cost is well worth the protections they provide.

Feel free to contact Marcos A. Segrera with any questions by phone 305.448.8882 ext. 212 or email: MSegrera@Evensky.com 

REFERENCES

https://www.marketwatch.com/story/401k-lawsuits-are-surging-heres-what-it-means-for-you-2018-05-09

https://www.employeefiduciary.com/blog/dol-guidance-for-paying-401k-fees-from-plan-assets

https://www.plansponsor.com/invesco-accused-self-dealing-401k/

https://www.planadvisor.com/general-electric-401k-fiduciaries-accused-of-self-dealing/

http://crr.bc.edu/briefs/401k-lawsuits-what-are-the-causes-and-consequences/

https://fa.morganstanley.com/todd.barden/mediahandler/media/142120/Understanding%20Your%20Fiduciary%20Liability.pdf

For more information on financial planning visit our website at www.Evensky.com

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