3(21) vs. 3(38) and are you holding yourself to the fiduciary standard?


This week we have a guest post from Mike DiCenso, who is president of GBS Investment Consulting, which provides integrity driven, comprehensive investment consulting services for institutions of higher learning, endowments/foundations, healthcare institutions, insurance companies, corporations, non-profit organizations, family trusts, and retirement plans. He is an AIF Designee and a former speaker at the fi360 Conference.

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We are all aware that many brokers, consultants and advisors are creating confusion in the market by positioning themselves as fiduciaries to a plan when they are not actually alleviating any fiduciary liability for plan sponsors. Making matters worse,  when the plan sponsor believes that an advisor is relieving them of its liability, the plan sponsor may be taking their eye off the ball because they think someone else is handling this for them, putting them at greater risk. This is exactly why the DOL is looking to enhance and evolve the 1974 version of the “Definition of Fiduciary.” The DOL is looking to make it more difficult to avoid fiduciary responsibility and make anyone who states they are a fiduciary to actually take on the corporate and personal liability of a fiduciary. To help alleviate this confusion in the market, we have assembled this piece to help clarify the differences between 3(21) Investment Advisors and 3(38) Investment Managers under ERISA. Let’s take a look:

ERISA Section 3(38) Fiduciary

This is pretty straightforward. Section 3(38) is an “investment manager” and by definition is a fiduciary because they take discretion, authority and control of the plan’s assets. ERISA provides that a plan sponsor can delegate the significant responsibility (and significant liability) of selecting, monitoring and replacing of investments to the 3(38) investment manager fiduciary.

A 3(38) fiduciary can only be (a) a bank, (b) an insurance company, or (c) a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940 (such as GBS Investment Consulting, LLC).

Once a 3(38) is properly named, the plan sponsor effectively hands over authority to the 3(38) fiduciary to make investment decisions. The 3(38) fiduciary therefore assumes legal responsibility and liability for the decisions it makes, which enables the plan sponsor to better manage and mitigate their fiduciary risk.

However, a point that is often overlooked is that the plan sponsor cannot completely eliminate its fiduciary liability. The plan sponsor is still responsible for the prudent selection of the 3(38) investment manager and must monitor and benchmark that 3(38) investment manager. Also, if the plan sponsor overrides the decisions of the 3(38) advisor, the plan sponsor assumes the responsibility and liability.

ERISA Section 3(21) Fiduciary

ERISA section 3(21) provides the standards by which any individual performing services for the plan might become a fiduciary due to the functions they actually (or have ability to) perform.  Any individual can be a fiduciary under section 3(21) if he or she exercises any authority or control over the management of the plan or the management or disposition of its assets; if he or she renders investment advice for a fee (or has any authority or responsibility to do so); if he or she has any discretionary responsibility in the administration of the plan, or is named in the plan documents.

Let’s apply that definition to advisors.  An individual who simply makes recommendations under suitability requirements to and for the plan for which it has no discretionary authority or responsibility is not a “fiduciary” and therefore has no legal liability under ERISA as a fiduciary.

In that case, even when the plan sponsor adopts the advisor’s recommendations, the plan sponsor retains all of the fiduciary responsibility and liability of the decisions. However, let’s suppose the advisor does perform some function that would cause the advisor to be a 3(21) fiduciary.  In that case, they still don’t completely protect the plan sponsor from fiduciary liability to the degree a 3(38) would – instead, they may share some of the liability related to investment decision making with the plan sponsor.

So, when is an advisor actually a fiduciary? It depends. To make that determination just look at how ERISA defines a fiduciary today.

If the advisor is named in the plan document and/or actually handles some portion of the plan’s administration by making decisions that affect the plan, then yes, he or she is a fiduciary under 3(21).

Similarly, if the advisor has discretionary control over the plans assets (actually makes decisions and has authority or control of the assets), then yes, he or she is a fiduciary under section 3(21). However, if the advisor is only giving recommendations and the plan sponsor has the discretion to take or disregard the advice, then the advisor is probably not acting as a fiduciary and offers no practical protection from liability for the plan sponsor. That is significantly different than a 3(38) investment manager who is presumed by definition to have actual discretion and control over the plan’s assets and management.

One more point to be made regarding advisors. In today’s world many so-called advisors are not acting per the fiduciary standard, which would require that the advisor:

  1. Act solely in the best interest of the plan sponsor, participants and beneficiaries of the plan
  2. Avoid conflicts of interest or fairly manage them in the client’s favor
  3. Disclose all forms of compensation both direct and indirect

Many of those advisors purporting to be 3(21) fiduciaries are registered reps who are investment advisory representatives (IARs, not RIAs) through a broker dealer RIA and take soft dollars, commissions, trips, meals, training and other non-disclosed compensation from providers, mutual fund and investment management companies.  This is a clear conflict of interest and most probably not in the best interest of the client. These registered reps are probably accepting commissions rather than fees. So is there an issue with claiming to be a 3(21) fiduciary while being held to a suitability standard rather than a fiduciary standard?  Absolutely.

Whether you are acting in a consulting or a fiduciary capacity, always adhere to the fiduciary standard.  It is the best and most ethical way to become the trusted advisor advocate for your clients.  This philosophy is what is fueling the growth of retirement services and enabling us to win more business and new clients in the market place every day.

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