Fiduciary Sudoku Part 3 – Comprehending ERISA 3(21), Explaining the 3(21) Fiduciary
June 19, 2017—Welcome to our third article in our fiduciary blog series, designed to clear up confusion and offer clarification regarding the nature and scope of fiduciary roles as they relate to corporate retirement plan management. In our most recent blog post we provided an overview of an ERISA 3(16) fiduciary. Today we’ll discuss the 3(21) fiduciary.
Keep in mind that the term “3(21)” in the retirement plan space has become associated with a financial advisor who helps the plan sponsor select and monitor its plan fund line up. But technically ERISA Section 3(21) defines ALL plan fiduciaries, not just those who provide outside investment advice.
You see, ERISA Section 3(21)(A) has 3 parts identified as (i),( ii), & (iii). In summary:
- Defines a party who has the ultimate decision-making role regarding plan investment options. This is a plan sponsor employee, a committee of employees, and/or an outside financial advisor who signs on for all or part of this role. The retirement plan industry refers to this type of advisor as a “3(38) fiduciary.” We will discuss ERISA Section 3(38) next month.
- Defines a fiduciary financial advisor who helps the part (i) fiduciary select and monitor their investments, and who is paid a fee by the plan for this service.
- Defines a party, usually an employee of the plan sponsor, who has the ultimate decision-making role regarding plan administrative issues. If an outside vendor signs on to perform some or all of this role they are referred to as a 3(16) fiduciary, as we addressed last month.
So, you see that using the term “3(21)” to describe the role of a financial advisor who helps the plan choose its investments is a tad misleading. In fact, anyone who has any discretion or authority to make any investment or administrative decision regarding a plan is a 3(21). The only difference is whether they are a part (i), (ii) or (iii).
Regardless, over time, in the retirement plan world, the term “3(21)” came to mean a 3(21)(A)(ii) fiduciary.
What can you expect from your 3(21) Advisor?
Your 3(21) helps your team by performing the following roles:
- Recommending investments for the plan
- Monitoring the investments you selected including suggesting replacements
- Helping you meet your fiduciary obligation by crafting an Investment Policy Statement for your adoption
The idea is that you will make better investment decisions with the help of the 3(21). As a result, your participants will be better served and your potential liability for breaching your fiduciary duty to make investment decisions prudently and expertly will be significantly reduced.
The Plan Sponsor’s Role
ERISA is clear that any plan sponsor who lacks the technical knowledge and experience to properly manage investments is required to hire a knowledgeable advisor.
Unless delegated away under 405(c)(1) as discuss in our last post to a Fiduciary Investment Manager, investment decision-making ultimately rests solely with the plan sponsor. By hiring a 3(21)(A)(ii) advisor you are not delegating any discretion for investment decision-making. With a “3(21)” advisor, If the DOL or attorney shows up and asks, “Who is responsible for this fund line up,” you’ll have to raise your hand. If things don’t go well with the regulators or a court I suppose you can try to get reimbursed by the advisor, but I wouldn’t count on it. The role of the 3(21) is to help you make better investment decisions, to appear to anyone who cares that you did adopt and implement a prudent process, and that investment decisions were made at an expert level.
You must identify the individuals in your organization who are responsible for investment decisions. These individuals can be the Trustee(s), or they may serve on an Investment Committee. They should be trained to best perform their role and, of course, should be made aware of their fiduciary responsibility and potential liability if they fail to perform their role prudently and expertly.
Although nothing in ERISA specifically requires that you adopt an Investment Policy Statement, the DOL has made clear that it’s tough to document a prudent process without something in writing.
And, as with any service provider the plan sponsor has hired, there is a duty to document the prudent hiring process and ongoing monitoring of your 3(21). This includes being very clear as to the fiduciary role the advisor is performing, and what they have left to you to perform.
Which financial advisors can serve as a 3(21)?
As of June 9, 2017 ALL financial advisors who service a retirement plan by recommending investment options are fiduciaries under 3(21)(A)(ii). Until recently, most firms who served as a 3(21) were registered investment advisors. As RIA firms are already fiduciaries under The Investment Advisers Act of 1940, they did not mind serving in a fiduciary role under ERISA as well. However, the vast majority of financial advisors who service retirement plans were not fiduciaries at all. They did not meet the definition of 3(21)(A)(ii) because they did not receive a fee from the plan. Instead they were paid by the fund or insurance company whose funds they sold to the plan fiduciaries. Most brokers had no contractual relationship with the plan. It was purely a sales relationship. I realize that optics were likely otherwise, but technically most brokers and insurance agents stayed as far away from the definition of fiduciary as legally possible and left it all to business owners.
Under the new Fiduciary Rule which went into effect June 9, 2017, after 6 years of pushback by the brokerage and insurance industries, all financial advisors who service retirement plans (and IRAs for that matter) became fiduciaries. However, this does not mean they do not have a conflict of interest with your plan participants. If they receive X% commission on investment option A and 1/2x% on option B, they make more on A and have a conflict of interest when they recommend investments to you and to your employees. A fiduciary advisor, on the other hand, had not been allowed to have this type of conflict because all fees had to be level. However, the Fiduciary Rule allows for a Best Interest Contract Exemption from the level fee requirement for brokers, but I’ll save the BICE topic for another article.
We hope you have found this post concerning the 3(21) fiduciary informative and clarifying. Join us in our next post as we discuss the nature and scope of the 3(38) fiduciary!