When plan sponsors offer a 401(k) plan for their employees, they take on a fiduciary responsibility for the performance and welfare of the plan. They must act solely on behalf of plan participants and their beneficiaries, focusing only on providing the best possible benefits. This includes making sure that all fees associated with the plan are reasonable and transparent, so participants can see exactly how much they’re paying and the services they’re paying for.
They also must make sure that the investments in the 401(k) plan’s portfolio are not only sound but diversified across asset classes and level of investment risk, and they must understand and follow the procedures laid out in the plan document. They may be held liable if they don’t follow established procedures and principles, and they may be required to restore funds that are lost through their negligent or improper actions.
Hiring an investment advisor has been standard practice for defined benefit plans. Professionals manage a pool of assets with one goal in mind, and participants aren’t really involved in the management. But under ERISA, being a plan fiduciary isn’t just about the investments. It’s about the plan document, compliance, diversification, and improving participation and employee balances.
These are heavy responsibilities.
Until recently, according to a recent Vanguard report, qualified plan sponsors have been bearing the burden on their own.
But now, a growing number of DC sponsors have been hiring an outside fiduciary in a trend that’s only expected to grow.
A matter of control
A 2012 Franklin Templeton/Chatham Partners study found that 81 percent of the plan sponsors surveyed said their advisors acted as an ERISA fiduciary. But when asked what kind of fiduciary role their advisors were taking on, 63 percent of them didn’t know. This can be a problem, because not knowing the nature of your fiduciary responsibility can lead to unintended liability.
Sponsors who go it alone can hire an investment consultant who accepts no fiduciary responsibility for his or her advice. This does nothing to mitigate the sponsor’s fiduciary risk. But for sponsors who are uncomfortable with bearing the risk alone, ERISA basically provides two options: sections 3(38) and 3(21).
The 3(38) relationship shifts the responsibility entirely onto the advisor. This means the advisor is the one who drafts the investment policy statement, designs and builds the initial fund menu, and monitors the investments. The advisor also makes whatever changes need to be made, determines mapping strategies, and provides overall documentation. In exchange for ceding total decision-making authority over the plan to the advisor, the sponsor relieves himself of all fiduciary responsibility for the plan – with one important exception.
Sponsors still must exercise due diligence in selecting a plan advisor. They must check out his or her credentials, background and track record. If they fail to do so, the advisor’s 3(38) status won’t protect the sponsor from liability and litigation if the investment advisor does something drastically wrong.
The 3(38) arrangement is attractive to many sponsors who don’t want to be bothered with the details of managing a 401(k) plan and are wary of the potential for litigation. In their view, passing fiduciary responsibility onto a third party enables them to disengage from the plan and get on with their real business.
The 3(38) route can be expensive. And the liability protection under a 3(38) relationship is not without limits. Even if they’ve taken prudent care in selecting a fiduciary, sponsors still need to continuously monitor his or her activities. Sponsors also can’t second-guess or resist the fiduciary’s decisions, or they risk losing whatever liability protection the 3(38) status affords them.
The value of engagement
Some sponsors are uncomfortable ceding total control of a plan to a fiduciary. In that case, they have the option of entering into a 3(21) relationship.
Under a 3(21) fiduciary arrangement, the advisor and sponsor become partners — in effect, co-fiduciaries.
Together, they develop and draft the investment policy statement, design the fund menu and monitor the investments. When the advisor recommends changes and mapping strategies, the decisions are made jointly with the sponsor.
For Jania Stout, vice president and retirement plan consultant with the Fiduciary Consulting Group at PSA Financial Services in Baltimore, Md., a 3(21) arrangement has an important advantage over the 3(38): sponsor involvement in the plan.
“In this day and age we need plan sponsors to be more engaged, not less,” she said. “We’re in the midst of a retirement crisis; people are just not saving enough and their retirement balances are nowhere near where they need to be.
“Plan sponsors need to be aware of this because, of course, it’s the right thing to do. But if their highly paid baby boomer employees aren’t able to retire on schedule, they won’t be making room for those new college graduates to come in at the lower end of the pay scale. The quicker we can focus on people having healthy balances, the quicker we can have a healthy workforce and get people through the cycle.
“It’s a win-win for everybody. But it doesn’t happen overnight. It’s a long-term process.”
In early conversations with clients, Stout advocates signing on as a 3(21) advisor. She works with the sponsor to design the plan, select the investments, educate the workforce, monitor the investments, and offer prudent advice when it’s time to make decisions about the plan.
“We gravitate toward employers who care about their employees, who want to collaborate in the process of providing for their employees’ retirement rather than disengage,” she said.
Working together as a 3(21) advisor gives the sponsor time to evaluate the advisor’s performance and learn how he or she makes decisions. Then, at a mutually determined point down the road, sponsors can decide whether they feel more comfortable moving to a 3(38) relationship, or maintaining the status quo.