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Hope to hide from fiduciary risk? Fuggedaboutit

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Looking for ways to minimize the fiduciary liability that comes from offering their employees a retirement plan, plan sponsors have historically turned to firms offering 3(21), 3(38) and, most recently, 3(16) expertise. Unfortunately for these sponsors, debate within the industry has raged over which approach is best and whether some of these service providers have the right qualifications. 

The Center for Due Diligence spotlighted the issue at one of the sessions at its annual conference in Texas last fall.

“Many advisors are claiming 3(38) expertise to differentiate themselves when they have never before taken discretion of plan assets and have no performance history to meet the (investment) standards established by the plan,” CFDD said in summing up part of the debate. “Advisory competition is creating so much noise that it is becoming difficult for a plan sponsor to identify a qualified 3(38) advisor from an impersonator.” 

Sponsors exploring their options should know that the level of risk mitigation can vary widely from one provider to another and that even the most careful sponsor could still find itself in violation of ERISA regulations.

Sponsors turn to these providers because they lack the time or the expertise to handle all that’s required under ERISA. They typically are motivated by how much risk they can offload. But, experts say, they should be looking as closely at the qualifications of the provider as they might at the varying degrees of services offered.

ERISA’s fiduciary standards of care, of course, require sponsors to act with “loyalty, care and prudence.” So retaining outside experts where expertise is lacking can put a sponsor in the hot seat fast.

As the presenters at the CFDD conference pointed out, sponsors weighing one provider against the other should remember that “no one cares about your money like you do.”

Outsourcing these duties no doubt reduces workload. But it could also simply lead to higher fees with no added value, increased risk for the sponsor and advisor, encourages complacency in oversight fiduciaries and, in the end, doesn’t eliminate fiduciary liability.

Among the three, 3(16) fiduciaries are the latest to come into the marketplace.

Typically, these are third-party plan administrators that offer to assume fiduciary risk for a range of administrative duties, which might include everything from handling loans and distributions to choosing and evaluating trustees, investments and the plan’s advisor.

Some firms offer a wide range of these services, while others offer only a few or specifically exclude some. Either way, the approach is commonly marketed to sponsors as a way to hand off a lot, if not all, of the responsibility for the plan to another fiduciary. 

But, as in selecting any vendor, it’s important to understand whether the provider is really qualified – and the limits to what they can offer.

“It’s not that no trust companies (some of the common providers of 3(16) services) are capable of doing a good job,” said Steven W. Glasgow, senior vice president at Avondale Partners, LLP, “but it’s an attempt to appeal to the plan sponsors to absolve themselves of any responsibility involved with the plan. (It’s a way) to sidestep the letter and spirit of the law.” 

“Trustees have the responsibility to make sure the plan is operated solely for the benefit of participants. How can they do that if they have no responsibility?” he asked. 

Mark C. Griffith, SVP, Envestnet Retirement Solutions, warned that if a sponsor isn’t careful about reviewing a 3(16)’s capabilities, it could be asking for trouble.

“The biggest question mark in 3(16) services is who is really acting in that capacity, and do they have the capability and financial backing and everything else to provide that benefit to the employer if anything goes wrong?” 

Griffith also cautioned that oversight may be required of an employer’s records on everything from payroll to hiring and firing. “A third party will have so many caveats on 3(16) agreements (because of all those records) that the employer (ends up) doing everything anyway,” he said. 

And, again, even if a sponsor hires a 3(16) fiduciary, that sponsor is still responsible for making sure that the 3(16) is providing the best service possible for plan participants.

That said, CFDD President Phil Chiricotti said he believes the majority of plans will be using 3(16) services in the coming decade. “Cost-effective outsourced 3(16) services from qualified vendors that  back up their service with fiduciary liability insurance, not E&O insurance, offer real value and will drive big business in the years ahead,” he said.

In the meantime, 3(21) fiduciaries can provide advice but do not have the authority to make and implement fiduciary decisions independently. That mean that if an investment decision is made that is determined to be a breach of fiduciary duty and if that decision was based on the advice of a 3(21) fiduciary, both the 3(21) fiduciary and the plan sponsor would share in liability for that breach.

Sponsors considering a 3(21) typically are looking to relieve themselves of some of the burden of investment decisions in a plan, although they don’t mind doing the actual investing. But, again, the ultimate responsibility for investments rests with the sponsor, according to ERISA’s prudent investor rule. 

That’s why “many companies, especially larger ones, have committees and processes involved (in investment decisions),” said Griffith. “They want the control (over those final decisions) because they know their plan participants and demographics better. They just want outside consultation, and a 3(21) would be very beneficial.” 

Then there’s the 3(38), typically a registered advisor, bank or insurance company that has the power to independently buy, sell and manage plan assets.

While a 3(38) can relieve a plan sponsor of some liability, Griffith cautioned that “the company still has to continuously monitor and do due diligence on a 3(38) to make sure they operate in the manner in which they were hired to operate.” 

Glasgow concurred, pointing out that attempting to pass off too much responsibility for a plan “is like being out on a limb, and getting farther and farther away from the trunk, where the limb is more precarious.”

While 3(38)s are marketed as offloading the responsibility for a plan from the sponsor, the reality is very different, he said. 

“The plan sponsor always has responsibility at the end of the day for the plan and for oversight,” Glasgow said. “So a lot of these 3(38)s say you don’t have to handle oversight authority. That sounds nice, but if the 3(38) is not properly vetted … the plan sponsor is responsible.

“The one thing plan sponsors need to understand is that they’re always the ultimate responsible party, and there’s no way to make that go away.”


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