A question we're asked almost every time we speak is "What is the difference between investment advice under §3(21), a §3(38) and basic investment advice as it pertains to hiring an investment “expert” under ERISA?"  The answer is simple, yet because it involves the government, complicated.  We know this because even investment professionals have asked us the difference.

First and foremost before I tell you the difference, no matter what you think or what anyone tells you, when you hire an investment manager, investment advisor, investment professional, bank, insurance company, (ANY third-party provider)… your fiduciary liability does not go away.  You are still responsible for their actions.

Co-Fiduciary means Co-Defendant if something goes wrong. 

The regulators come after both of you.  The plan sponsor for not properly monitoring them.  And them for whatever they did wrong.  You are responsible for their actions – again no matter what you think or what they say!

Because their duties and responsibilities are different, the monitoring you must do is also your monitoring is also differs between a §3(21) and a  a §3(38).  The §3(38) takes on a much bigger fiduciary role, responsibilities and duties.  In many cases, they will cost more, but they also remove some of the fiduciary liability from the plan sponsor, as well as, much of the responsibility.  (Full disclosure, I have been a fiduciary all my career and ran a $2 billion RIA so I am slightly biased, however, what I am saying is also very true).

That being said…here are the differences:

  §3(21) §3(38) Basic Investment Advice
Who? Registered Investment Advisor Or Broker-Dealer Registered Investment Advisor

Any Investment Professional

Co-Fiduciary Limited – states in writing Full – states in writing N/A
Investment Policy Statement (IPS) Assists In Drafting IPS Drafts IPS Advises on what should be included
Initial Fund Menu Helps Design Builds Initial Fund Menu Advises/Educates
On-going Menu Provides Monitoring Provides Menu Advises/Educates
Changes Recommends Changes Make Changes Advises/Educates
Mapping Strategies Recommends Determines Advises/Educates
Documentation Provides Provides N/A

A §3(38) is like giving an investment manager full discretion with the account.  Once the Plan or Investment Committee has approved the IPS, the investment manager does not need to come back to the Plan or Investment Committee to ask permission for changes in the menu choices or individual assets.  A §3(38) takes the full fiduciary responsibility for the IPS, selection of menu, selection of the individual assets, and any changes to those decisions.

However, this does not mean the plan sponsor has NO responsibility.  They MUST monitor the investment manager and make sure they are following the IPS including the type of investments that are selected.  For example, if the IPS says you must have a small cap fund, look at the fund that the §3(38) has chosen and verify its a small cap fund made up of small cap stocks.  Do not make sure that that is the “best” small cap fund available.  That is the job of the §3(38) investment manager.  They assume the fiduciary responsibility for that decision. 

Plan fiduciaries also have to monitor to make sure the investments are meeting industry indices/benchmarks over a period of time, their risk measurements are within standards and the fees paid on the funds are not out of industry standards.  The plan sponsor should also monitor if any complaints have been made to the investment manager and, if so, how have they been resolved.  The regulators will often look at these complaints first to see how you are monitoring your providers.

A very important thing to remember, if a revenue sharing arrangement is in place, the plan sponsor needs to monitor the fees paid on this arrangement to ensure they do not go above what would normally be paid if the fees were paid out of pocket. This is the responsibility of the plan sponsor.  If too much in fee arrangement needs to cease and you need to speak with your ERISA counsel about recouping the overpayment.

Next time we will review Section 3(21) and Basic Investment Advice.