What type of fiduciary should retirement plan advisers be?

The choice of 3(21) or 3(38) status depends on the client, type of practice and the requirements of broker-dealers and RIAs

Jan 22, 2019 @ 3:19 pm

By Fred Barstein

For many 401(k) plan advisers, the Department of Labor fiduciary rule was a nonevent. The question for advisers was not whether they would act as a fiduciary, but what kind: a 3(21) or 3(38) fiduciary?

Now that the DOL rule has been vacated, advisers are trying to answer that question, as are the plan sponsors that hire them.

The 3(21) and 3(38) designations refer to sections of the Employee Retirement Income Security Act of 1974. An adviser acting as a 3(21) fiduciary makes investment recommendations, but the ultimate decision to implement the advice lies with the plan sponsor. On the other hand, a 3(38) adviser decides, exercising full control.

The caveat is that a plan sponsor employing a 3(21) fiduciary cannot rubber-stamp the adviser's recommendations. There must be documentation that the plan sponsor exercised its own judgment.

So which is better?

Plan sponsors

The benefits of using a 3(38) adviser for a plan sponsor is limited liability — almost like an insurance policy. The committee will be able to spend less time evaluating investments, and one could argue that results will be better if an investment professional is making the decisions. The plan sponsor must still make sure the 3(38) fiduciary is qualified and performing the prescribed duties.

Some plan sponsors will employ a 3(21) adviser because they like to retain control over the investment decisions because they believe they know their employees best. So these plan sponsors get the benefit of an adviser making recommendations, but the sponsors stay engaged with the process. They do lose that "3(38) insurance policy," but it may cost less.

Plan advisers

Advisers who act as a 3(38) fiduciary may be able to distinguish their services, simplify the investment selection and monitoring process, and possibly charge more for their services.

The 3(38) status creates more liability for advisers, and many broker-dealers and registered investment advisers will limit advisers who do it. In addition, there is less engagement with clients.

There's also the question of whether advisers should outsource 3(21) or 3(38) services. Some advisers, especially inexperienced plan advisers, do not have a choice with mandates from their broker-dealer or RIA. But even those who have a choice may want to partner with a big-name provider like Morningstar or Envestnet to save time and leverage the brand.

Plan sponsors of ERISA retirement plans are expecting advisers either to act as a fiduciary or partner with a firm that acts as one, even with the DOL rule's demise. Ultimately, plan sponsors want to outsource as much work and liability as possible at the lowest possible cost.

Regardless, plan advisers will have to decide what's right for them and their clients, which may depend on the needs of their clients, the type of practice they want to have and the requirements of their broker-dealer and/or RIA.

Fred Barstein is founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews' Retirement Plan Adviser newsletter.

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