The Retirement Plan Fiduciary: 3(21) vs. 3(38)

Continuing with the ‘Fiduciary’ theme from our last blog post, and since Plan Sponsors are increasingly looking for investment advisors who can shoulder some of the fiduciary burden related to offering employee retirement plans, I thought it would be beneficial to write about the difference between a 3(21) and 3(38) retirement plan fiduciary.

There’s definitely an uptick in having an independent entity sign off as a fiduciary along with the plan sponsor. The number of plan sponsors interested in such an advisor has increased as the number of class action lawsuits filed by plan participants against their retirement plans has risen.

In February 2008, the U.S. Supreme Court ruled in LaRue v. De Wolff, Boberg & Associates, Inc. that plan participants may take action against plan sponsors. Many lawsuits followed, which has scared many advisors away from becoming fiduciaries.

If you are a plan sponsor and a fiduciary to the plan, you have a duty to act in the best interest of your participants. You need to be a prudent expert. If you are not, you need to go out and find that expertise. In today’s environment, a 3(21) or 3(38) fiduciary is another expert that a plan sponsor can share some responsibility and liability with.

According to the Employee Retirement and Investment Security Act (ERISA), a 3(21) fiduciary serves as a ‘co-fiduciary’ to the plan. As a ‘co-fiduciary,’ a 3(21) investment advisor will provide the plan with a recommended menu of funds. This recommended lineup is then approved by the company providing the retirement plan (investment committee, retirement plan committee, plan sponsor etc.). With this arrangement, the plan sponsor has merely hired a ‘partner’ to help them carry out their fiduciary responsibilities.

ERISA 3(38) fiduciaries stand in stark contrast to their 3(21) counterparts. A 3(38) fiduciary does not provide the plan with a recommended menu of funds; it actually selects and manages the lineup of funds that are used in the plan. A 3(38) fiduciary is considered the investment manager to the plan. Therefore, the plan sponsor does not retain any fiduciary responsibilities relating to the fund lineup, giving that person relief from any related liability.

Please note, not everyone in the marketplace will serve as a fiduciary. Some only act as a broker and won’t sign on as a fiduciary. Most plan sponsors prefer a 3(21) or 3(38) fiduciary. If you are in charge of making this decision for your company’s plan, it is important to understand in what capacity your investment advisor is acting.

- Brian Valenti

Generation Capital Management (GCM) is an independent, SEC-Registered Investment Advisor located in Rochester, NY. Since 2003, we have provided value to our clients through a premium level of investment service and an unbiased, effective investment process. If you have questions or need additional information, please feel free to contact us at: (585) 232 – 8560.

Fiduciary Duty… Say What?

When investors look for a trusted investment professional to guide them through the murky investing waters, they have many decisions to make. One of those decisions is whether to work with a Broker, who works under the ‘suitability standard,’ or to work with an Investment Adviser, who works under the ‘fiduciary duty.’

At the center of this decision are business practices and regulatory guidelines that are rarely understood by the client and often blurred in practice. Brokers are governed by the ‘suitability standard,’ which requires them to have “reasonable grounds for believing that the recommendation is suitable,” according to the Financial Industry Regulatory Authority. Registered Investment Advisors (RIAs) are supposed to adhere to a higher standard, called the ‘fiduciary duty,’ an ethical and legal requirement that the investor’s best interest comes first, not the adviser’s own financial gain.

The conventional view of the two camps goes like this: the brokers at the big firms have access to every product imaginable, but may be pressured to sell you one of them and earn more if they do. They are not obligated to get you the best price for what they advise you to buy or sell - or even to be free of conflicts. And that’s where the problem lies. In the wake of Michael Lewis’ recent book, ‘Flash Boys,’ this concept is coming under even more fire. If a broker isn’t obligated to get you the best price, then are you paying too much? Are you the one left holding the bag?

On the flip side, the independent investment advisers proudly promote their independence and lack of conflicts. If their clients feel that the fiduciary responsibility was not met, they have legal recourse through the state courts. Since independent investment advisers trade through a third party, usually using limit orders (which sets a price they are willing to transact a purchase or sale), the client is getting best execution for their orders.

In practice, though, the two standards seem to confuse investors. When explaining the difference to clients they usually come to understand the difference, but overall the investment adviser and brokerage businesses don’t do a good job of educating the public on this topic. I wonder if the powerful brokerage business doesn’t want anyone to know!

- Brian Valenti

Generation Capital Management (GCM) is an independent, SEC-Registered Investment Advisor located in Rochester, NY. Since 2003, we have provided value to our clients through a premium level of investment service and an unbiased, effective investment process. If you have questions or need additional information, please feel free to contact us at: (585) 232 – 8560.