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Weighing In on the 3(21) vs. 3(38) Debate

Adam C. Pozek 03/10/10

Several weeks ago, I had a lengthy conversation with a prospective client (we’ll call her Alice) and her investment advisor.  After the standard dialogue about fees, service guarantees, etc., the discussion inevitably turned to the retirement plan “F” word – FIDUCIARY.  Alice had read this article and wanted to know if the advisor would be a 3(21) or 3(38) fiduciary.

In a nutshell, one of the key differences between 3(21) and 3(38) fiduciaries is discretionary authority.  An advisor who receives a fee for the investment advice he or she provides is per se a plan fiduciary according to ERISA § 3(21).  When an employer hires a 3(21) advisor, the employer is not relieved of fiduciary responsibility.  Rather, they simply engage an expert to join them at the fiduciary table.  Typically, the advisor makes recommendations, but it is ultimately up to the plan sponsor to decide whether and how to act.  You know, something like leading a horse to water.  The advisor is responsible for his/her advice but not for the outcome if the employer goes in a different direction.

When an employer hires an ERISA § 3(38) investment manager, they transfer responsibility/liability for the investment management process to that person.  Since the buck now stops with the advisor, he or she pretty much calls the shots when it comes to investment decisions.  The sponsor should recall, however, that they cannot completely eliminate liability.  If they neglect to monitor and replace a 3(38) that is running amok, the employer can find themselves right back on the hook.

So which is better?  While the article I referenced earlier seems to say 3(38)s rule while 3(21)s drool, there is a place for both.  Let’s go back to our friend, Alice, who found herself in a bit of a contradictory position.  She wanted her advisor to be a 3(38) investment manager, so she could minimize her liability; however, she also felt strongly that her plan should only include index funds and wanted to retain veto power if the advisor tried to include any non-index options.  You know, something like having one’s cake and eating it too.

Many sponsors have the knowledge to take active roles in the investment selection process, and engaging a 3(21) advisor to provide analysis and recommendations is a perfectly valid option.  The services of 3(21) are usually less expensive, but why should an employer pay extra for services they do not believe add sufficient value?

Hiring a 3(38) investment manager is also a valid option when a plan sponsor is comfortable turning over the investment reins.  The 3(38) will likely carry a higher price tag, but the mitigation of some of the sponsor’s fiduciary risk may well justify the added expense.

At the end of the day, both 3(21)s and 3(38)s have a place in the fiduciary universe, and we must help our clients cut through the spin, understand the differences and engage advisors who will provide the services that add value.

Topics: ERISA, Fiduciary Responsibility, DWC


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The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.