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The One Topic Every 401k Plan Sponsor Must Know Right Now: Fiduciary Education Curriculum (Part III)

The One Topic Every 401k Plan Sponsor Must Know Right Now: Fiduciary Education Curriculum (Part III)
May 21
00:03 2019

We began this three-part series by focusing first on core topics (see, “5 Critical Topics to Teach 401k Plan Sponsors: Fiduciary Education Curriculum (Part I),” FiduciaryNews.com, May 7, 2019). Then we looked at a couple of popular topics (see, “The Meat and Potatoes Topics of 401k Plan Sponsor Training: Fiduciary Education Curriculum (Part II),” FiduciaryNews.com, May 14, 2019). In this final segment, we’ll explore the one fundamental topic every 401k plan sponsor must know right now.

Topic #8: Mitigating Fiduciary Liability Through Prudent Delegation
Most 401k plan sponsors will readily admit they are not experts when it comes to retirement plans. They understand they have a role in the process. They understand that role carries with it certain fiduciary obligations. They understand (and accept) that role also exposes them to liabilities. Most importantly, they’ve come to realize prudent delegation can mitigate much of that fiduciary liability.

This greater understanding begins with knowing how “prudent expert” is defined with the appropriate regulations. “Under the Employee Retirement Income Security Act of 1974 (ERISA), the Department of Labor requires that a ‘prudent expert’ have the discretion to select and monitor the plans investment options,” says Kyle P. Webber, Principal & Managing Partner at Quartz Partners Investment Management in Troy, New York. “The Department of Labor expects a lot of prudent experts. The most important items are being familiar with ERISA, have a repeatable process in place to select and monitor a diversified menu of investment options monitoring plan fees, along with avoiding conflicts and prohibited transactions.”

The term “prudent expert” has evolved from its very beginnings as the “Prudent Man Rule,” which helped limit a trustee’s liability if the trustee acted within certain “prudent” bounds. This concept was broadened via various state-initiated “Prudent Investor” laws. These laws permitted trustees to shift fiduciary liability onto professionals when they hired investment advisers on a discretionary basis.

ERISA’s “Prudent Expert” language works the same way. Plan sponsors can shift liability to a professional “expert,” but they can only accomplish this by delegating full discretionary authority to that professional. “Unless the plan sponsor hires and appoints one, the prudent expert by default is the plan fiduciary, typically an executive member of the plan sponsor,” says Webber.

Problems can arise when plan sponsors believe they’re hiring an “adviser” to served in the prudent expert role while they’ve only hired an “advisor.” “We have found that in over 75% of the plans the plan fiduciary serves as the prudent expert despite having a plan ‘advisor,’” says Webber. “This often leaves plan sponsors scratching their head wondering what their plan sponsor is being paid for. To put it simply, many plan advisors’ responsibility falls under ERISA 3(21) and they have no other responsibility than ‘recommending’ service providers and the investment menu. They don’t even have to avoid conflicts of interest, leaving the plan sponsor on the hook for essentially everything.”

The Difference Between and “Adviser” and “Advisor”
It’s more than just a vowel. It a potential legal nightmare (see “401k Plan Sponsors Not Only Ones Affected by ‘Adviser’/‘Advisor’ Fiduciary Confusion,” FiduciaryNews.com, October 28, 2014). Remember, the plan sponsor’s advantage to hiring a prudent expert consists of that prudent expert exercising discretionary authority over plan investments. This requires the expert not merely recommend investments, but actively make investment decisions. Only a Registered Investment Adviser (or discretionary trustee) can legally perform this service. Notice the spelling of “Adviser.”

You can’t call yourself (or your firm) and “adviser” with registering as one with the SEC. Not all service providers are duly registered; hence, they cannot refer to themselves as an “adviser.” As a result, they call themselves an “advisor.” The words sound similar, but they represent a world of difference in the ERISA world of “prudent expert.” An “adviser” (legal term) may be an “advisor” (noun), but an “advisor” (noun) is not necessarily an “adviser” (legal term).

Confused? You’re not the only one. There are rumors the SEC, as part of its Regulation BI effort, is considering outlawing the use of “advisor” unless you are also an “adviser.”

That might help plan sponsors from making a common mistake.

“The single most important topic for a plan sponsor or an investment committee to be educated on is their role as fiduciaries and the role the ‘advisor’ from the 401k provider is playing,” says Joshua Escalante Troesh, Founder of Purposeful Strategic Partners in Alta Loma, California. “Sadly, if the 401k plan is provided by a broker/dealer or insurance company, the advisor is not an adviser at all but a sales rep giving a sales pitch. This means all of the liability is on the plan sponsor and investment committee for the plan, and the plan provider is accepting zero liability for the investment choices. This was the insurance and broker/dealer industries’ legal argument in their fight against the Department of Labor Fiduciary Rule, and the 5th circuit called the recommendations made to investment committees ‘sales pitches’ seven time in their ruling against the Department of Labor.”

This isn’t the only terminology that can trip of 401k plan sponsors seeking to mitigate their fiduciary liability. While this first area of misperception involves words, then next area involves numbers.

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The Difference between 3(16), 3(21), and 3(38)
As Webber alludes, the “flavor” of fiduciary selected by the 401k plan sponsor can have a bearing as to whether fiduciary liability can be reduced (see “3 Ways 401k Plan Sponsors Can Reduce Fiduciary Liability,” FiduciaryNews.com, November 11, 2014). Just as “adviser” and “advisor” can offer an important distinction to the 401k plan sponsor, so can they type of ERISA fiduciary. “Along the same lines, plan sponsors and committees should be familiar with their ability to delegate fiduciary duties under ERISA sections 3(16), 3(21), and 3(38),” says Troesh. “Each of these sections allows an employer to delegate much of their fiduciary duties (and liabilities) to the advisor and other plan providers. Proper delegation to a qualified fiduciary greatly reduces the investment committee’s liability for investment options within the plan.”

A 3(16) fiduciary only handles the administrative functions of the plan. Since the primary source of fiduciary liability lies in the investment arena, this type of outsourcing can’t provide the full need.

As described earlier, the 3(21) fiduciary merely provides recommendations. This leaves the plan sponsor exposed to a liability the plan sponsor might wish to mitigate. The 401k plan sponsor can achieve such mitigation through hiring a 3(38) fiduciary.

“Unless plan sponsors hire a plan adviser who is a 3(38) fiduciary,” say Webber, “they will maintain the ‘prudent expert’ responsibility and the liability that is attached. When a plan sponsor hires a plan adviser who is a 3(38) fiduciary, if audited by the Department of Labor (DOL) or sued by a disgruntled performance for expensive or poor performing mutual funds, the 3(38) plan adviser is on the hook for responding to the DOL or litigation proceedings.”

It’s not like all of the fiduciary liability is transferred, but a good portion of it is. In addition, plan sponsors will benefit from a significant reduction in workload, too. “The interesting thing is now plan sponsors are merely tasked with a management and review role,” says Bradford Creger, Retirement Plan Specialist at Total Financial Resource Group, Inc. in Glendale, California. “They are reading reports to determine if what was done matches what was contracted and more importantly, if the decisions and actions taken seem reasonable and were well documented. This model shifts most of the liability to these ‘outsourced’ fiduciaries and really limits the time commitment necessary when offering a retirement plan.”

Any good fiduciary education syllabus will cover in depth all eight of the topics presented in these three articles. But’s it not a “one and done” proposition. Rules and regulations are constantly being revised and updated. It’s important that 401k plan sponsors periodically seek educational updates.

Ideally, such education would come from objective sources. That means searching for opportunities beyond the plan’s existing vendors.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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