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What Do Most 401k Plan Sponsors Use: a 3(38) or a 3(21) Adviser?

What Do Most 401k Plan Sponsors Use: a 3(38) or a 3(21) Adviser?
August 20
00:03 2019

We previously outlined the differences (and similarities) between a 401k adviser acting in a 3(38) capacity vs. acting in a 3(21) capacity (see “What’s the Difference Between 3(38) and 3(21) 401k Advisers?, August 6, 2019). Delineating these comparisons leaves open the obvious questions: What do most 401k plan sponsors do? Moreover, are we witnessing a change in preference as new state and federal laws and regulations have slowly been introduced into the marketplace?

First, it might prove useful to recap the key differences between the two alternatives. “An ERISA 3(38) discretionary investment manager is very different from an ERISA 3(21) investment adviser,” says Mike Cagnina, Vice President and Managing Director of SEI’s Institutional Group in Oaks, Pennsylvania. “A 3(38) discretionary investment manager takes contractual responsibility for selecting, monitoring, and replacing the investment managers in the plan thereby relieving the plan sponsor of those functions; a 3(21) investment advisor is only responsible for giving the plan sponsor reasonable recommendations and the plan sponsor retains both authority and responsibility for their ultimate decisions.”

In other words, when choosing between a 3(21) and a 3(38), one of the key decision factors is whether the plan sponsor wants to maintain control or lighten fiduciary liability. “A 3(21) investment adviser makes investment recommendations, but ultimately leaves the final investment decision up to the plan sponsor,” says Matthew Zokai, Senior Advisor Retirement Services at 1st Global in Dallas, Texas. “A 3(38) investment manager has discretionary authority and takes on full responsibility of managing the lineup and can make necessary changes as it deems appropriate. An easy way to differentiate the two services is a 3(21) ‘helps you do it’ while a 3(38) ‘does it for you.’”

Despite the differences from a plan sponsor perspective, today’s investment advisers can easily maintain an agnostic position between the two options. “A retirement plan adviser could be either or both,” says Dr. Guy Baker, Ph.D, founder Wealth Teams Alliance in Irvine, California. “The plan sponsor will dictate which is more suited to the trustees and the plan.”

In the past, plan sponsors have gone a fairly consistent route. “Most plan sponsors choose to engage a 3(21) fiduciary over a 3(38) investment manager,” says Ryan Barnett, VP of Retirement Services at Heritage Retirement Plan Advisors, Oklahoma City, Oklahoma. Why is this the case? Barnett believes “plan sponsors feel the need to be involved in the investment selection process. Most plan sponsors want to help employees become financially secure and feel like they should have input in the 401k plan offered to their employees.”

In the past, since plan sponsors were less familiar with the value-add of “fiduciary,” service providers didn’t see a need to push the market farther than it wanted to go. “An ERISA 3(21) fiduciary arrangement has been the most prevalent role for advisers of 401k plans historically,” Mark Olsen, Managing Director at PlanPILOT in Chicago, Illinois.” Advisers traditionally have held shared responsibility with the plan sponsor, but were slower to embrace the full fiduciary role. Advisers saw their role as providing advice, not as having discretionary management power.”

Even today, there’s not necessarily a clear consensus on the value-add. “3(21) is still most prevalent for DC plans,” says Anna Dunn Tabke, Principal at Alpha Capital Management in Atlanta, Georgia. She believes there are three good reasons for this. “Most plans do not need the additional customization and complexity that a 3(38) offers. The plan sponsor is still a fiduciary under both arrangements in an industry where lawsuits are prevalent and therefore must still be closely involved in key decisions. The nature of DC plans mean that responsibilities typically outsourced to a 3(38) in defined benefit plans (namely, asset allocation and rebalancing) are managed by the participants, and changes to the manager line-up require participant notices anyways so 3(38) cannot shorten the implementation time.”

Indeed, some 401k plan sponsors are playing “catch-up” with regard to provider choice as the new emphasis on “fiduciary” has them replacing service providers with outdated business models. A 3(21) option represents a smaller, bite-size step on the fiduciary ladder. “Until recently,” says Deborah Castellani, a Senior Fiduciary Strategist and Sales Trainer at Akros Fiduciary Management in Austin, Texas, “the most prevalent form of investment arrangement was simply a broker with no fiduciary responsibility. With the words ‘investment’ and ‘fiduciary’ being so prevalent in the press, brokers are now going back to clients and having their relationships updated to include a 3(21) features.”

That doesn’t mean change isn’t on the horizon, although it may prove slow in coming as there’s a comfort with the status quo. “While there has certainly been an uptick in 3(38) utilization amongst plan sponsors in recent years, the use of 3(21) solutions is definitely higher,” says Zokai. “Many plan sponsors and advisers are drawn to the inherent qualities of 3(21) solutions such as their flexibility and the ability of the plan sponsor and adviser to participate in the selection and due diligence process.”

As the advantages to plan sponsors have become clearer to service providers, there’s been a greater push by those on the vanguard towards the 3(38) arrangement. Olsen says, “Advisers have adopted the full 3(38) fiduciary responsibility over the last decade or so as their comfort level with the fiduciary role grew and as plan sponsors demanded greater fiduciary protection. Since most advisers will provide the same recommendations under either role, they became more agnostic to the actual responsibility they were operating under.”

Recently, bottom-line oriented plan sponsors have begun to realize how 3(38) might be a better fit not just for the company’s 401k plan, but in freeing up executive capacity to focus more in the execution of the company’s strategic plan. “Over the past five to six years, the uptick has been towards companies offering a 3(38),” says Daniel R. Hill, president of Richmond, VA-based investment advisory firm D.R. Hill Wealth Strategies, LLC. “While the actions to maintain a 401(k) are more quickly resolved in this capacity, there are more risks involved, too. Specifically, if a fund needs to be modified, added or removed, the 3(38) adviser can immediately take action. In this same scenario under a 3(21), the adviser, being a co-fiduciary, will need to have a discussion with the employer and make a recommendation of action and then wait for all parties to make a consensus as to how to proceed. I think the case for the rise in 3(38)s could be attributed to companies wanting to focus more on revenue and building wealth, now that the economy is relativity solid and thereby relinquishing these duties to professionals with dedicated experience.”

It’s fascinating to track the evolution of the plan sponsor/provider arrangement. What started as a non-fiduciary relationship grew into a 3(21) co-fiduciary and now appears to be blossoming into a 3(38) fully delegated fiduciary. Who knows what changes will come as the 401k MEP relationship becomes more prevalent?

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary Solutions,  Hey! 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 Twitter, Facebook, 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.



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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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