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What’s the Difference Between 3(38) and 3(21) 401k Advisers?

What’s the Difference Between 3(38) and 3(21) 401k Advisers?
August 06
00:03 2019

Company 401k plan sponsors can hire service providers under a number of arrangements. Sometimes they merely accept what’s offered by the provider they happen to be using. Other times, once they become aware of the differences between the types of service offerings, plan sponsors will explicit solicit proposals for each type of offering to determine which kind of offering best serves their unique situation. This latter example represents the ideal strategy for all 401k plan sponsors. For that reason, this article presents a comprehensive overview of the difference between the two most likely service arrangements used by 401k plans.

“We actually see three types of arrangements,” says Mike Cagnina, Vice President and Managing Director of SEI’s Institutional Group in Oaks, Pennsylvania. He explains these three arrangements as follows:

  • The Bundled Provider: “In this case, a plan sponsor selects a single provider to deliver manager lineups to the participants, often from a single fund management company. This practice has been rapidly fading away yet is still present today.”
  • The 3(21) Investment Adviser: “This would be plan sponsors seeking oversight and turning to the traditional consultant model. In this case, the committee retains all responsibility but leans on a consultant from time to time for advice. Most 401k and defined contribution plan sponsors remain in this 3(21) investment advisory arrangement with their advisers. Plan sponsors choose to remain in these arrangements for a similar reason to why participants stay in the same investment allocation for long periods of time – inertia; they aren’t necessarily feeling the pressure to make a change and thus have stayed in the same arrangement, often with the same provider, for years.”
  • The 3(38) Discretionary Investment Manager: “Some of the litigation in the space against plan sponsor fiduciaries has driven interest in elevating advisory services to this arrangement. It is also the fastest growing amongst plan sponsors in the DC marketplace. Plan sponsors have also raised the bar for a more simplified and cost-effective plan for their participants that takes into account the longevity of the asset pool and the desired outcomes of its participants. In doing so, 3(38) providers lean heavily on their fiduciary heritage and responsibilities to deliver on all of those multiple facets as they have in the past with Defined Benefits Plans and Endowment & Foundation pools.”

Clearly, the two relevant terms are 3(21) and 3(38). “These terms come from the ERISA Sections defining the role of the fiduciary,” says Anna Dunn Tabke, Principal at Alpha Capital Management in Atlanta, Georgia. “3(21) means that the investment adviser does not have discretion to make changes. The adviser provides analysis and advice to the plan sponsor, who makes the ultimate decisions. 3(38) means that the investment manager does have discretion to make certain changes without approval from the plan sponsor.”

Plan sponsors would be most interested in learning what the practical difference between the two options. “The primary difference between a 3(38) and a 3(21) is the level of authority,” says Ryan Barnett, VP of Retirement Services at Heritage Retirement Plan Advisors, Oklahoma City, Oklahoma. “A 3(21) can make recommendations to the plan fiduciaries, but they do not have any discretionary authority to make decisions. A 3(38) investment manager can make decisions by reviewing and ultimately selecting investment options offered by the plan.”

While these functional differences can be quite evident to the plan sponsor, less obvious but perhaps of greater significance is the difference in personal fiduciary liability exposure. “An ERISA 3(21) fiduciary is an investment adviser to a plan,” says Mark Olsen, Managing Director at PlanPILOT in Chicago, Illinois. “They make recommendations, but at the end of the day, the named fiduciary or plan committee makes the final decisions and retains responsibility for those outcomes. An ERISA 3(38) is the investment manager and is granted discretionary authority over the management of the plan’s assets. Under this arrangement, the fiduciary liability transfers to the 3(38) manager. However, the named fiduciary or plan committee still retains liability over the selection and monitoring of that manager.”

In determining which arrangement works best for them, 401k plan sponsors need to determine what’s more important: increased control or reduced liability. “Plan sponsors who want assistance with their fiduciary responsibilities but still want to maintain discretion and control of their plan’s investment menus will opt for a 3(21) adviser, says Dr. Guy Baker, Ph.D, founder Wealth Teams Alliance in Irvine, California. “Plan sponsors who want to shift most if not all of the fiduciary responsibilities to an independent third party will do so if they lack expertise, and fear personal liability.

Baker describes the differences as follows: “Under 3(21), retirement plan advisers will exercise authority and/or control over the management of the plan or disposition of its assets. They will give investment advice for a fee and if they have discretionary responsibility in the administration of the retirement plan, they will be liable for their advice. On the other hand, 3(38) advisers are ‘investment managers.’ They assume the fiduciary responsibility to manage plan assets. ERISA says a plan sponsor may delegate the responsibility of (and, as a result, the liability for) selecting, monitoring, and replacing investments to a 3(38) fiduciary.”

In addition to this narrative description, Baker offers the following chart that outlines the working differences between the two arrangements:

3(21)                                                                            3(38)
Relationship must be in writing.                            Provides statement of relationship in writing
Helps to drafts IPS                                                    Drafts IPS
Helps design funds available                                  Recommends funds
Monitors performance                                             Monitors offerings
Recommends changes to funds                              Makes changes as required
On takeovers, will provide                                       Provides mapping strategies on take over
recommendations for mapping
Documents plan meetings                                       Documents plan

For all their differences, these two types of services have one important commonality. Baker says, “Both 3(38) and 3(21) advisers accept fiduciary responsibility and adhere to ERISA §404(a)’s duty to 1) serve interest of plan participants and 2) adhere to the ‘prudent man’ standard of care. Plan sponsors have the right to change advisers if they are not fulfilling their duties.”

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.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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