Even if retirement plan participants decide how to allocate their accounts from among their plan’s investment options, selecting those options is a fiduciary responsibility.
When selecting and monitoring investment options, a
plan’s committee members are held to a special fiduciary standard often referred to as the prudent man rule. This means
committee members must act with the care and skill that a
prudent person would if acting in a similar capacity and being
familiar with such matters.
But most committee members are not investment experts
and don’t know what type of prudent process to follow. So what
should they do? Hire a discretionary investment manager—what
we refer to here as a 3( 38) investment manager—to select the
investments. Alternatively, they can hire a nondiscretionary
investment adviser—referred to here as a 3( 21) investment
adviser—to provide advice.
How the Two Types Differ
For committees deciding between the two types of advisers, 3( 38)
investment managers are fiduciaries that take on responsibility
for selecting the plan’s investment options. While the committee
doesn’t choose the plan’s investment lineup, it retains the obligation to prudently select and monitor the investment manager.
Typically, the investment manager selects the plan’s investment
options, including the qualified default investment alternative
(QDIA), monitors investment performance and makes changes
as he deems necessary. He reports back to the committee periodically so it can monitor his performance.
A 3( 21) investment adviser is also a fiduciary, but, instead
of selecting investment options, he provides the committee with
investment advice and recommendations. In addition, he assists
with monitoring performance and recommends when to remove
or replace an investment option. While the adviser is a fiduciary
with respect to providing such investment advice, the committee
retains fiduciary responsibility for the ultimate investment-option decisions and uses the 3( 21)’s assistance to engage in a
prudent process and to make prudent investment decisions.
Which Type Will Be a Better Fit?
The right answer is the one that works best for a particular
committee and its plan(s). Here are a few factors to consider:
• By hiring a 3( 38) investment manager and delegating
responsibilities, the committee potentially reduces plan
liabilities, while lessening its engagement and giving up control.
• Even though responsibility for selecting some or all of the
investment options may be delegated to the 3( 38) investment
manager, the committee still has fiduciary responsibility to
monitor the manager. This requires that the committee understands the investment manager’s methodologies and monitors
his performance on an ongoing basis.
• Because of the liabilities associated with taking on investment responsibility, investment managers generally charge
more than do investment advisers. However, by taking advantage
of the 3( 38)’s greater “buying power,” a committee could potentially offer participants investment options with significantly
lower fees. This may mean the funds offered to plan participants
will no longer be brand name funds but more generic, “white
labeled” funds. The committee must consider how any additional cost correlates with any risk reduction.
• With a 3( 21) investment adviser, the committee members
may remain more interested and involved as they work with the
adviser to better understand the plan’s options, make decisions
and get much needed investment help and guidance.
• The committee must still “ask the right questions” of its
3( 21) adviser and not follow his advice blindly. The committee is
ultimately responsible for the investment decisions.
Generally, 3( 21) investment advice services are more suitable when the committee wants to reduce liability but still
participate meaningfully in investment decisions; 3( 38) investment manager services are generally more suitable when the
committee does not wish involvement. The type of plan may be
a relevant factor, as well. Often, we see committees hire a 3( 38)
to manage the investments held by a defined benefit (DB) plan,
while using a 3( 21) adviser to help select and monitor the investment options for a 401(k) or other defined contribution (DC)
plan. However, 3( 38) investment managers have been shifting
focus toward finding solutions for DC plans, and this will likely
Our next column will discuss monitoring an investment
manager or adviser.
Two main ways to get fiduciary advice
Summer Conley is a partner in the Los Angeles office of
Drinker Biddle & Reath LLP; Michael Rosenbaum is a partner
in the firm’s Chicago office. Josh Waldbeser, an associate in
the Chicago office, assisted with this article.