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3(21) versus 3(38) Advisors

Over the last several years, the retirement plan marketplace has done a great job at confusing plan sponsors about who is a fiduciary, who is not, and what their obligation to the retirement plan is.

We thought it would be helpful to address this and also state our legal relationship to the retirement plans that we engage with.

We believe the DOL (Department of Labor) would like greater clarity on this issue to help plan sponsors have greater accountability from the service providers in the retirement plan marketplace. We've observed within the industry, that sales processes often imply a fiduciary duty, while the fine print of contracts attempts to deny fiduciary status. At Garde, as a 1940 Act Registered Investment Advisor, we have a fiduciary obligation to all of our clients, and believe the better a client understands the contractual distinctions, the better they will be in navigating the marketplace.

ERISA Section 3(38) Fiduciary

ERISA states that a plan sponsor can delegate much of its fiduciary duty to a service provider in the selection, monitoring, and changing of investment selections and programs if certain conditions are met. The types of entities that can take on this responsibility are banks, insurance companies, or a Registered Investment Advisor. Garde Capital is a Registered Investment Advisor. Legally defined a fiduciary has discretionary authority to make changes to the plan as they see fit. By definition, a broker dealer is not a fiduciary and only has a suitability standard to adhere to, thus a plan sponsor is not relieving themselves of any responsibility when hiring a broker dealer for plan services, such as providers that receive 12(b)(1) fees for selling investments, in fact, they may even be engaging with a service provider that is at conflict with the very nature of a fiduciary.

A 3(38) advisor is an advisor that takes on the discretionary responsibility of evaluating, selecting, and discretionarily changing the investments, investment managers, model portfolios, and the monitoring of these portfolios. To claim this status it's important that this responsibility is turned over to the 3(38) advisor, and should a client override the advisor's decision, at that point, the plan sponsor has regained the responsibility on that portion of the plan that the advisor may have been responsible for.

However, if the plan sponsor has not given them discretionary authority, then it's likely they will fall out of this 3(38) classification. A good 3(38) advisor is likely to communicate with the plan about changes it intends to make, but once a plan sponsor overrides that decision, then they have theoretically rescinded that 3(38) responsibility. Garde Capital prefers to operate as a 3(38) advisor, but does not necessitate this. A plan sponsor can choose an ERISA 3(21) relationship if desired.

ERISA Section 3(21) Fiduciary

To the degree that the advisor does not have discretionary authority with respect to changes in the retirement plan, the advisor is then likely charged with recommending, assisting, helping, or advising. But the key distinction is that they plan sponsor is ultimately making the decision. As ERISA then describes, although the contract might say that the advisor is acting as a fiduciary, it is likely also to clarify that it is of the 3(21) variety which will significantly deflect the legal responsibility when something goes wrong. This can also be described as limited scope.

Keep in mind that although there is a full-scope 3(21) fiduciary, this is the named fiduciary of the plan, the person ultimately responsible for the plan, this fiduciary can delegate responsibility to a limited scope 3(21) fiduciary or several of them.

Summary

When choosing between a 3(21) and a 3(38) fiduciary, we recommend engaging in the relationship that works best for the corporate governance policies consistent with your organization. A good advisor will allow you to work within a contractual relationship that is best for your firm, not your advisor.

Although the nuance can be challenging, we invite the conversation and are delighted to help educate plan sponsors in this particular area and refer appropriate legal counsel where necessary.