Who’s Responsible? The 3(21), 3(38) and the Discretionary Trustee

Got five minutes? The topic of this blog post is covered in our Fiduciary Five Podcast series hosted by Chuck Hammond of the 401(k) Study Group. The Fiduciary Five Podcast…your fiduciary questions, answered in about five minutes.  To listen to the related podcast, click here.

In one of my favorite episodes of the classic television series, M*A*S*H* a sleep-deprived Hawkeye Pierce, desperately seeking to find out what caused the start of the Korean War, dictates a telegram in the middle of the night to President Truman with a simple question that reads “Who’s responsible?”

For a number of years our industry has seen an increasing focus on the nature of the fiduciary roles that are inherent in sponsoring a retirement plan. Everyone wants to know, “Who’s responsible?”  While the truth is that retirement plan sponsors, and their appointed Plan Administrators and Plan Trustees, have been Named Fiduciaries to their company plans for decades; many of them have never fully understood the extent of those responsibilities.  Because of that, the ability to outsource their fiduciary responsibilities was never really a main concern until recently.  As lawsuits targeting plan sponsors have increased, and the courts answered the question “Who’s responsible?” the demand for outsourced fiduciary services has soared.

Let’s focus on the fiduciary liability of the Plan Trustee who is ultimately responsible for managing the plan’s assets for the sole benefit of the plan’s participants and their beneficiaries. The list of fiduciary responsibilities is long, resulting in an increased desire to outsource as many as possible.  This has led to new opportunities for plan advisors, record keepers and custodians to enhance their service offerings in the effort to attract new clients by saying “Hey, WE’LL be responsible.”  Enter the 3(21), 3(38) and Discretionary Corporate Trustee (“Discretionary Trustee”) roles. These roles are three of the higher levels of fiduciary liability protections pertaining to plan assets under ERISA.

Retirement plan advisors who act in a 3(21) capacity are fiduciary advice givers. They give recommendations with respect to a plan’s investments menu, but it is still the Plan Trustee who retains the responsibility to make the final decisions.  Under this arrangement, the risk (fiduciary liability) for investment decisions remains with the plan’s trustee.  So, if the plan trustee still has the risk, is there a way to get rid of some or all of it?

The next step up on the fiduciary hierarchy is the ERISA §3(38) Investment Manager. There are many different versions of this type of plan fiduciary.  A common one is where a 3(38) is given the discretion to make many of the basic plan-level investment decisions as opposed to simply providing advice.  When hiring a 3(38), the Named Fiduciary delegates a portion of the duties normally assigned to the Plan Trustee.  In most instances, the services provided are restricted to determining which investments to offer in the plan’s menu to participants, providing a periodic monitoring report of those investments and making decisions regarding the replacement of investments in the menu.  In some instances, the services may also include the offering of pre-mixed asset allocation model portfolios and/or a managed account solution for the participants’ consideration.  When a 3(38) is hired, the Plan Trustee is able to reduce their fiduciary liability to the extent of the services outlined in the 3(38)’s service agreement.  Because this appointment is done via contract, the contract will have boundaries indicating where responsibility begins and ends.  It then becomes incumbent upon the appointing fiduciary to understand what gaps remain and thus what responsibility is retained.

The next and final step up on the fiduciary hierarchy is the Discretionary Trustee which provides the highest level of fiduciary risk mitigation available under ERISA. Similar to a 3(38), a Discretionary Trustee has the discretion to make all investment menu decisions for a plan.  However, there are several other duties related to managing a plan’s assets that a Discretionary Trustee becomes responsible for while a 3(38) does not.  As an example; A Discretionary Trustee will take responsibility for collecting and applying all revenue owed to the trust.  This includes revenue sharing that may be refunded from investments but also contributions from participants.  No 3(38) we’ve encountered will take on these responsibilities.

The distinctions between a 3(21) Investment Advisor, 3(38) Investment Manager and Discretionary Trustee boil down to different service models and, importantly, the amount of fiduciary protection that each provides (or doesn’t). The protection provided by a 3(21) is limited. The 3(38) will provide a broader level of risk protection than a 3(21), but those protections will still be limited to the scope of services defined in the 3(38)’s service agreement. The nature of the Discretionary Trustee provides the most fiduciary risk protection of the three.  In the scenarios where a 3(21) or a 3(38) is hired by a plan sponsor, they are simply delegated a few of the responsibilities normally assigned to the Plan Trustee.  However, when a Discretionary Trustee is hired, it is allocated all of the Plan Trustee’s normal responsibilities.  The Discretionary Trustee becomes a Named Fiduciary in the plan’s governing document and is allocated the full control and authority of managing the plan’s assets.

Hawkeye never did receive an answer to his question but I hope this information clears up the question of who’s responsible when it comes to managing retirement plan assets under the scenarios outlined here.

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