Pozek On Pension

Weighing In on the 3(21) vs. 3(38) Debate

Several weeks ago, I had a lengthy conversation with a prospective client (we’ll call her Alice) and her investment advisor.  After the standard dialogue about fees, service guarantees, etc., the discussion inevitably turned to the retirement plan “F” word – FIDUCIARY.  Alice had read this article and wanted to know if the advisor would be a 3(21) or 3(38) fiduciary.

In a nutshell, one of the key differences between 3(21) and 3(38) fiduciaries is discretionary authority.  An advisor who receives a fee for the investment advice he or she provides is per se a plan fiduciary according to ERISA § 3(21).  When an employer hires a 3(21) advisor, the employer is not relieved of fiduciary responsibility.  Rather, they simply engage and expert to join them at the fiduciary table.  Typically, the advisor makes recommendations, but it is ultimately up to the plan sponsor to decide whether and how to act.  You know, something like leading a horse to water.  The advisor is responsible for his/her advice but not for the outcome if the employer goes in a different direction.

When an employer hires an ERISA § 3(38) investment manager, they transfer responsibility/liability for the investment management process to that person.  Since the buck now stops with the advisor, he or she pretty much calls the shots when it comes to investment decisions.  The sponsor should recall, however, that they cannot completely eliminate liability.  If they neglect to monitor and replace a 3(38) that is running amok, the employer can find themselves right back on the hook.

So which is better?  While the article I referenced earlier seems to say 3(38)s rule while 3(21)s drool, there is a place for both.  Let’s go back to our friend, Alice, who found herself in a bit of a contradictory position.  She wanted her advisor to be a 3(38) investment manager, so she could minimize her liability; however, she also felt strongly that her plan should only include index funds and wanted to retain veto power if the advisor tried to include any non-index options.  You know, something like having one’s cake and eating it too.

Many sponsors have the knowledge to take active roles in the investment selection process, and engaging a 3(21) advisor to provide analysis and recommendations is a perfectly valid option.  The services of 3(21) are usually less expensive, but why should an employer pay extra for services they do not believe add sufficient value?

Hiring a 3(38) investment manager is also a valid option when a plan sponsor is comfortable turning over the investment reins.  The 3(38) will likely carry a higher price tag, but the mitigation of some of the sponsor’s fiduciary risk may well justify the added expense.

At the end of the day, both 3(21)s and 3(38)s have a place in the fiduciary universe, and we must help our clients cut through the spin, understand the differences and engage advisors who will provide the services that add value.

In Search of the Elusive Non-ERISA 403(b)

Crikey!  We’ve just discovered the rare non-ERISA 403(b) plan meandering along, oblivious to such details as filing Form 5500 or worrying about fiduciary responsibility.  Wait…could it be this harmless creature only offers investments from a single vendor?  Danger! Danger! Danger!

Last week, EBSA published Field Assistance Bulletin 2010-01 to provide additional guidance to those trying to figure out how to cope with life under the new 403(b) regulations.

Of potentially more interest, however, is what has NOT changed…the determination of ERISA coverage.  Generally speaking, there are three broad categories of 403(b) plans not subject to ERISA.

•       Governmental plans such as public schools enjoy a statutory exemption from ERISA.
•       Church plans are also exempt by statute unless they make a formal election to be covered.
•       Plans in which the employer has only very limited involvement in the ongoing operation, administration, etc. of the plan are also exempt.

It is this third category - addressed in DOL Reg 29 CFR 2510.3-2(f) - that is most misunderstood.  What, exactly, does it mean for the employer to have limited involvement?

For starters, there can be no employer matching or non-elective contributions to the plan.  Not only will such contributions trigger ERISA coverage, they will also require the plan to satisfy nondiscrimination testing (ACP test for employer match and 410(b)/401(a)(4) tests for NEC).

A second factor is the number of investment vendors and options within each vendor platform available to participants.  According to Q&A 16 in FAB 2010-01, “To meet the terms of the safe harbor, the arrangement generally must offer a choice of more than one 403(b) contractor and more than one investment product.” [emphasis added]  This is the one I have seen bite many unsuspecting non-profits, and it is not new.  Not only are single-vendor plans subject to ERISA now, they always have been.

The most obvious consequence is that Forms 5500 should have been filed for each year since plan inception.  Fortunately, this can be easily remedied using the DOL’s Delinquent Filer Voluntary Correction Program.  There is also a matter of required notices such as the Summary Plan Description.  ERISA-covered plans that do not satisfy timing requirements to distribute the SPD can be penalized up to $100 per participant per day.

What may be less obvious but exceedingly more risky is the issue of fiduciary responsibility.  Many of these arrangements were setup and left to their own devices without a trace of any prudent processes to analyze fees or select/monitor investment options.  A recent GAO report confirms that 403(b) plans generally pay higher fees their for-profit counterparts.

If the FAB is any indication, non-ERISA 403(b) plans may be headed for the endangered species list.  For those realizing they must deal with ERISA and all of its ramifications, much time and attention are needed to determine how to appropriately, yet cost-effectively address past neglect while creating a habitat for these beasts to flourish in the future.

The Quest for Quality & Unconflicted Expertise

In the last few days, there have been several new media reports of professional wrongdoing.  One describes a CPA suspended for preparing a false tax return.  Another alleges a TPA firm provided conflicted advice when it referred clients to a CPA firm in which it held a stake.  Hopefully the allegations will turn out to be false, but these situations reinforce the importance of quality, unconflicted advice.

Fortunately, there have been relatively few examples of egregious conflicts in our industry…at least not many have been exposed.  However, our industry has not done as thorough a job as it could to self-regulate.  We do not have standards of practice similar to those created for Enrolled Actuaries.  Unless individuals are Enrolled (Actuaries, Agents or Retirement Plan Agents), Attorneys or Accountants, they are not subject to oversight or rules of professional conduct.  Investment advisors must be licensed to engage in their trade, but the examinations deal more with securities knowledge than with the duties imposed on clients by ERISA.  One does not need to obtain any license or certification to hang out a shingle as a TPA, recordkeeper or consultant.

It has surprised me how many colleagues have been outspoken against the application of penalties to those who inaccurately prepare Form 5500.  Some have been perplexed that they can no longer accept a client’s instruction that all employee contributions were timely deposited despite account statements that are clearly to the contrary.  Others are surprised to hear that instructing a client to back-date a plan amendment can amount to tax fraud.  Still others lament the coming fee disclosure regulations, because it will spell the end of retaining revenue sharing payments that far exceed what their fees would normally be.

Just to set the record straight, I am not a fan of expanded government regulation.  I do, however, advocate our industry setting high ethical and quality standards for the work we do.  Not only is it the right thing to do, but it may also stave off potentially over-reactive government intervention.  As part of its financial services regulatory reform efforts, the House has already passed a measure that would create the Consumer Financial Protection Agency, a new government agency whose jurisdiction would include otherwise unregulated plan service-providers.

We must always act in the best interest of our clients and take advantage of every opportunity to demonstrate our commitment to quality. This could mean accepting responsibility for a mistake and correcting it rather than hiding it.  It may include voluntarily subjecting ourselves to rules of professional conduct by becoming ERPAs or devoting the time and effort to obtaining professional credentials like those offered by ASPPA and NIPA.

And lest there be any undisclosed conflicts, I am an ERPA and I am a member of ASPPA’s Board of Directors.