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Is There a "Mini-Me" ERISA Section 3(38) Investment Manager?

There doesn't appear to be anything in ERISA that would allow a product provider to limit its fiduciary role to the fund level or platform level.

W. Scott Simon, 11/09/2012

Some providers of investment products assert in their marketing materials that they are an investment manager as defined in section 3(38) of the Employee Retirement Income Security Act of 1974 (ERISA). However, in their contracts—where the rubber really meets the road—they make a critical distinction: They say that they're a 3(38) investment manager—but only at the level of a mutual fund or at the level of a retirement plan platform, not at the level of the retirement plan itself.

Is that a legally tenable distinction? Is there such a thing as a "mini-me" version of an ERISA section 3(38) investment manager? Advisors to retirement plans, the vast majority of which choose not to assume 3(38) fiduciary status, nonetheless may wish to have a good understanding of this issue so that they can educate their clients.

The Assertions in More Detail
Mutual fund companies do not have a fiduciary duty to investors in their mutual funds, but they do have a fiduciary duty to shareholders in those fund companies. That set-up characterizes Fidelity, for example, but it doesn't characterize Vanguard, because Vanguard does have a fiduciary duty to investors in its mutual funds; indeed, the investors in Vanguard funds are the same as the owners of that fund company. (The legendary John Bogle often speaks of the necessity for mutual fund management to be fiduciaries to the investors in their funds.) In the main, though, mutual funds are simply products whose management offers no fiduciary protection to those that invest in them. 

In the retirement plan marketplace, however, some providers of investment products assert that they are a fiduciary to their products—i.e., as a 3(38) investment manager—but only at the fund level. A simple example of this arrangement is a trust company that offers its own collective investment trust (CIT) in a retirement plan. This kind of provider would agree that it has fiduciary responsibility for the selection, monitoring, and replacement of the stocks and/or bonds that constitute the "guts" of its fund, that the fund is a prudent and suitable investment option for a retirement plan, and that the fees charged for the fund are reasonable. The provider can unilaterally make changes to the composition of the stocks and/or bonds of its fund without any approval or input from a plan sponsor.

Certain providers also assert that they can be a 3(38) fiduciary at the level of a plan's trading platform. In this kind of arrangement, it's typical, for example, that a registered investment company (RIA) or a trust company offers 3(38) investment manager services to a plan sponsor via a tri-party agreement among the RIA/trust company, the plan sponsor, and the plan's record-keeper. At the platform level, the plan sponsor agrees to use the services of a 3(38) to prescreen and assess the investment universe, sharply narrowing the list of prudent investment options to be made available to the plan. However, a 3(38) at the platform level doesn't select the investment options that will actually appear on the plan's investment menu. That duty is still left to the plan sponsor (or possibly another ERISA 3(38) that's charged specifically with selecting, monitoring, and replacing the investment options on the plan menu). Many major record-keepers provide this kind of arrangement.

But such providers ordinarily would not agree to be a 3(38) investment manager at the plan level (although some of these providers do carry out the discretionary selection/monitoring/replacing duties concerning the specific investment options on a plan's investment menu). They assert in their agreements with plan sponsors that the sponsors retain the ultimate fiduciary responsibility to determine what particular investment options will actually be offered on a plan's investment menu. As such, the sponsor would retain fiduciary responsibility (and liability) for the selection, monitoring, and replacement of the plan's investment options. For example, if a plan sponsor placed an S&P 500 Index fund and a money market fund on the platform, a provider such as a trust company would retain fiduciary responsibility for the underlying holdings in the S&P 500 fund, but it wouldn't be responsible for, say, the failure of the plan sponsor to provide sufficient investment options to permit participants to create a diversified portfolio. 

The Text of ERISA Section 3(38)
To help determine the validity of these assertions, let's turn to the text of ERISA section 3(38), which reads, in part:

The term "investment manager" means any fiduciary other than a trustee or a named fiduciary, as defined in [ERISA] § 402(a)(2) [29 USC § 1102(a)(2)]—

(A) who has the power to manage, acquire, or dispose of any asset of the plan;

(B) who (i) is registered as an investment adviser under the Investment Advisers Act of 1940; (ii) is… registered as an investment adviser under the laws of the State… in which it maintains its principal office and place of business…; (iii) is a bank, as defined in that Act [15 USC §§ 80b-1 et seq.]; or (iv) is an insurance company qualified to perform  services…under the laws of more than one State; and

(C) has acknowledged in writing that he is a fiduciary with respect to the plan.

It's worth noting that, by its terms, section 3(38) not only defines an "investment manager" as a fiduciary but defines it further as a fiduciary "to the plan" that's required to acknowledge such fact in writing. While this may (or may not) seem pretty straightforward, bear in mind that section 3(38) merely defines an investment manager, but it doesn't provide for the definition of a fiduciary. That would be the job of ERISA section 3(21)(A), which defines fiduciaries according to the different functions they perform for a retirement plan.

U.S. Department of Labor Advisory Opinion 2011-08A reads, in part: "Section 3(21)(A) of ERISA provides that a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan."

To actually be a 3(38) investment manager, then, an entity must first be a fiduciary within the meaning of ERISA section 3(21)(A). Since a 3(38) has discretion, though, it must more particularly first be a discretionary fiduciary within the meaning of section 3(21)(A)(i): "a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets."

(A fiduciary pursuant to ERISA section 3(21)(A)(ii) is not a discretionary fiduciary with decision-making authority for which it is responsible and liable but rather one performing an advice-giving function; that is, it "renders investment advice for a fee or other compensation, direct or indirect…" A fiduciary pursuant to ERISA section 3(21)(A)(iii) is, however, a discretionary fiduciary, but the functions it performs for a retirement plan concern "the administration of [the] plan," not the investment of plan assets, which is what concerns a 3(38) investment manager.)

Conclusion
A review of the relevant law leads to the conclusion that there is no such thing as a "mini-me" version of ERISA section 3(38), allowing a 3(38) to avoid status as a fiduciary to a plan. In fact, a sine qua non of section 3(38) is that an investment manager must "acknowledge in writing that [it] is a fiduciary with respect to the plan." So a provider of investment products that says it's an ERISA section 3(38) investment manager but only at the fund level or at the platform level is making a legally invalid assertion. All ERISA section 3(38) investment manager are, by (legal) definition, fiduciaries at the plan level. There doesn't appear to be anything in the law of ERISA that would allow any such product provider to limit its fiduciary role to the fund level or platform level; rather, it can only be at the plan level.

Having said this, though, ERISA provides that a delegator of duties to a 3(38) has the freedom as it sees fit to use, say, a light touch or, say, a heavy hand in how broadly or narrowly it wishes to shape the subject matter of a delegation. That delegator—a 402(a) named fiduciary (named in the plan document or someone who has been delegated the authority of a named fiduciary pursuant to a procedure described in the plan document)—appoints 3(38) investment managers. A 3(16) plan administrator or a 403(a) trustee, for example, could appoint 3(38) investment managers but only if it were also a 402(a) named fiduciary.

A 402(a) named fiduciary can use a "light touch" when it delegates narrowly drawn duties to a 3(38), such as making it responsible (and liable) only for the company stock investment option on a retirement plan's investment menu. Or a 402(a) can use a "heavy hand" when it delegates broad overall responsibility to a 3(38) investment manager for the selection, monitoring, and replacement of the investment options that will be on a plan's investment menu. So while every 3(38) is a fiduciary "to the plan" (and not merely to a fund or a platform), nonetheless its responsibilities and liabilities can be restricted or expanded according to the scope of the duties for which it was appointed.

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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