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Concerning a Third-Party ERISA Section 3(38) Investment Manager

Retaining a third-party 3(38) that is not independent of a record-keeper can result in an inferior and conflicted process.

W. Scott Simon, 03/06/2014

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.


Last month's column generated some blowback concerning my comments about third-party investment managers that are retained pursuant to section 3(38) of the Employee Retirement Income Security Act of 1974 (ERISA). I contended that such investment managers typically deliver services that are inferior in value and protection compared to independent (i.e., non-third party) 3(38) investment managers.

This month's column will delve into the contractual language drafted by a well-known third-party 3(38) to help underscore my contention. Analysis of that language shows how a plan sponsor deciding to retain this third-party 3(38), which is not independent of a record-keeper--instead of a 3(38) that has no dependence on any record-keeper--could subject the plan participants (and their beneficiaries) for which it has fiduciary responsibility to an inferior and conflicted process. Before engaging in that analysis, though, let's get back to some basics about ERISA section 3(38).

Fiduciary Status Pursuant to ERISA Section 3(38)
The text of ERISA section 3(38) 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)…(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; 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."

ERISA states that a trustee, a named fiduciary, the plan administrator, an investment manager, or anyone else (as relevant) will be deemed to be a fiduciary of a qualified retirement plan to the extent that the person (1) exercises any discretionary authority or control in the management of the plan or disposition of the plan's assets (ERISA section 3(21)(A)(i)), (2) can or does render investment advice for a fee (section 3(21)(A)(ii)) or (3) has any discretionary authority or control in administering the plan (section 3(21)(A)(iii)).

The assessment of whether or not an entity that deals with a qualified retirement plan is to be deemed a fiduciary under ERISA requires such entity, in effect, to fit through at least one of the three preceding funnels contained in ERISA section 3(21)(A). This is also true even in cases where a particular ERISA statute actually specifies that an entity is a fiduciary. By relevant example, section 3(38) identifies an investment manager as a fiduciary. Nonetheless, an investment manager must first qualify as a fiduciary under ERISA section 3(21)(A)(i) by assuming duties concerning discretionary authority or control in the management of a plan or disposition of the plan's assets.

The Contract
A review of the contract drafted by a well-known third-party 3(38) investment manager between it and a plan sponsor reveals some germane issues that follow.

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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