Journey to Financial Mastery: HANDS

You have probably heard by now that the new DoL fiduciary rule, slated to go into effect on Monday April 10^th, has had implementation pushed back to June 9^th. The short version of this rule is that it requires any advisor who oversees IRA money on behalf of clients to function in a fiduciary role. The rule has been especially disturbing to the brokerage and annuity industry.

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To the financial profession however, this ruling is long overdue. The rule brings to bear on the retail side, guidelines similar to those which have been in place for many years for those who interact with employer sponsored retirement plans. And of course the most common employer sponsored retirement plan is the 401(k) plan.

The Employee Retirement Income Security Act of 1974 (ERISA), as amended with TRA ’86, and other legislation, is the primary governing legislation when it comes to how retirement plans function. The Department of Labor (DoL), through its Employee Benefit Security Administration, is responsible for generating regulations which interpret the legislation.

ERISA defines several types of fiduciaries, and DoL and the EBSA continue to interpret these definitions. DoL and the EBSA continue to encourage plan sponsors, and those who make decisions on behalf of plan sponsors, to assure that the plan is managed exclusively for the benefit of participants and their beneficiaries, and that the plan is managed with a prudent, documented, process.

ERISA identifies three broad categories of fiduciaries who may interact with retirement plans. They are defined in Sections 3(16), 3(21), and 3(38).

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A 3(16) fiduciary acts as the plan administrator. These administrative functions are varied and many, though they fall into the broad categories of maintaining and interpreting the plan document, providing all required disclosures to participants, providing benefit statements to participants, complying with all government reporting, ensuring timely deposits of participant contributions, and overseeing the plan investment menu.

Some specialty firms within the 401(k) service universe would purport that they could or can provide all these services, therefore relieving the employer of some or all fiduciary liability. Whether the employer/plan sponsor chooses to outsource some of these administrative services or not, it is our professional opinion that no service provider, regardless of what they propose, can shift all fiduciary liability away from the plan sponsor, and the executives that act on behalf of the plan sponsor.

We seldom suggest that a plan sponsor pay a separate fee for 3(16) fiduciary services, as we remain unconvinced that this offers any real handoff of fiduciary responsibility.

Section 3(21) has a broad definition and a narrow definition. The broad definition of Sec 3(21) says that anyone who offers guidance or input to the 401(k) plan, or has decision making authority relative to the plan, is considered a fiduciary. This would and could include owners and officers of the plan sponsor, members of the investment committee, financial advisors and consultants, institutions who oversee compliance and some administrative functions, and legal counsel, among others.

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The financial institutions/asset managers in the marketplace who offer 3(21) services do not and almost always will not use this broad definition, nor do they mean to imply this broad definition, in their service offerings, or the language which defines these service offerings.

The narrow definition of 3(21), which almost all financial institutions and asset managers use, applies to investment selection. The narrow definition of 3(21) says that the financial institution will make recommendations about which funds are appropriate, though plan trustees, or the investment committee charged with this responsibility, have the final decision. This is often referred to as non-discretionary authority, as the 3(21) fiduciary makes recommendations, but does not make the final fund or investment selection.

It is common for the insurance based providers to offer the narrow definition of 3(21) services, and less common for the asset managers or mutual fund shops to offer the narrow definition 3(21) services.

Then, we come to what’s called a 3(38) fiduciary. A 3(38) fiduciary makes decisions on which funds to use. The 3(38) fiduciary doesn't go to the plan sponsor investment committee for approval. They make the decision on which funds to use, and replace them as they see fit. This is often referred to as discretionary authority.

However, a 3(21) or a 3(38) fiduciary can offer services to different entities. These fiduciary services can be offered at the platform, the plan, the portfolio, or the participant level. This is a part of the fiduciary offering which can be confusing to plan sponsor decision makers, as ascertaining what is actually being offered isn’t easy.

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We have noticed that some vendors offer 3(38) services. When reading the detail, we find that what they are offering is to approve and select that large group of funds which are available on their platform. This is the large body of funds which are approved for all plans offered by the financial institution, and which are appropriate for any plans served by this institution. This is the most common level of 3(38) fiduciary services, and the one which comes with the least risk to the organization offering the service. It is often provided at no additional cost, over what is already being paid for the existing service suite.

A second level of 3(38) services is deciding, for the plan sponsor, which funds will be used for their specific plan. This is a less common form of 3(38) service. When it is offered or available, it is typically available for an additional charge or cost.

A third level of 3(38) services is at the portfolio level. Many plans offer either age-based or risk based portfolios, as the majority of participants find this the simplest way to participate in the plan. It is our belief that any financial institution which offers age or risk-based portfolios, and also chooses which funds and allocations are appropriate for those portfolios, serves as a 3(38) fiduciary at the portfolio level.

A fourth level of 3(38) services is at the participant level. There are firms which specialize in custom built portfolios for participants. These generally require a separate acknowledgement or agreement by the participant, of the services being offered. And participants pay separately for these services, typically some percentage of their plan assets, if they choose to use this service.