Client Service March 6, 2019

Clear Ground Rules Essential With 3(38) Fiduciary Clients

Experts share strategies for helping advisers taking on 3(38) fiduciary clients understand how they can set up the right processes and procedures—up front—for dealing with client concerns and questions about the investment menu.
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Art by Linda Liu


Phil Edwards is principal of Curcio Webb, a firm that helps both defined contribution (DC) and defined benefit (DB) plan sponsors identify the most appropriate service providers for outsourced 3(38) fiduciary investment management.

Besides consulting with plan sponsors, Edwards explains, a big part of this business involves working with the retirement plan advisers and other entities that provide Employee Retirement Income Security Act (ERISA) Section 3(38) outsourced fiduciary investment management services. Edwards says providers in this space are constantly reevaluating their service models to promote client outcomes and improve their own returns from a business growth and efficiency perspective.

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According to Curcio Web Chief Compliance Officer and Consultant Elliot Raff, it doesn’t happen very often that a plan sponsor client decides to go down the 3(38) investment outsourcing route and totally misunderstands what they are signing up for in terms of handing over fund menu discretion. However, there are occasionally some misunderstandings about the nitty-gritty details, which can be unsettling for clients and the adviser alike. As such, Raff highly recommends advisers moving into the 3(38) area put strong processes and procedures in place—up front—for dealing with client concerns and questions about their investment menus.

In their experience as 3(38) matchmakers, Edwards and Raff say there are two basic things advisers must do at the outset of this type of a relationship to prevent misunderstandings and even potential compliance lapses. The first and simper of the two agenda items is describing in sufficient and written detail all the specific duties and responsibilities being taken on by the 3(38) provider—as well as detailing in the same specific manner which responsibilities will remain with the plan sponsor client.

“We make sure to work with our clients to go way down into the weeds and create a very clear understanding of who is responsible for what decisions and on what timeframes,” Edwards says. “That clarity is critical. Of course, sometimes it’s going to be an evolving situation, especially with very large plans that may decide to almost do a trial period, where they delegate increasing portions of the responsibility to the 3(38) provider over time as confidence increases. This type of thing should also be clarified.”

The second and more subtle agenda item is to ask clients, what is the objective of the retirement plan and how will outsourcing the investment management support that goal?

“The adviser and the client must be able to answer the question of to what goals they are managing and how 3(38) service will be beneficial,” Edwards says. “This is important for DC plans but especially for DB plans that are bringing in an outsourced chief investment officer (OCIO). DC plans have a more straightforward and open-ended objective of growing participant accounts, while DB plans have much more variability in terms of time horizons and goals.”

Beyond these two points, Raff emphasizes the importance of making sure plan sponsor clients know the retirement plan committee must remain highly active even when a 3(38) manager is brought onboard.

“Plan sponsors must take as much time as necessary to understand these issues,” Raff says. “Advisers can help guide them by asking, what are the functions you want to hold onto? What functions are you comfortable handing over? And what functions do you really want to get rid of? Advisers and sponsors need to start dealing with these questions at the earliest stage of the outsourcing process.”

While Raff and Edwards say they have broadly had success finding appropriate fits between plan sponsors and providers of 3(38) services, some jobs require more up-front legwork than others.

“We occasionally see companies that may be thinking about jumping on the bandwagon without really understanding why or what it means to give over discretion to a 3(38) provider,” Edwards says. “They hear about outsourcing as a way to reduce their fiduciary liability and the amount of time they spend on the plan. We have to teach them that 3(38) outsourcing is much more involved than that.”

Edwards points out that, surprisingly, there is no strong correlation between plan size and the sponsor’s quality of understanding of the plan’s goals and objectives.

“We’ve met several multi-billion dollar plans where there has not been a well-defined goal,” Edwards says. “It’s not like the committee didn’t have the expertise to think about this stuff, they just haven’t had the time. And then we have much smaller plans that we meet that have clearly been able to spend a whole lot of time thinking about this—and so they are much better prepared to get started.”

Joe Connell, partner, retirement plan services, at Sikich Financial (and a former winner of a PLANSPONSOR Plan Adviser of the Year designation), says he has not had much experience with clients being confused about what 3(38) relationships entail—even though he has been offering 3(38) services for years.

“I have not had any issues with any client or participant asking for a fund we would not feel comfortable using,” Connell says. “You must set expectations up front and be very clear about the role of a 3(38) adviser and how this role does change the decisionmaking and fund evaluation process for the plan sponsor.”

Connell adds that the adviser should be mindful of whether a client is a good fit for 3(38) services. Some plan sponsors just won’t feel comfortable giving over discretion to an outside adviser, and that’s okay. These plans may be a better fit for 3(21) service, wherein the investment process is much more collaborative and discretion remains with the sponsor.

“The plan sponsors we assume 3(38) services for are looking to remove that decisionmaking from the committee level and looking to us to provide the expertise on fund decisions,” Connell explains. “So, they are very supportive of us saying ‘No,’ when we have to, to a fund addition that would not meet our investment policy statement criteria.”

In Connell’s experience, when a plan sponsor brings on an outside discretionary fiduciary under ERISA Section 3(38), the client is not necessarily trying to remove themselves entirely from all plan-related decisions. Instead the move is more about getting the right expertise in place for the challenging task of investment selection and monitoring, by the same token freeing up time for the plan sponsor to worry about other things.

“They are just looking to use our expertise in this specific area and allow themselves more time to focus on other plan related decisions and discussions,” Connell says. “They will be spending more time on plan design, participant services, education programs and other initiatives focused on their employees.”

Scott Matheson, managing director, defined contribution practice leader at CAPTRUST, echoes many of these points and says his firm continues to see tremendous growth in the demand for 3(38) services.

“In fact, nearly all of the adviser RFPs we filled out last year asked about 3(38) capabilities,” he says, “and many of those asked for 3(38) pricing, even if the intent of the plan sponsor issuing the RFP was the hire a 3(21) adviser. We have continued to invest in our resources and infrastructure to support the growth in our 3(38) business.”

To the question of friction points when hiring a 3(38), Matheson has a few additional thoughts.

“To the extent we see friction points with plan sponsors accepting a 3(38) engagement, it tends to come during the transition period as plan sponsor employees and/or committee members are settling into their newly evolved roles,” Matheson says. “Much of this, however, can be reduced or avoided by proper expectation setting and by advisers ensuring a good fit for plan sponsors before transitioning them to a 3(38) service model.”

Matheson agrees that plan sponsors that are very interested in the investment selection and monitoring process are likely not good fits to transition to a 3(38) approach and, as such, would likely experience more friction during a transition period. 

“We also find that 3(38) service models continue to vary considerably across the adviser community, with many advisers still accepting 3(38) assignments yet continuing to run investment decisions by plan sponsors before finalizing,” Matheson adds. “This is not much, if at all, different from how they were operating as 3(21) advisory fiduciary. The industry lack of a standardized service model/offering only adds to the potential for friction during transitions to 3(38) because expectations were often set during the adviser search/proposal phase of transitioning to 3(38).”

According to Matheson, part of the fuel behind the growth in 3(38) service can be tied back to the Great Recession of 2008 and 2009. He says the financial crisis forced many of CAPTRUST’s clients to reduce the headcount in their finance and human resources departments, and while the economy has improved significantly since that time, U.S. employers have not broadly added back the positions. Many companies, Matheson says, have fewer staff working on retirement plan administration as a result.

“Faced with financial market volatility, rising interest rates, regulatory scrutiny, and rising plan-related litigation activity, plan sponsors are looking for help managing their plans,” he says. “In some cases, they are turning to their plan advisers, asking them to do more on their behalf [as a 3(38) fiduciary].”

Matheson says it is important for retirement plan sponsors to understand that ERISA Section 3(38) does not define “investment advisers with discretion,” nor does it say “here’s a way to transfer more risk to your investment adviser.”

“Rather, it defines investment managers as distinct fiduciaries contracted with full discretionary authority over plan investments and making plan investment decisions,” he says. “An appropriately contracted and executed 3(38) arrangement frees the plan sponsor from the time involved in selecting and monitoring plan investment options and the liability associated with these decisions. As explained in ERISA Section 405(d), the plan sponsor and/or trustees of the plan are not liable for acts or omissions of the 3(38) investment manager, and are under no obligation to invest or otherwise manage any asset of the plan which is subject to the management of that investment manager.”

Plan fiduciaries must still monitor the work of the 3(38) manager to ensure plan participants and assets are being managed in a best-interest capacity, but that workload can be significantly lighter than managing the plan’s investment menu alone.

Compliance March 4, 2019

Changes the Retirement Plan Market Could See With Open MEPs

For retirement plan advisers, passage of open MEP legislation could change relationships with plan sponsors and providers, as well as create the need for new distribution models.
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Art by Pete Ryan


There are many proposed bills that would pave the way for the use of open multiple employer plans (MEPs)—arguably the most well-known being the Retirement Enhancement and Savings Act (RESA)—and these bills have wide bipartisan support.

Pete Swisher, senior vice president and national practice leader at Pentegra Retirement Services, in White Plains, New York, notes that MEPs are not exactly new; multiple employer plans have been in existence for many decades, but they require a common nexus, such as industry or locality, among the employers who participate. Legislation for open MEPs would remove that common nexus requirement.

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Lawmakers and retirement plan industry stakeholders support the idea of open MEPs, also known as pooled employer plans (PEPs), because they believe open MEPs will be cheaper plans for small employers and will improve employer-sponsored plan coverage among working Americans. But, how many have thought about the changes in the retirement plan industry open MEPs may bring?

In a webcast, Kelly Michel, chief marketing officer for Envestnet Retirement Solutions (ERS), based in San Jose, California, said, “My personal take is MEPs will be the next big disruptor for the retirement plan market. They will impact nearly every single stakeholder.”

Changes for plan sponsors

Swisher says the only fundamental difference between a MEP and a single employer plan is the pooling, especially the centralization of plan administration and governance. For example, rather than 100 plan sponsors each having their own plan document and each having to document committee minutes and file a Form 5500, there will be one governing plan document, one governing committee and one administrator filing a Form 5500. How exactly these mechanics work will depend on how the MEP plan sponsor puts its program together, he says.

Swisher says he likes an expression used by Michael Kreps, with Groom Law Group in Washington, D.C., who suggests that in crafting MEP legislation, lawmakers can take a “let a thousand flowers bloom” approach. His argument is that it is not necessary for the government to require a MEP to be run in just one way with one type of service provider. Instead, Congress can let providers innovate. There could be various structures of open MEPs—one that is centralized and homogenous for plan sponsors; one that is centralized, but offers choices that can be customized for employers; or even one that is not fully centralized and keeps some plan governance actions with employers.

“We probably can’t predict all the different variations that will emerge,” Swisher states.

Michel says employers currently have lots of options to outsource fiduciary responsibilities, but when they have the opportunity to participate in an MEP and completely shift the risk of day-to-day plan management, it could create a new way of thinking for plan sponsors. “Most of the time, if they can lay off risk, they will,” she says.

For this reason, Michel believes the conventional wisdom that MEPs will be a path for small employers is short-sighted. She contends that among large plans, there is not a lot of variance in plan design; there are some with special provisions, but with the introduction of automatic plan features, the uniqueness of plan designs has diminished. “If you’re a large plan sponsor, and 80% of your plan provisions are similar to that of a MEP, you’ll weigh the uniqueness of your plan against the risk of maintaining it yourself,” she says. Michel believes that, as better solutions evolve, all plan sponsors will evaluate shifting their responsibility to another entity.

Changes for plan advisers

Swisher says one of the flowers that may bloom will be a MEP with no advisers, “Those plan sponsors will get a different service experience—via mobile technology or phone—there will be no hand holding by an adviser,” he says.

However, he questions how such a MEP will be distributed and served. Swisher believes the adviser community is what gets plans distributed. “The notion that plans will distribute themselves has been proven false,” he says. “If we’re talking about closing coverage gaps, MEPs would have to cover plans for a very large number of employers. Even if there are state mandates, there will be no action without people to spur action along. Distribution is important to this.”

In addition, according to Swisher, some lobbying groups are trying to make sure open MEP legislation includes a provision that employers are responsible for selecting the fund options for their participants. If that happens, there will be different fund menus within an MEP, and there will be advisers helping employers.

However, Swisher does see the possibility for disintermediation. Current plan sponsors may each have advisers serving in various capacities, but if these plan sponsors join a MEP, there will be just one committee and perhaps just one adviser for all employers.

Michel says advisers will look to MEPs to deliver better solutions at a better cost structure. “Retirement plan advisers only have so many hours in a day, and they have to decide how to spend their time and with whom. They may have 100 clients and run investment reports quarterly with different parameters. To drive efficiencies, they will look to MEPs.

In addition, Michel says with large broker/dealers (B/Ds) not completely in the retirement plan market and not really knowledgeable about plan design, MEPs will provide more supervision. “A large organization with 20% of advisers focused on retirement plans and the rest who are really wealth managers—retirement plans are not their core focus—MEPs can bring them supervisory needs and professionals. It will help B/Ds deliver products to help advisers have guardrails to deliver what they are comfortable with,” she says. “It will help large advisory firms expand the number of advisers working in the retirement plan space without having to be knowledgeable about every aspect of the retirement plan market and steer them from making bad choices.”

Changes for plan providers

Both Swisher and Michel believe the use of technology has the ability to change how a retirement plan is managed. Swisher says open MEPs may accelerate the use of technology—but also create a less personal experience for plan sponsors and participants. Will technological ability drive what entity sponsors an open MEP?

Retirement plan recordkeepers are often risk averse and may not be the first to raise their hand to sponsor an open MEP, but once one does, there will be a reaction from the rest of the market, Michel says. Large recordkeepers will have an advantage—they will have captive clients, they can streamline a way to deliver services and they can deliver product solutions geared more toward turnkey support, she adds.

“Recordkeepers could be the biggest market disruptor. We’ve seen over the last decade more recordkeepers taking on 3(16) administrator duties; it is not far beyond that to sponsor MEPs,” Michel says.

Recordkeepers sponsoring open MEPs could lead to more disintermediation. For example, Michel says, if a defined contribution investment only (DCIO) provider is not on the list of options available for the plan, it can be disintermediated for a large part of that recordkeeper’s business. Likewise, if a recordkeeper that sponsors an open MEP was partnering with third-party administrators (TPAs), they could be disintermediated.

But, open MEPs may also mean a chance for more innovation, as MEP sponsors try to differentiate themselves in the market. For example, as Swisher mentioned, some lobbying groups are trying to make sure open MEP legislation includes a provision that employers are responsible for selecting the fund options for their participants. This could create more diversity of funds, more diversity of sales efforts and the notion of giving participants more choice.

In addition, Michel notes that the focus of much retirement plan market innovation has shifted from accumulating assets to helping employees with asset decumulation in retirement. “Open MEPs could be a new opportunity for more focus on how to deliver more robust solutions and engage more advisers,” she says.

Michel suspects that an entity outside of the retirement plan market could join it to sponsor an open MEP. Google and Amazon, for example, have the technology and are always looking for ways to add value.

Swisher believes there will also be different types of fiduciary service providers. “A service provider can’t sponsor a MEP, decide its own compensation, and tell employers, ‘You can leave the MEP, but you can’t change my compensation.’ That is a clear prohibited transaction under the Employee Retirement Income Security Act,” he says. He adds that after open MEP legislation is passed, there will need to be regulatory action including prohibited transaction exemptions and provisions for who will be the fiduciary of an MEP.

“I have been saying for years, and continue to believe, [open MEPs] are poised for major growth. But, the entire industry will not be reshaped overnight, and it won’t be a complete toppling of the order of the day. Everything will happen gradually,” Swisher says.

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