Getting Your Bearings
In an era of increasing regulatory and fee burdens, it makes sense for more advisers to become fiduciaries. “A lot of this [taking on fiduciary status] goes back to fee compression resulting from the Department of Labor [DOL] putting pressure on sponsors and other fiduciaries to keep costs low,” says Jeffrey Zimon, founder and president of law firm Zimon LLC in Cleveland. “So advisers are saying, ‘What additional services can I offer to relieve the company of some duties it doesn’t want anyway?’ And some advisers were performing some of these functions already. Now they are saying, ‘Well, we were doing a lot of this stuff anyway. Shouldn’t we articulate it and help legitimize our fee?’”
The following is a rundown of what advisers can expect if they assume 3(16), 3(21) or 3(38) fiduciary status.
The 3(16): Focusing on Administration
In its role as a 3(16), The Retirement Readiness Institute, an independent registered investment adviser (RIA) headquartered in Boca Raton, Florida, assumes responsibility for a plan’s day-to-day administration. “We step into the plan sponsor’s shoes,” says Managing Director Craig Freedman.
As a 3(16), the advisory firm ensures, for example, that participants get enrolled into the plan at the proper time and that employees receive the proper plan information prior to enrolling. It monitors contributions to a plan to certify their timeliness and oversees all of the plan’s service providers other than itself. The advisory firm also makes sure the plan complies with 408(b)(2) fee-disclosure rules, and it reviews and signs the plan’s annual Form 5500 document.
Which administrative duties a 3(16) handles can vary considerably from case to case, as no standard lineup of 3(16) services exists, Zimon says. “It really does depend on how the services are defined in the agreements and contracts that govern the relationship,” he says.
What does a 3(16) not do? Many of the advisers Zimon works with who serve as 3(16) administrative fiduciaries also function as 3(21) investment fiduciaries. However, the 3(16) has no fiduciary involvement with investments, so the adviser’s contract with the sponsor must clarify this.
The Retirement Readiness Institute specifies its fiduciary role in its service agreement with a plan, but the sponsor itself, rather than the advisory firm, remains the named fiduciary in the plan document, Freedman says. That means the institute is subject to the authority of the named fiduciary, reducing the risk of misappropriation of plan assets, he explains. However, he adds, it otherwise can perform a full range of fiduciary tasks on plan administration.
In some cases, plan sponsors may choose to retain some 3(16) administrative responsibilities, which could be fiduciary or nonfiduciary, Zimon says, noting that, in all cases, sponsors must monitor the 3(16).
“[The sponsor’s] responsibilities are really focused on the hiring, evaluation and monitoring of those it hands that responsibility over to,” Freedman says. As a 3(16), his firm oversees other providers but cannot oversee itself. “We go through a process with plan sponsors so that they are able to evaluate our services,” he says. The Retirement Readiness Institute issues documents to each sponsor twice a year, detailing the services it has provided to that plan and its participants, and also gives the sponsor benchmarking data that compares the fees it has charged with those of similar firms providing similar services.
Fees for advisers serving as fiduciaries vary, depending on a number of factors, including plan assets, services provided and the competition for that business, Zimon says. “Certainly if the adviser was taking on 3(38) responsibility, that would command a higher fee, because there is more responsibility,” he says. “If an adviser was adding a 3(16) role to a 3(21) role, that adviser could command a higher fee, of course, until the next provider offers that add-on for free.”
Adviser Robert C. Lawton, president of Lawton Retirement Plan Consultants LLC in Milwaukee, offers this summary of current fee levels: “It has become fairly standard to charge 2 to 3 basis points [bps] for 3(21) services, subject to a minimum for small plans,” he says. “I have seen charges for 3(16) and 3(38) services vary between 10 and 20 basis points, based on plan size.”
The 3(21): Making Investment Recommendations
Unlike a 3(16) fiduciary, with its administrative focus, a 3(21) concentrates on a plan’s investments. The 3(21) adviser “recommends specific investments or changes to investments and provides support, with an appropriate level of due diligence and documentation,” Zimon says. Consistent with the Employee Retirement Income Security Act (ERISA)’s expectation that a 3(21) fiduciary act reasonably, the 3(21) also has a responsibility to meet with the sponsor client on a periodic basis, usually biannually or quarterly, he says.
When it works as a 3(21), Stiles Financial Services Inc., in Edina, Minnesota, does investment reviews for the sponsor and advises it when a fund in its lineup has a significant development such as performance lagging the benchmark, says Susan Stiles, the company’s president. That fund goes on the watchlist in accordance with the investment policy statement (IPS), and then Stiles Financial does an in-depth search for potential replacements, should the fund’s situation fail to improve over the next few quarters. Ideally, the adviser would present three to five viable replacement-fund options to the plan investment committee, then provide a detailed discussion of the pros and cons of each, as well as the differences among them. The committee votes on which fund to choose. Stiles Financial does not make the decision, or even serve as a voting member of any plan committee, but often will share its opinion.
What does a 3(21) fiduciary not do? It is critical to realize that a 3(21) adviser cannot make investment decisions for a sponsor. “A 3(21) investment fiduciary is not doing anything other than providing advice with respect to investment selection by the sponsor,” Zimon says.
When talking to plan sponsors, Adam Pozek, a partner at DWC ERISA Consultants LLC in Boston, likes to explain how 3(21) and 3(38) investment fiduciaries differ in responsibility, by using a driving analogy: “A 3(21) adviser is more like a GPS device you have in your car. You put in the address, and the GPS says, ‘This is the best way to get where you want to go.’ But you are free to override those directions and follow a different route,” he says. “With a 3(38), it is more like hiring a chauffeur. The chauffeur has to decide how to get there, where to turn and how fast to go. It’s up to you as the passenger to make sure you make a wise choice in hiring a chauffeur. But, ultimately, you are not driving the car.”
So in a 3(21) scenario, a sponsor makes the ultimate call on investments. “The plan sponsor is the final decisionmaker relative to any investment changes,” Lawton says.
A plan sponsor also has a duty to regularly evaluate the 3(21), and Lawton believes the fiduciary adviser can help by offering a written review of his work. “A 3(21) fiduciary should provide documentation to the plan sponsor, showing a logical path to the [investment] recommendations,” he says. “Most importantly, the 3(21) fiduciary should be providing reports that the plan sponsor can understand. A plan sponsor should [then] review these reports to determine whether a prudent, logical, unbiased selection process has been used.”
The 3(38): Taking Investment Discretion
Unlike in its 3(21) role, as a 3(38) adviser, Stiles Financial makes investment decisions about portfolio allocations as it builds custom risk-based or target-date portfolios for plans. The firm talks with the sponsor about key issues—employee demographics and investing sophistication, for example—before creating asset-allocation models. Then, as a 3(38), Stiles Financial makes decisions on an ongoing basis about investment issues, such as the strategic asset-allocation and tactical asset-allocation adjustments. However, it informs the sponsor of those decisions before making any change.
“The 3(38) has direct responsibility not only for investment selection but for that selection being prudent,” Zimon says. “The 3(38) investment manager is making the discretionary call.” So if a participant subsequently sues over investment performance or fees, he says, “the 3(38) would be on the hook.”
Some firms such as The Retirement Readiness Institute will take on both the 3(38) fiduciary role for investments and the 3(16) fiduciary role for administration. But otherwise, with its focus on investments, a 3(38) fiduciary remains uninvolved in other aspects of plan management such as design, administration and retirement-readiness concerns. “A 3(38) adviser can provide advice and guidance in all of these areas, provided he or she has the expertise,” Lawton says. “However, a 3(38) adviser would not be providing any fiduciary protection for the plan sponsor in these areas relative to the advice shared.”
Depending on an adviser’s arrangement with a particular sponsor, a 3(38) fiduciary may utilize its discretion only at the plan level, not the participant level, Freedman says. But some firms, such as The Retirement Readiness Institute, provide services that include engaging participants one-on-one in the retirement-readiness process, in addition to functioning as a 3(38) at the participant level by managing participants’ accounts for them.
While the fiduciary adviser’s tasks may vary somewhat from plan to plan, Freedman says that advisers serving as fiduciaries need appropriate protection: a fidelity bond as well as insurance coverage for fiduciary liability and errors and omissions (E&O). “If the E&O policy includes fiduciary-liability coverage, then it will specifically state what liability it is covering,” he says. “One cannot assume that it provides coverage, or that the coverage it provides covers all related fiduciary instances. The devil is in the details.”