PLANADVISER - Summer 2023 - 35

Viewpoints
Do 3(38)s Assume More Risk?
The answer may not be what you'd expect
SERVING AS A 3(38) investment adviser has
become a mainstay for many talented financial
professionals. Others are still troubled by
the additional responsibility imposed by 3(38)
status, compared with acting as a 3(21), and go
no further than offering advice to sponsors. In
reality, the assumption of primary fiduciary
duty for plan investments is unlikely to result
in increased actual liability.
The Basics
What the industry calls a 3(38) relates to the
first prong of the Employee Retirement Income
Security Act Section 3(21)-i.e., one who
manages the plan investments. This investment
manager is a special type of plan fiduciary,
as defined in ERISA Section 3(38). An
investment manager has been specifically
appointed to have full discretionary authority
and control to make the actual investment
decisions. The manager may select, monitor,
remove and replace the investment options
offered under the plan.
Only certain types of financial institutions
may be appointed as a 3(38) investment
manager. It's important that service agreements
be carefully drafted to provide for
both the appointment of a 3(38) and for the
acknowledgement of fiduciary status.
Once properly appointed, the 3(38) has full
fiduciary responsibility for the plan's investment
decisions, subject to the plan documents
and investment policy statement. The
sponsor and other fiduciaries are relieved of
all fiduciary responsibility for the investment
decisions the manager makes. The sponsor
must still monitor whether the manager is
performing the services but need not secondguess
the 3(38)'s investment decisions.
This
shifting of
fiduciary responsibility
is the key distinction, and core advantage, of
using a 3(38) investment manager. In the face
of ever-increasing litigation and heightened
regulatory scrutiny, many sponsors want this
extra layer of protection, especially if they're
uncomfortable making the plan's investment
decisions themselves.
Ultimate Authority
The 3(38) is a trained, licensed and presumably
highly skilled investment professional. A
firm's chief compliance officer may require
more experience and credentials to allow an
adviser to act as a 3(38). This adviser has many
resources available to study investment performance
and maintains sophisticated tools to
monitor investments available to a plan. The
3(38) manager also has established relationships
with fund providers to surveil potential
investments. The manager's services are often
benchmarked against industry peers'.
The plan sponsor, or other fiduciary responsible
to manage the investments, is engaged in
another business and may or may not have
investment experience or current investment
knowledge. Despite this,
the plan fiduciary
has ultimate authority to " pull the trigger "
and choose the plan's investments. The 3(21)
investment adviser may provide well-reasoned
recommendations as well as reports to support
those recommendations, any of which the
sponsor could fully reject for any reason at all.
When the 3(21) shares fiduciary responsibility
with the nonprofessional, the adviser's
risk becomes entangled with decisions made
by a novice. And when that novice makes a
mistake, he may look for someone to blame.
The facts surrounding what was recommended
can become confusing. The 3(38), however,
stands alone in complete clarity about what
investments were selected and will be held to
a purely professional standard of care. That
seems to be the better position to defend.
Insurance Coverage
When 3(38) services became more popular,
many fiduciary liability insurance carriers
were skeptical of the perceived increased risk of
the manager and excluded 3(38) discretionary
services from standard insurance coverage.
Special riders or policies were required to
insure the risk. Current policies typically cover
these services, but advisers are encouraged to
confirm that they have no major coverage gap.
Even though the 3(38) assumes sole investment
authority, the 3(21) adviser may actually
face a higher risk of fiduciary liability.
Kimberly Shaw Elliott is a partner in The Wagner Law Group. She engages
in a multidisciplinary practice helping clients navigate the complex intersection
of ERISA, securities law, broker/dealer regulation and tax regulation.
When the
3(21) shares
fiduciary
responsibility
with the
nonprofessional,
the
adviser's risk
becomes
entangled
with decisions
made
by a novice.
Awards & Innovation | Summer 2023 | planadviser.com 35
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PLANADVISER - Summer 2023

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