More plan sponsors are asking third parties — including you, as their plan’s financial advisor — for assistance when it comes to selecting and monitoring retirement plan investment menus. Whether you decide to be or not to be a fiduciary probably depends on several factors, not least of which is: Are you able or willing to serve as a fiduciary?
Assuming you’re able to serve as a fiduciary, you may wish to ask yourself if this is a service that:
- All your plans will value and need?
- Is scalable so you can continue to build your retirement plan practice efficiently?
- You should spend your limited and highly valuable time on?
If the answer to any of these questions is no, it may make more sense to operate as a nonfiduciary and align with a third party to provide fiduciary investment selection and monitoring services. And since many advisors are turning in this direction, our industry has seen the rise of third-party fiduciaries willing to take on this role.
In a Nutshell
Providers who offer these services are considered “investment advisors” and typically serve in one of two fiduciary capacities for a client’s retirement plan:
- ERISA 3(21) investment advisor: The investment advisor makes recommendations, but the sponsor makes the decisions and approves the recommended changes.
- ERISA 3(38) investment manager: The investment advisor has full discretion and serves as the final authority over plan investment decisions.
In short, the key difference between a 3(21) and 3(38) fiduciary is who retains discretion over investment menu decisions.
Note: Choosing a fiduciary is, in itself, a fiduciary act that requires prudent selection, monitoring and evaluation of services provided and the fees paid for them. As such, the named fiduciary — typically the plan sponsor or an investment committee — is never completely relieved of fiduciary responsibility.
Evaluating Third-Party Fiduciary Services
Although third-party fiduciary services may appear to be similar, a closer look can reveal important differences. How the contracts are arranged, the pricing methodology and, most important, the investment screening methodology can vary substantially. To assist you in helping sponsors conduct their own due diligence when assessing third-party fiduciaries, consider the following pertinent questions and commentary:
- How long has the provider served in this capacity?
- What depth, strength, experience and accreditation does its staff have?
- Is the third party affiliated with a broker-dealer or other sales organization?
- Can you explain the investment screening methodology?
- Is that methodology too focused on the short term? Basing investment decisions on short-term results can be imprudent and disruptive. Too-frequent changes in the investment lineup could force participants to buy high and sell low (as investments come and go) and can add to the administrative burden.
- How is the service priced — are there any confusing or hidden fees? Pricing for third-party fiduciaries will likely be a topic of discussion each year when the plan sponsor reviews the now-required service-provider fee and service disclosure.
Possible bias or conflict of interest
- Who pays the third-party fiduciary? If the sponsor pays the plan provider, who may have proprietary funds in the plan, could it be considered a conflict of interest?
- Is the cost of the service buried in the recordkeeping fees or investment expense ratio? If so, plan sponsors who don’t subscribe to the fiduciary service are, in effect, subsidizing those who do subscribe.
- What does — and doesn’t — the service cover? Generally, third-party fiduciary services indemnify the plan for losses (including reasonable attorney’s fees) attributable to a breach of fiduciary duty. For example, if investment recommendations are deemed to be imprudent, financial judgments against the plan would be covered. These services, however, won’t indemnify the plan for judgments against platforms, plan operations, fees, participant education, qualified default investment alternatives (QDIAs) and participant notifications.
Plan support and benefits
- Does the fiduciary service offer a fail-safe option? A 3(21) program with an automatic-execution option helps avoid lapses of coverage if the plan sponsor inadvertently fails to act on the service provider’s recommendations.
- Does the program have a carve-out feature? A program with a carve-out feature permits inclusion of noncovered investments in the plan menu without voiding the entire agreement.
- How difficult will it be to make the transition to the fiduciary service? Does the program offer an accurate mapping process to make it easier to move assets from the current plan lineup to the new, covered plan lineup? Ask if the provider can map current investments to like investments during the transition to help reduce the administrative burden.
Educating Sponsors About Their Fiduciary Duties Can Pay Off
However you choose to help your clients select and monitor plan investments, you may find encouragement from a recent survey of plan sponsors.
Chatham Partners found that helping to educate plan sponsors about their fiduciary obligations, whether delivered in person or facilitated through a third party, resulted in higher sponsor loyalty (by 6 percentage points) and a lower risk of losing the plan (by 4 percentage points).
This may be particularly important considering the recent DOL announcement that it plans to “substantially increase the number of ERISA compliance audits it conducts each year.”
“That announcement may strike fear into the hearts of many HR professionals, particularly those responsible for this area,” reports Human Resource Executive Online. “While experts and advisors don’t believe that companies or their staff members are deliberately doing things incorrectly, they do believe that significant opportunities for error — and audit — exist.”
Be True to Your Practice
For some advisors, the decision not to serve as a fiduciary — opting instead to help meet a plan sponsor’s investment selection and monitoring needs through a third-party fiduciary — may be based on restrictions associated with broker-dealer policies or preferences. For others, the decision may be driven by the plan sponsor’s preferences, or practice needs or requirements.
Fortunately, the rise of third-party fiduciary service providers has added even more diversity to the repertoire of services you can draw upon to meet more plan sponsor and participant needs.
Since not all plans will need or value all services, it may be worthwhile for you to develop a customized value proposition statement for each practice segment.
Not all broker dealers allow fiduciary services in every capacity. Please check with your dealer home office for approval when choosing a fiduciary service program.