The Frugal Fiduciary Blog

Hiring an ERISA 3(38) Investment Manager can be the simplest way to limit 401k investment liability.

Posted by Greg Carpenter on Oct 15, 2014

401k investment liability 401k Investment Liability

In recent years, several high-profile lawsuits have alleged that employers violated their fiduciary duty to prudently select and monitor the investment options offered in their 401k plans. These lawsuits have targeted larger plans, but the fiduciary standards cited apply equally to both large and small business retirement plans.

Because employers want to avoid 401k litigation, which could result in personal liability for fiduciaries, many employers are seeking ways to manage the risks associated with serving as a fiduciary, and, specifically, ways to help mitigate the risks that arise from selecting and monitoring their plan’s investment lineup.

Delegating control of a 401k plan’s investment lineup to an “Investment Manager,” as defined by section 3(38) of ERISA, can be one of the easiest and most effective ways an employer can minimize their liability for poor investment selection and monitoring decisions.

Meeting the “Prudent Expert” Standard

401k fiduciaries are held to an extremely high standard— the “prudent expert” standard. Under this standard, a plan fiduciary must act: “. . . with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use . . .”

ERISA’s standard of prudence for fiduciaries is not that of a prudent layperson, but rather that of a prudent investment professional. A lack of familiarity with investments is no excuse. If fiduciaries are unsure what to do, they are expected to retain professional advisors to make recommendations.

Types of Professional Advisor

When plan fiduciaries decide to hire a third-party professional advisor to assist with investment decisions, they generally have 3 types to choose from: 1) consultants, 2) investment advisors, and 3) investment managers. Each type assumes a different level of fiduciary liability.

Consultant – Assumes no fiduciary liability for investment recommendations. Hiring a consultant helps to mitigate risk because it demonstrates plan sponsors have taken that extra step to contribute to a deliberative process. However, because consultants do not have discretionary authority and are not plan fiduciaries, the plan sponsor retains full fiduciary responsibility.

ERISA 3(21) Investment Advisor – Assumes co-fiduciary liability. Has a fiduciary responsibility to deliver prudent investment advice consistent with ERISA’s fiduciary standards. While an investment advisor is liable for the investment advice they provide, the plan sponsor retains the ultimate decision-making power over plan assets. That said, the plan sponsor is not relieved of fiduciary liability for selecting and monitoring the plan’s investment options.

ERISA 3(38) Investment Manager – Assumes sole fiduciary liability for investment selection and monitoring. Hiring an investment manager offers the plan sponsor the greatest protection from claims related to poor investment selection and monitoring decisions. The plan sponsor’s liability is limited to selecting and monitoring the investment manager.

Hiring an ERISA 3(38) Investment Manager

The fiduciary protection provided to a plan sponsor who utilizes an investment manager is not absolute. The plan sponsor is still responsible for prudently selecting and monitoring the investment manager. Accordingly, the sponsor must select an investment manager prudently, taking into account the manager’s qualifications and all other relevant factors.

Investment managers require a specialized understanding of retirement plan rules to meet their fiduciary obligations under ERISA. An investment manager’s ERISA qualifications are even more important than investment experience or past performance. Fiduciaries don’t get sued for investment performance, they get sued for imprudent investment selection.

Not all investment managers offer the same services. Some offer plan-level and participant level services while others offer plan-level or participant-level services. Plan-level services include Investment Policy Statement (IPS) preparation and ERISA 404(c) assistance while participant-level services include model portfolios and investment education.

Can You Let Go?

Once appointed, the investment manager becomes the sole decision maker for investment selection and monitoring. In other words, the plan sponsor generally has no say in matters concerning plan investments. Input from the plan sponsor may negate the fiduciary protection sought by the sponsor.

This can be a hard thing for some plan sponsors to do. That said, the trade-off could be well worth it – reduced fiduciary liability while giving employees access to professional investment advice.

Topics: ERISA 3(38) Investment Manager, small business retirement plans, 401(k) Investments, 401k blog, ERISA 3(21) Investment Advisor, small business 401k, 401(k), Investment Policy Statement (IPS)

Written by: Greg Carpenter

Greg Carpenter founded Employee Fiduciary in 2004. With 29 years of experience in accounting and finance, Greg has brought his expertise to a variety of advisory, senior and executive management roles. Greg has worked for a national accounting firm, a Fortune 500 plan sponsor, a major brokerage firm, and he served as the CEO of a major 401k TPA firm. He is a CPA and earned his BA from Yale and his MBA from The University of Chicago Booth School of Business.

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