Both numbers refer to sections of ERISA that define fiduciary advice, but their meanings are very different. While ERISA section 3(21) actually describes the different types of plan fiduciaries, it is commonly used—at least conversationally—to refer to non-discretionary fiduciary investment advisers. In other words, and in the context of retirement plans, e.g., 401(k) plans, it refers to a fiduciary adviser who makes recommendations to a plan’s primary fiduciaries (often a plan committee) about the selection, monitoring, removal and replacement of investments in a plan’s lineup. On the other hand, section 3(38) is used to refer to discretionary investment managers. In other words, a 3(38) investment manager would actually select and monitor the investment lineup for a 401(k) plan. In addition, a 3(38) would remove and replace investments without needing to go to the plan’s fiduciaries for approval. 

To add some perspective to that, the primary fiduciaries in the 3(21) scenario are the plan committee members, and they engage a 3(21) investment adviser to help them with the investments. But, in a 3(38) setting, the primary investment fiduciary is the 3(38).

These differences affect the fiduciary responsibilities of plan committees. If a plan committee uses a 3(21) nondiscretionary investment adviser, the committee must prudently select and monitor the adviser and must make prudent decisions about the plan’s investments, with help from the adviser. But, with a 3(38) discretionary investment manager, a committee must prudently select and monitor the investment manager, but is not responsible for the investment decisions. In this sense, the committee’s duty to monitor is less burdensome if a 3(38) investment manager is used.

There may also be differences in the development of a plan’s investment policy statement (IPS). Where a committee works with a 3(21) adviser, the adviser typically helps the committee make investment policy decisions and document those decisions in an IPS. The 3(21) adviser must then follow the IPS in formulating its recommendations to the committee about the selection, monitoring, removal and replacement of the plan’s investments.

On the other hand, 3(38) investment managers for 401(k) (and ERISA 403(b)) plans may take on the fiduciary responsibility for the IPS, rather than having that responsibility remain with the committee members. That makes sense since one of the advantages of a 3(38) is that a committee can transfer much of the fiduciary responsibility to the investment manager. In addition, it aligns with the superior investment knowledge of the investment manager (as compared to the typical committee member).

However, fiduciary advisers who serve as 3(38)’s and who take responsibility for IPS’ should still consider deferring to plan committees on at least two issues. The first is that a plan’s investment lineup should be consistent with the demographics of the covered workforce. For example, are the covered employees knowledgeable about investing? Are they low income earners or highly paid professionals? Would they understand volatility in the context of long-term investing? Those kinds of questions should be asked to and answered by the committee. With that information, a 3(38) investment manager can make investment policy decisions consistent with the covered workers and include those decisions in the IPS.

Another issue to address with the committee is whether the investment manager should select investments that pay “revenue sharing” to cover the costs of the plan’s recordkeeper. Those investments may be more expensive than options that do not pay revenue sharing. While is it permissible to either have the plan pay the recordkeeping fees (and show the charges to the participants’ accounts) or to have revenue sharing from the investments pay for the recordkeeping, it is a decision that needs to be made, and it seems more appropriate for the committee members to make that decision. The committee members have knowledge of the covered employees and the factors that could influence their perception of the plan. Once the committee makes it decision about whether to use revenue sharing for the payment of plan expenses, that decision should be documented in the IPS and the investment manager should make investment decisions consistent with that provision.

There are other issues for an investment manager to consider in developing the IPS. For example, based on the demographics of the covered workforce, should the target date funds used for defaulting employees be designed conservatively, moderately, or aggressively? That decision can be made through consultation with the committee members. A similar issue arises in deciding whether the plan should offer participant-level investment advisory or management services. There isn’t a right or wrong answer to these questions. It’s a matter of consulting with the plan committee about the nature of the workforce, developing a thoughtful decision based on that discussion, and then documenting the decision in the plan’s IPS. Keep in mind that an IPS is not etched in stone; it is a living document that should be periodically updated for changes in circumstances.

 

Parting Thoughts

There are similarities between 3(21) advisers and 3(38) managers, but there are also differences. Both are fiduciaries, and must adhere to ERISA’s prudent man rule and duty of loyalty. Both probably use the same processes for determining the prudence of investments. But 3(38)’s are decision makers. Nondiscretionary 3(21) advisers make recommendations, but no decisions are made until the committee agrees.

In both cases, though, it’s a best practice to let the committee be the arbiter of the characteristics of the covered workforce and about the method of paying the plan’s service providers. In both of those cases, committee members have superior knowledge of the abilities, preferences and perceptions of the covered employees.