Financial Opinion and Insights

3(21) or 3(38)?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®


If you are someone who makes decisions regarding your company’s retirement plan, this could be quite important for you to know.

I entered the advisory business in 1990, coming from the world of management consulting; so, I was used to a business model where the consultant works for the client and is paid on a pure fee basis.  The way you kept clients was by bringing value to the client beyond the size of the fee charged and by avoiding interest conflicts – a standard beyond merely ‘disclosing’ them.

What I wasn’t used to was the marketing hype used to sell the products and services in the advisory industry, as opposed to the management consulting industry.  Let’s face it:  The advisory industry certainly has its share, always built around whatever is currently happening in the marketplace.

These days, especially with new disclosure rules coming down the pike, plan sponsor fiduciaries are rightly concerned with minimizing liability exposure and, of course, there are advisors now jumping out of the bushes telling plan sponsors how they can virtually eliminate their liability for investment management.   All they have to do is hire a 3(38) investment manager instead of a 3(21) advisor.  By the way, an advisor can be either a 3(38) or a 3(21), it’s simply a matter of taking discretion and meeting a few other requirements; so, why wouldn’t all advisors get on the band wagon?

The fact is, many are jumping on board; but, like all marketing fads, this one may prove to be little more than a smoke screen, after all.

Now, I’m not an attorney, let alone an ERISA specialist; but, I did study enough law to know that the doctrine of constructive knowledge doesn’t refer to the building of an overpass, and it helps that I can get ERISA attorneys on the phone.

With those limitations in mind, here is my own humble take on the 3(38) vs. 3(21) discussion.

First, the 3(21):   ANY individual is a fiduciary under Section 3(21) if he or she exercises any authority or control over the management of the plan or the management or disposition of its assets; if he or renders investment advice for a fee (or has any authority or responsibility to do so); or if he or she has any discretionary responsibility in the administration of the retirement plan, not to be confused with the ministerial duties of a third party administrator.  

The point:  It’s a functional test; it’s not about titles.   If YOU make any decisions regarding your plan, YOU are functioning as a 3(21) fiduciary.  If you think it’s a good idea to get professional help, you can hire a 3(21) consulting professional to become a co-fiduciary to help you perform your duties.  The ERISA regulations even appear to encourage this and will allow you to pay the consulting professional from plan assets, something many company plan sponsors appreciate.  Included among a fiduciary’s responsibilities is the prudent screening, selection, and monitoring of plan investments (and managers), including establishing and following a documented prudent process for the selection, review, and possible replacement of the investments or managers.  This includes documenting a decision not to replace investments or managers; and, by the way, doing nothing is a decision that should be documented.  So much for our cursory description of a 3(21).

What’s a 3(38) manager?  ERISA section 3(38) defines “investment manager” as a fiduciary due to their responsibility to manage the plan’s assets.   ERISA provides that a plan sponsor can delegate the responsibility (and thus, likely the liability) of selecting, monitoring and replacing investments to a 3(38) investment manager/fiduciary.  A 3(38) fiduciary may only be a bank, an insurance company, or a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940. 

So, is the plan sponsor ‘off the hook’?  You need only review the plan fiduciary’s responsibilities:  The plan sponsor is acting – remember, it’s a functional test – as a 3(21) when they make ANY decision regarding the plan.  Selecting a 3(38) manager is a 3(21) function, don’t you think?  Monitoring and possibly replacing the 3(38), including documenting your actions or inactions, is also a 3(21) function!  If that makes sense to you – and it should – then it will be easy to follow this logic:

  1. The 3(21) plan fiduciaries are relieved of investment related management decisions of the 3(38), provided the 3(21) fulfills his/her fiduciary responsibilities, a few of which I outlined earlier.
  2. Failure to fulfill fiduciary responsibilities by a 3(21) could likely result in a loss of those protections afforded by the 3(38).
  3. You can’t escape it:  You still have the obligation to perform your 3(21) responsibilities, or hire a professional to help, which can make the process a lot easier and likely more thorough.  You still need a 3(21) to provide oversight of the 3(38).
  4. The 3(38) manager can relieve you of investment related liability (see #1 and 2), but is now actually functioning as another service provider.  To conclude that the 3(38) manager’s reporting fulfills your oversight requirement might be somewhat naïve.  Whoever heard of fulfilling a fiduciary obligation to monitor a service provider by allowing them to monitor themselves?  (Note:  Just as many advisors are now jumping on the 3(38) bandwagon and promoting the `elimination’ of fiduciary liability, those same advisors are marketing their services to 3(21) advisors in hopes of getting plan takeovers… “We can remove liability, etc.”).

The Bottom-Line:

Plan sponsors are still responsible for the selection, monitoring, and possibly replacing the 3(38) advisor who, after all, may be held to be little more than a vendor selling an investment service but responsible for their own actions.   Failure to follow a prudent process in doing this just might result in a loss of the protections.  To me, that logic is pretty clear to see.  The short takeaway:  You’ll probably still need a 3(21) on your side of the table to conduct due-diligence on the 3(38) manager, who should be regarded as another service provider, albeit with increased responsibilities.

Be safe:  Talk to your ERISA attorney.



Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

January 17, 2012 at 8:00 am

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