ERISA has given 401(k) plan sponsors several alternatives whenit comes to addressing unwanted fiduciary liability (see “3Ways 401k Plan Sponsors Can Reduce Fiduciary Liability,”, Nov. 11, 2014). Two of the methodsoutlined in the law focus on the provision of investmentservices.

While both can deal with discretionary investment authority,convention has deemed the 3(21) ERISA fiduciary as offeringnon-discretionary services while the 3(38) ERISA fiduciary offersdiscretionary services. In addition, only certain specificallyenumerated entities can offer 3(38) services while there are noqualification requirements for 3(21) providers.


From both the plan sponsor’s and the service provider’s point ofview, the real difference between 3(21) and 3(38) comes whendetermining each party’s level of fiduciary liability. A 3(21)provider becomes a co-fiduciary and only shares the liability withthe plan sponsor. On the other hand, the plan sponsor transfers allfiduciary liability pertaining to investments to the 3(38)provider. That’s a big difference.


From the perspective of the 401(k) plan sponsor, especially forsmaller companies that neither possess nor desire to possess therelevant expertise when it comes to selecting and monitoring planinvestments, why take on any fiduciary liability in that area ifyou don’t have to?

In almost all cases, a 3(38) provider offers more to the plansponsor than a 3(21) provider.

Given that, why would any 401(k) plan sponsor still hire a3(21) advisor when a 3(38) adviser (notice the spelling) addsimmeasurable value?


I can think of a few reasons why the 3(38) option may not bepreferred. First and foremost, in transfer the fiduciary liability(generally considered a good thing), the plan sponsor cedes totalcontrol of investment selection to the adviser. Some plan sponsorsmight not be comfortable with losing this control. Sure, they canwrite in the agreement certain “oversight” (e.g., giving 30 noticebefore replacing investment options), but adding that oversightwill now add fiduciary liability – the very thing the plan sponsoris trying to remove.


There are also cases where the plan sponsor will want to retaincertain preferred investment options, despite the 3(38) adviser’sclear insistence they may not be appropriate for the plan. These“favorite sons” can range from specific mutual funds to companystock to an open-ended self-directed option. Again, the investmentmanagement agreement can be written to remove the decision to offerthese options from the 3(38) adviser’s discretion, but then theplan sponsor re-assumes the previously transferred fiduciaryliability.


But there’s another angle in this.

That’s the perspective of the 3(38) “Investment Manager” (the termcomes directly from ERISA and is probably a better descriptionsince it avoids that whole “advisor”/“adviser” mess we got into acouple of weeks ago).

There are not many 3(38) providers who would be willing to take onthe potential fiduciary liability of, say, company stock or aself-directed option, even if an agreement purports to waive thatspecific liability. (We all know what smart lawyers can do tosupposedly “air-tight” agreements.)


So there we have it. A plan sponsor might not want to hire a3(38) in order to retain control over plan investments, and a 3(38)Investment Manager might not want to be hired by plan sponsors whodesire to include what that Investment Manager determinesmight be risky options in the plan investment menu.

These are two branches from the same tree. I’m tempted to call itthe Tree of Knowledge, but I don’t want to go all Biblical onyou.


Let me be frank (which is that same as saying “politicallyincorrect” only with fewer syllables.) These issues stem fromcorporate arrogance – from both extremes of the size-o-meter.

It’s most noticeably prevalent among smaller, closely held firms,most notoriously when ownership is help within a very fewhands.

The classic example is the doctor who insists his investing acumenis on par with his medical awareness. That’s the kind of situationthat often ends in tears – for the doctor, who decided to bet itall on pork-bellies, not the employees, whom the doctor was kindenough to consider too unsophisticated to make investment decision;thus were placed in those meager choices selected by theprofessional investor.


On the other end of the scale, we have very large companies whonever met a product they themselves could not have invented better.That includes their retirement plan investment options. If theydon’t have the expertise in-house, they’ll hire a new employee withthat expertise (or worse, train an internal employee to attain thatexpertise). Very rarely does this work. Even experts hired into thefirm will lose that expertise as their experience becomes more andmore confined to what happens inside the walls of thecompany.


I look at it this way (and, as a private portfolio manager, Iactually do look at things this way): If I am a shareholder of acompany, I don’t want to see company resources wasted onnon-essential activities that can be easily outsourced.

The company retirement plan – again to be brutally blunt – is notan essential activity. All right, all right, I’ll be morediplomatic. It’s not a proprietary activity. It can be just asefficiently run by independent third parties without taking up thevaluable time of the company’s human resources. And suchoutsourcing can remove non-essential liabilities, too.


So what’s not to like?

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Christopher Carosa

Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook ( Twitter (