Marcia S. Wagner, Esq.

The Do’s, Don’ts and Best Practices for 3(16), 3(21) and 3(38) Fiduciaries

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Introduction

Traditional Arrangement for Plans◦ Plan sponsor has primary fiduciary responsibility◦ Recordkeeper and TPA are non-fiduciary service

providers◦ Financial advisor is broker (non-fiduciary)

Providers of Fiduciary Services ◦ TPAs may serve as 3(16) Fiduciaries◦ Advisors may serve as 3(21) or 3(38) Fiduciaries◦ Providers may strategically adjust service models

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Employer’s Traditional Roleas Named Fiduciary

Definition of “Named Fiduciary”◦ Named in plan document◦ Employer traditionally serves in this role

Powers of Named Fiduciary◦ Managing investment menu◦ Administration of plan◦ Engaging service providers

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Employer’s Traditional Roleas 3(16) Fiduciary

Definition of 3(16) Fiduciary◦ Also known as “Administrator” under ERISA◦ Plan document must identify its 3(16) Fiduciary

Role of 3(16) Fiduciary◦ Has ERISA reporting and disclosure duties◦ Does not refer to traditional TPA firms providing non-

fiduciary services

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Engaging Fiduciary Service Providers

Selection of 3(16) Fiduciary◦ Plan document may appoint TPA to serve as plan’s

Named Fiduciary and Administrator◦ Service agreement would be required for TPA firm◦ Employer may also serve as Named Fiduciary

Selection of 3(21) or 3(38) Fiduciary◦ Named Fiduciary may appoint investment fiduciaries

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Core Responsibilities of 3(16) Fiduciary

Disclosure Duties of Administrator◦ Provide SPDs◦ Provide benefit statements◦ Provide 404a-5 participant disclosures◦ Provide plan document (upon request)

Reporting Duties of Administrator◦ Sign and file Form 5500◦ Arrange for plan’s financial audit (as necessary)

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3(16) Fiduciary’s Oversight Role

Oversight of Other Providers◦ 3(16) Fiduciary may hire other providers to assist with

participant disclosures and Form 5500◦ 3(16) Fiduciary remains responsible and must oversee

providers

Flexibility for TPA Firms◦ TPA firm may provide all related services as 3(16)

Fiduciary, or hire and oversee other providers

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Special Liability and Penalty Rules for 3(16) Fiduciaries

No Delegation of Administrator’s Duties◦ Administrator cannot delegate responsibility for its

reporting and disclosure obligations◦ 3(16) Fiduciary subject to potential liability, even if

error caused by non-fiduciary service providerSpecial Penalties

◦ Form 5500 Failure - $1,100 per day◦ Disclosure Failure - $110 per day

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Transferring Reporting and Disclosure Duties to TPA

Plan Document Names TPA as Administrator◦ TPA becomes responsible for participant disclosures

and Form 5500◦ Employer would not have ultimate responsibility◦ TPA potentially liable for penalties as Administrator

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Core Duties of 3(21) FiduciariesNamed Fiduciary May Appoint 3(21) Fiduciary

◦ Named Fiduciary has power to hire other fiduciaries◦ Plan sponsor may hire financial advisor to provide

“investment advice” under ERISA Section 3(21)◦ Advice needed for selection and monitoring of plan’s

menu optionsReliance on 3(21) Fiduciary’s Advice

◦ Named Fiduciary must not blindly follow advice◦ Plan sponsor retains duty:

(1) To investigate qualifications(2) To provide complete and accurate info(3) To ensure reliance is reasonably justified

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Overview of 3(38) FiduciariesDefinition of “3(38) Fiduciary”

◦ Also known as “investment manager” under ERISA Section 3(38)

Legal Requirements for 3(38) Fiduciary◦ Must have discretionary authority◦ Must be RIA, bank or insurance company◦ Must acknowledge fiduciary status in writing

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Core Duties of 3(38) FiduciariesInvestment Control Over Plan Menu

◦ 3(38) Fiduciary must have authority to unilaterally add or remove investment options

◦ Plan sponsor must give up control over menu

Liability Protection for Plan Sponsor◦ Plan Sponsor is not responsible for individual acts of

3(38) Fiduciary◦ Named Fiduciary merely responsible for prudently

selecting and monitoring 3(38) Fiduciary

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3(38) Fiduciary vs. 3(21) FiduciaryWhen Plan Sponsor Relies on 3(21) Fiduciary

◦ Both sponsor and 3(21) fiduciary are jointly responsible for plan’s investment decisions

◦ Both can be held liable for imprudent decisions

When Plan Sponsor Relies on 3(38) Fiduciary◦ No fiduciary liability for Plan Sponsor if it prudently

appoints 3(38) Fiduciary

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Fiduciary Liability and PenaltiesCivil Actions Under ERISA

◦ May be brought by DOL, participants or co-fiduciaries◦ Fiduciary is personally liable for losses caused by

breachDOL Civil Penalty

◦ Penalty amount is 20% of applicable recovery amount

Excise TaxesPotential Co-Fiduciary Liability

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Considerations for 3(16) Fiduciary Service Models

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Administrator vs. Named Fiduciary

Serving as Administrator and Named Fiduciary◦ 3(16) Fiduciary may limit responsibility to

Administrator’s reporting and disclosure duties◦ Many firms also assume discretionary authority over

management of plan as Named Fiduciary◦ Scope of responsibility determined by service

agreement and plan document

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Scope of 3(16) Fiduciary’s Services

Determining TPA’s Fiduciary Services◦ May accept responsibility for 5500 reporting and

disclosures as plan’s Administrator◦ May also accept comprehensive management

responsibilities as plan’s Named Fiduciary◦ Illustration: TPA agrees to adjudicate benefit claims

Consider TPA’s Expertise and Procedures◦ Prudent process must be established for each

fiduciary service◦ Illustration: Benchmarking review conducted to

satisfy TPA’s duty to evaluate reasonableness of fees

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TPAs and Bundled ProvidersAbility of TPAs to Offer 3(16) Services

◦ TPAs are traditionally involved in plan administration◦ Can modify non-fiduciary service model by adding

3(16) Fiduciary servicesBundled Providers ◦ Recordkeepers with TPA acting as its subcontractor

may offer 3(16) Fiduciary services◦ TPA with recordkeeper acting as its subcontractor may

also offer 3(16) Fiduciary services

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Oversight of Plan’s Recordkeeper

Importance of Recordkeeper’s Role◦ Recordkeeper is typically responsible for generating

participant 404a-5 disclosures and statements◦ Also provides website and system for processing

participant transactions◦ 3(16) Fiduciary is responsible for disclosures and may

also be responsible for plan administration

When Plan Sponsor Hires Recordkeeper◦ 3(16) Fiduciary should require use of approved

recordkeeper to ensure plan runs properly

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3(16) Fiduciary’s Non-Fiduciary Services

Types of Non-Fiduciary Services◦ 3(16) Fiduciary may offer bundled recordkeeping and

TPA services◦ May also offer TPA services only

When Offering TPA Services ◦ 3(16) Fiduciary must coordinate its TPA services with

recordkeeper’s administrative services◦ Areas of potential overlap include preparation and

delivery of disclosures, loans and withdrawals

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When 3(16) Fiduciary Hires Non-Fiduciary Providers

Relationship with Other Service Providers◦ 3(16) Fiduciary’s ERISA reporting duties include hiring

accounting firm for audit as necessary◦ Additional duties may including hiring non-fiduciary

service providers (e.g., recordkeeper)

Accountability of 3(16) Fiduciary◦ 3(16) Fiduciary has duty to prudently select and

monitor provider on ongoing basis◦ Not accountable for individual errors of provider, but

responsible for prudent selection and monitoring

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Responsibilities Retained by Plan Sponsor

Coordination of Fiduciary Responsibilities◦ Any responsibilities not accepted by 3(16) Fiduciary

remain with Plan Sponsor◦ 3(16) Fiduciary’s agreement and plan document

should be reviewed to confirm responsibilities

Duties Relating to 3(16) Fiduciary◦ Plan Sponsor is responsible for prudently selecting

and monitoring 3(16) Fiduciary◦ DOL requires consideration of

(1) Qualifications of 3(16) Fiduciary(2) Quality of services(3) Reasonableness of fees

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408(b)(2) Fee DisclosuresFee Disclosure Requirements

◦ 3(16) Fiduciary must describe services and fees◦ Must also identify any subcontractors and disclose

their compensation

When 3(16) Fiduciary Hires Recordkeeper◦ Recordkeeper must provide 408(b)(2) fee

disclosures to 3(16) Fiduciary◦ Plan Sponsor should consider requiring 3(16)

Fiduciary to disclose recordkeeper’s fees◦ Should also confirm 3(16) Fiduciary is not hiring

affiliated recordkeeper or receiving “kickbacks”

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Suggested Best Practices:Scope of Fiduciary Services

Level of 3(16) Fiduciary Responsibility ◦ Offer fiduciary service only if prudent process can

be established and followed◦ Document selection and monitoring criteria when

hiring other providers◦ Prepare regular reports of other providers’ services

Advisability of Different Service Levels◦ Simpler and easier to provide uniform level of

fiduciary oversight across all plan clients

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Suggested Best Practices:3(16) Contractual Considerations

Service Agreement for 3(16) Fiduciary◦ Should state which responsibilities will shift to TPA◦ Should confirm that Plan Sponsor remains

responsible for hiring 3(16) Fiduciary◦ Plan Sponsor should remain responsible for

providing complete and accurate information

Coordination with Plan Document◦ Confirm Administrator and Named Fiduciary

provisions are consistent with agreement◦ Plan document may provide that both TPA and Plan

Sponsor will serve as Named Fiduciaries

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Suggested Best Practices:Monitoring Support for Plan Sponsor

Employer’s Duty to Monitor 3(16) Fiduciary◦ Must monitor 3(16) Fiduciary’s performance at

reasonable intervals◦ Plan Sponsor should ask for regular updates

Illustration◦ 3(16) Fiduciary provides updates on annual basis◦ Updates include summary information of:

(1) number of benefit claims adjudicated(2) exception reports identifying potential

issues(3) performance assessment of other providers(4) benchmarking analysis

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Considerations for 3(21) and 3(38) Fiduciary Service Models

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Fiduciary Service Models for Financial Advisors

Legal Requirements for Fiduciary Advisors◦ ERISA requires advisor to receive levelized

compensation to serve as plan fiduciary◦ Advisers Act requires registration as RIA before

offering advice for level, fee-based compensation

Spectrum of Possible Service Models◦ Helpful to focus on 3 basic approaches:

- Core 3(21) Fiduciary- Hybrid 3(38) Fiduciary- Full 3(38) Fiduciary

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Core 3(21) Fiduciary Service ModelCore Service Provided by 3(21) Fiduciary

◦ Assisting Plan Sponsor in selection and monitoring of Plan’s investment menu options

◦ Advice is non-discretionary (i.e., recommendations)

Related Services◦ Assisting with IPS document where Plan Sponsor is

responsible for reviewing and adopting IPS◦ Providing quarterly reports and meeting with Plan

Sponsor annually◦ May also offer non-fiduciary services

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Full 3(38) Fiduciary Service ModelFull Investment Control by 3(38) Fiduciary

◦ 3(38) Fiduciary has authority to unilaterally change plan’s investment menu

◦ Also has authority to make unilateral changes to IPS ◦ Provides quarterly reports to Plan Sponsor, but only

meets as needed◦ May also offer non-fiduciary services

Liability Protection for Plan Sponsor◦ Plan Sponsor only remains responsible for prudently

appointing and monitoring 3(38) Fiduciary◦ Service model preferred by Plan Sponsors that want

minimal involvement in plan investments

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Hybrid 3(38) Fiduciary Service ModelAdvantages of Hybrid Model

◦ Plan Sponsor is insulated from liability for mistakes concerning plan’s investment menu

◦ Also retains indirect control over investment menu◦ 3(38) Fiduciary has discretion over menu but

discusses proposed changes with Plan Sponsor

Plan Sponsor’s Authority◦ Plan Sponsor may terminate 3(38) Fiduciary before

any proposed change is implemented◦ Control over IPS gives Plan Sponsor ability to impose

specific investment guidelines on 3(38) Fiduciary

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Considerations for Determining Service Model

Advisability of Different Service Choices◦ Advisor may choose to offer Core 3(21) services only◦ May also offer plan clients choice of 3(21) or 3(38)

services◦ Offering different choices may allow advisor to serve

greater range of plan clientsComparing Fiduciary Service Models

◦ Same level of accountability for any bad advice (discretionary or non-discretionary) under ERISA

◦ Hybrid 3(38) model requires more coordination with Plan Sponsor and less scalable than Full 3(38) model

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Services for ParticipantsNon-Fiduciary Investment Education

◦ Asset allocation models that use plan’s investment options may be provided if disclaimers are included

Non-Discretionary Investment Advice◦ Individualized advice should be provided on one-on-

one basis and written records should be maintained

Discretionary Investment Advice◦ Advice may be provided in form of risk-based model

portfolios◦ Model portfolios may also be used as plan’s QDIA

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Fiduciary Benefits of 404(c) ComplianceLiability Protection Under ERISA 404(c)

◦ Plan fiduciaries are not liable for losses resulting from participant’s investment control

◦ Participants must have “opportunity to exercise control” for 404(c) purposes

◦ Plan menu must have broad range of investment alternatives

Ensuring 404(c) Compliance◦ Advisor can ensure plan menu requirement is met,

but not other 404(c) requirements◦ Ask Plan Sponsor to represent that other 404(c)

requirements will be met in agreement with advisor

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Suggested Best Practices:Contractual Considerations

Investment Menu Responsibilities◦ Should define scope of advisor’s fiduciary services◦ Should specify investment areas in which advisor

will not be responsible (e.g., employer stock)

Other Responsibilities◦ For any non-fiduciary services, agreement should

clarify advisor will not be acting as plan officer◦ Should also clarify if participants will be receiving

education or advice from advisor

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Suggested Best Practices:Recordkeeper Considerations

Recordkeeper’s Impact on Investment Costs◦ Recordkeeping platform determines universe of

available investment funds and their share classes◦ Different share classes have varying expenses

(e.g., 12b-1 fee, shareholder service fee)◦ Should clarify that advisor will not be responsible for

share class determined by recordkeeper’s program

Recordkeeper’s Mandatory Funds◦ Recordkeeper may require use of certain funds

(e.g., proprietary TDF)◦ Should clarify advisor will not monitor such funds

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Suggested Best Practices:Special 3(38) Considerations

General 3(38) Considerations◦ Plan should transition to recordkeeper capable of

supporting advisor, including model portfolios◦ Recordkeeper may require authorization letter or

side agreement with Plan Sponsor

Hybrid 3(38) Considerations◦ Advisor should provide notice of proposed menu

changes except in extraordinary circumstances◦ Fiduciary must have power to take any necessary

action in accordance with ERISA

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ConclusionsNo “One Size Fits All” Model for Providers

◦ TPAs have flexibility in accepting Named Fiduciary duties in addition to duties as plan’s Administrator

◦ Financial advisors can serve as Core 3(21), Hybrid 3(38) of Full 3(38) Fiduciaries

Consulting with ERISA Counsel◦ Providers should consult ERISA counsel before

implementing any service model changes◦ Plan sponsors should consult ERISA counsel to ensure

fiduciary responsibilities are allocated properly

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Important InformationThis presentation is intended for sponsors of 401(k) plans and other types of defined contribution retirement plans with participant-directed investments that are subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA), as well as the service providers that work with such plans.

This information is intended for general informational purposes only, and it does not constitute legal, tax or investment advice on the part of The Wagner Law Group or its affiliates.

Marcia S. Wagner, Esq.q.

99 Summer Street, 13th FloorBoston, MA 02110

Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com

marcia@wagnerlawgroup.com

A0115595

The Do’s, Don’ts and Best Practices for 3(16), 3(21) and 3(38) Fiduciaries