by W. Scott Simon | 12-03-09ERISA Selection, Monitoring, and Replacing Functions
…The significance of the added protection afforded a plan sponsor when it utilizes the services of an advisor serving as a fiduciary under section 3(38) of the Employee Retirement Income Security Act of 1974 as opposed to an advisor serving as an ERISA section 3(21) fiduciary
…A critical duty is the sponsor's legal responsibility (and therefore legal liability) to select, monitor, and (if necessary) replace the plan's investment options. This duty is so central to any ERISA-qualified retirement plan that its breach is often pleaded in the recent cases filed against plan sponsors involving plan investment options bearing costs that are not reasonable. … The appropriate fiduciary of a plan must (affirmatively) find costs to be reasonable in order to justify their expenditure for the corresponding services rendered. …
An ERISA Section 3(38) Fiduciary
ERISA provides that a plan sponsor can delegate the significant responsibility (and therefore significant liability) of the selection/monitoring/replacing functions to an ERISA section 3(38)-defined "investment manager" who, upon delegation, then becomes an ERISA section 405(d)(1)-defined "independent fiduciary." An ERISA section 3(38) fiduciary can only be (a) a bank, (b) an insurance company or (c) a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940. This means that a stand-alone broker-dealer, for example, cannot be an ERISA section 3(38) fiduciary. …
An ERISA 3(38) fiduciary has ERISA legally defined "discretion" that makes it a decision-maker. This means that a 3(38) fiduciary actually makes decisions for which it is legally culpable (and for which the plan sponsor is no longer legally culpable). An ERISA 3(38) fiduciary decides what investment options such as stand-alone mutual funds or model portfolios should be placed on a plan's menu, whether to remove them from the menu and, if it does remove them, what investment options will replace them. …
An ERISA Section 3(21) Fiduciary
In sharp contrast to the legally culpable, discretionary decisions made by an ERISA section 3(38) fiduciary are the legally blameless, nondiscretionary recommendations made by an ERISA section 3(21) fiduciary. To the extent that an advisor is even named as any kind of fiduciary in an investment management agreement between a plan sponsor and an advisor, in most cases the advisor is an ERISA 3(21) fiduciary tasked with "recommending," "assisting," "helping," or "advising" the sponsor as the sponsor itself goes about making selection/monitoring/replacement decisions.
Such contracts make clear that an advisor who is a 3(21) has no legally defined "discretion" to actually make decisions about plan investment options but only to be a helpful gnome to the plan sponsor who continues to retain the significant responsibility (and therefore the significant liability) to select, monitor and (if necessary) replace plan investment options. …
In many agreements, of course, the advisor is not even named as a fiduciary and its roles are simply described as "assisting," the plan sponsor in making investment option selections (for which the sponsor is legally responsible and liable).
Summing UpIn a nutshell, here is the difference between ERISA section 3(38) fiduciaries and ERISA section 3(21) fiduciaries:
* An ERISA section 3(38) fiduciary must make decisions for which it has legal responsibility (and therefore legal liability), because such a fiduciary is charged with ERISA-defined "discretion." … This gives a plan sponsor significant cover from fiduciary risk.
* An ERISA section 3(21) fiduciary makes only recommendations for which it has no legal responsibility (and therefore no legal liability), because such a fiduciary has no ERISA-defined "discretion." This does not give plan sponsors cover from fiduciary risk.
An Important Caveat
It's important to understand that the part of the preceding discussion referring to an ERISA section 3(21) fiduciary concerns what can be described as a "limited scope" 3(21). …
Distinct from a limited-scope 3(21) fiduciary (the kind which is almost always discussed in the investment media) is what can be described as a "full scope" ERISA section 3(21) fiduciary. The full scope 3(21) is the "named fiduciary" of a plan; that is, the person who has ultimate authority over a plan. All qualified retirement plans governed by ERISA have a named fiduciary, and that person is always a 3(21) fiduciary, representing the plan sponsor. The plan sponsor, as the originating full scope 3(21) fiduciary of the plan, can delegate all the duties associated with same to an entity that will assume them. …
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