Posted by Joe Bert, CFP®, AIF®
At Certified Financial Group, we live by a simple rule: act in the best interests of our clients. This philosophy is also the underpinning for the financial advisory industry’s “Fiduciary Standard.”
But the word fiduciary is truly a sophist’s dream. There’s a veritable alphabet soup of numbers and letters that can allow certain actors to play games with what the meaning of “fiduciary” truly obligates them to do and the way they must act.
In this piece we’ll briefly explain the difference between the two primary codified definitions of a fiduciary. The first is known as a 3(21) fiduciary, the second a 3(38). These are both so-named for their sections under the Employment Retirement Income Security Act or ERISA, which is administered by the Department of Labor or DOL.
When is a Fiduciary Not a Fiduciary
For many plan sponsors and asset owners that do not possess the requisite time and/or talent under ERISA to administer their investments, an outsourced investment adviser may appear to be an ideal solution.
On its surface hiring an adviser appears to “offshore” some of the liability inherent with managing a large and highly regulated pool of other peoples’ money. However, the simple act of hiring an adviser does not, in fact, mitigate the risk for the plan’s fiduciaries. A simple difference of 17 sections in ERISA explains why.
Under ERISA’s 404(a)(1)(B) plan sponsor fiduciaries are required to exercise the “highest standard of care.” The law mandates that these fiduciaries act:
“With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”
This “prudent man” standard often comes into play when non-investment professional fiduciaries are put in a position of making investment decisions. This can create an immediate liability. There are several procedural criteria used by courts to determine if prudence was used that we do not have space to delve into here, but as you can see, fiduciary determinations and decisions are quite complex. This observation begins to make a strong case for outsourcing liability given these various legal gray areas.
One way to mitigate fiduciary liability is to hire a 3(21) or 3(38) fiduciary. This should be codified in your management agreement and in an Investment Policy Statement (IPS) to document the processes and procedures around who is responsible for making investment decisions and why those decisions are being made.
When deciding to outsource fiduciary liability it is important to understand the differences between fiduciary types under ERISA. A truly outsourced investment fiduciary under ERISA is identified as a Section 3(38) fiduciary, so named for the 38th definition in the ERISA law. However, all fiduciaries for a retirement plan also fall under the definition of a Section 3(21) fiduciary.
The primary difference between a 3(21) and 3(38) fiduciary is that the former makes “recommendations” on plan assets with the employer/plan sponsor having the final decision. In contrast, a 3(38) fiduciary has control and management of the plan assets fully delegated to them.
It is important to note that while a section 3(21) fiduciary may de facto arise from certain actions and involvement with the plan’s assets, a 3(38) fiduciary designation must be accepted explicitly by the third party. Plan sponsors often assume that their investment advisor is a 3(38) fiduciary automatically, thereby absolving them of certain responsibilities. In fact, the investment advisor is only a 3(21) fiduciary, placing certain liabilities back on the shoulders of the plan sponsor.
Again, the complexities, vagaries and nuances of fiduciary rules under ERISA, combined with the severe consequences for even inadvertent violation, seem to mandate work with a true and knowledgeable fiduciary such as Certified Financial Group.
At Certified Financial Group, it is our wish to help you discern the complicated answers to the questions above, and, in turn, help reduce your risk and fiduciary liability. Our Registered Investment Advisor, Certified Advisory Corp, is a CEFEX certified firm, so you can be assured that you are working with a true fiduciary, providing you the latest insight to achieve distinctive results.