PSNC 2019: Understanding 3(16) and 3(38) Fiduciary Outsourcing

Good candidates for outsourcing include plan sponsors who want to spend more time focused on plan design innovation and tracking outcomes of investment management and administrative oversight.

From left to right: Joshua Ulmer of Morgan Stanley, Pete Swisher of Pentegra Retirement Services, and Spencer Goldstein of Stone Street Equity. Photograph by Matt Kalinowski

According to panelists speaking during the second day of the 2019 PLANSPONSOR National Conference, held last week in Washington, D.C., it is still quite common for small business owners and even larger, sophisticated corporate organizations to misunderstand the fiduciary duties attached to their tax-qualified retirement plans.

The panel included Spencer Goldstein, principal and chief investment officer at Stone Street Equity; Pete Swisher, senior vice president and national practice leader for Pentegra Retirement Services; and Joshua Ulmer, senior institutional consultant at Morgan Stanley. The trio shared various examples they have seen of employers operating under faulty assumptions about which parties—internal and external—servicing the retirement plan carried ultimate liability for ensuring participants’ assets are protected and that all regulatory requirements having to do with communications, transparency and prudence are being met.

“Many of the clients that choose to work with us in an outsourced fiduciary capacity have come to realize that retirement plan oversight is not part of their core business,” Goldstein said. “Once their plan reaches a certain size and they learn more about their fiduciary duties, they decide they don’t have sufficient time, resources or expertise in-house. For these plan sponsors, the common goal is to reduce the administrative burden of the plan, saving time and potentially reducing costs overall.”

The panel offered novice plan sponsors a quick overview of the fiduciary outsourcing options available in the marketplace today. Very simply put, the different flavors of fiduciary service are named for the section of the Employee Retirement Income Security Act (ERISA) under which service providers are regulated. Section 3(16) fiduciary service focuses on such things as mandatory plan communications and disclosures; Section 3(21) fiduciary service is provided by investment advisers that do not have final discretion over plan assets; and Section 3(38) fiduciary service is provided by advisers or investment managers that have full control or discretion over plan participants’ assets.

Ulmer, Swisher and Goldstein pointed out that fiduciary outsourcing can save plan sponsors a lot of time and can potentially insulate them from liability in certain circumstances, but plan sponsors always maintain a duty to “kick the tires” and remain cognizant of what is happening in the plan. On this point, they discussed a recent federal court judgement that concluded in part that retirement plans working with outsourced fiduciaries have a duty to not just unequivocally accept the advice or opinion of even fiduciary service providers.

Swisher noted that it is particularly important for plan sponsors working with 3(16) fiduciaries to carefully study the formally contracted scope and terms of the service arrangement.  

“A provider offering ‘3(16) services’ is not necessarily a fiduciary,” he warned. “And even if they are a fiduciary, they may only be fiduciaries for a very limited purpose. It’s important to know what you have actually outsourced contractually versus what you are just getting help with. Even though you contract someone to do something, if you have not contracted them as a formal fiduciary, you remain liable and responsible as the plan sponsor.”

Ulmer noted that the defined contribution (DC) retirement plan industry initially grew up to sell services and products to fiduciaries—rather than to act in a fiduciary capacity. But the marketplace is now pushing for true fiduciary support, and this thinking is driving a broader trend towards outsourcing.

“As the 401(k) system becomes the core of the retirement system, this is also pushing plan sponsors to look for more expertise and support,” Ulmer said.

Ulmer went on to note that outsourcing can be attractive not just to retirement plan committees that feel like they are stretched thin. He suggested an ideal candidate for 3(38) engagement is a committee that is dedicated but wants to focus on other things beyond investments, such as financial wellness.