W. Scott Simon
In this column last month I promised that, given the widespread interest in the different flavors of fiduciaries under the Employee Retirement Income Security Act of 1974, I would delve into these subjects even more than I’ve done already to satisfy the craving for accurate information concerning these often misunderstood subjects. So away we go.
The Essential Fiduciary Players in a Retirement Plan
The ERISA statutory scheme contemplates that all fiduciary duties originate with, and belong to, the sponsor of a qualified retirement plan such as a 401(k) plan. Some of these duties are usually parceled out to different named fiduciaries through the plan document and trust instrument of the plan. In this column, I’ll use the term “plan document” to encompass a plan’s plan document and trust instrument. That term will also include any written contract between an appointing fiduciary and an appointed fiduciary involving the plan since any such contract appointing a fiduciary is deemed by the U.S. Department of Labor to be a “plan document.” For example, an ERISA section 3(38) Investment Manager is not typically named in a plan document or trust instrument but instead is appointed by the plan sponsor or the Named Fiduciary in a contract; that contract then becomes part of the plan document.
Four Named Fiduciaries
Upon signing the plan document, a plan sponsor, in effect, “announces” the “arrival” or the “birth” of a qualified retirement plan. Some of a plan sponsor’s duties, as noted, are parceled out to different named fiduciaries. A “named fiduciary” is “a fiduciary who is named in the plan instrument [i.e., plan document] or who, pursuant to a procedure specified in the plan, is identified as a fiduciary.” (ERISA section 402(a)(2).)
There are four “named fiduciaries” under ERISA: (1) the ERISA section 3(21) Named Fiduciary, (2) the ERISA section 3(16) Plan Administrator, (3) the ERISA section 403(a) Trustee and (4) the ERISA section 3(38) Investment Manager. The first three of these named fiduciaries are named in the plan document (specifically, the plan document and trust instrument) while the fourth one–the 3(38) Investment Manager– can be named in a contract “pursuant to terms set forth in the plan.”
A plan sponsor typically retains the duties of the first and second named fiduciary, delegates duties to the third named fiduciaries, and more rarely delegates duties to the fourth named fiduciary.
1. The ERISA Section 3(21) Named Fiduciary: The Mother of All Fiduciaries
The ERISA section 3(21) Named Fiduciary (referred to in this column previously as the “full scope” 3(21) fiduciary) is the Big Kahuna, the Head Honcho, the Main Man in a qualified retirement plan (ERISA section 402(a)-(b); DOL regulation 2509.75-5, FR-3). This is the named fiduciary that has control over all other plan fiduciaries–whether a named fiduciary, a retained or appointed fiduciary, an advice-giving fiduciary (whether to a plan or the participants in the plan) or a functional fiduciary–and it reigns supreme. Folks, the 3(21) Named Fiduciary is the Mother of All Fiduciaries; it is not to be messed with.
In the typical 401(k) plan, the plan sponsor–or more precisely some executive employed by the plan sponsor–is named in the plan document as the principal fiduciary: the 3(21) Named Fiduciary. The 3(21) is the chief decision-maker, not an advisor. It hires, evaluates and monitors all plan fiduciaries and service providers to a plan, and consequently all fiduciaries and service providers must report to the 3(21) Named Fiduciary. The 3(21) understands and adheres to principles of fiduciary prudence, and even if it’s compensated directly by a plan sponsor the 3(21) is bound by ERISA section 404(a), including the great “sole interest” and “exclusive purpose” rules, to work only on behalf of plan participants (and their beneficiaries).
2. The ERISA Section 3(16) Plan Administrator: The Great Communicator
The ERISA section 3(16) Plan Administrator should not be confused with a third party administrator (also referred to as a TPA) for a plan. In the typical 401(k) plan, either the plan sponsor or some executive employed by the plan sponsor is named in the plan document as the 3(16) Plan Administrator.
The 3(16) is essentially a coordinator of communications. For example, it has statutory responsibility for making important disclosures to plan participants such as disclosures, Summary Plan Descriptions, notices and statements. In addition, it has statutory responsibility for ensuring that all filings with the federal government such as form 5500s are timely made. Whenever someone needs to communicate with the plan, those communications are directed to the 3(16) Plan Administrator. The 3(16), then, is in charge of all communications with plan participants, the government, and any to or from the plan.
The 3(16) Plan Administrator also hires plan service providers if no other fiduciary has that responsibility and fulfills any other responsibilities set forth in the plan document that are assigned to it.
3. The ERISA Section 403(a) Trustee: The Investment Fiduciary
The ERISA section 403(a) Trustee is named in the plan documents as the fiduciary solely responsible and liable for the plan’s investment options; it’s usually an employee of the plan sponsor. More explicitly, the ERISA section 403(a) Trustee is “a person or a group of persons recognized as having exclusive authority and discretion over the management and control of plan assets.” (ERISA section 403(a) and (b).)
There are, of course, exceptions to a 403(a) Trustee’s “exclusive authority and discretion over the management and control of plan assets.” One exception is when the plan sponsor appoints a 3(38) Investment Manager to take over the discretionary management and control of plan assets. Upon such appointment, the 3(38) becomes solely responsible (and liable) for the selection, monitoring and replacement of the plan’s investment options. At that point, the 403(a) Trustee becomes subservient to the 3(38) and, as such, is subject to direction by the 3(38) which makes the 403(a) a directed 403(a) Trustee required to report to the 3(38). A second exception kicks in when the 3(21) Named Fiduciary (in the situation where the 3(21) has been appointed by the plan sponsor), in effect, “seizes” from the 403(a) Trustee “exclusive authority and discretion over the management and control of plan assets.” The 3(21) Named Fiduciary is granted this authority by the plan sponsor via a plan amendment. A third exception is when the 3(21) Named Fiduciary appoints a 3(38) Investment Manager to take over the discretionary management and control of plan assets. Same ultimate result: the 403(a) Trustee loses its authority and must then report to the 3(38).
Many opinions handed down by federal trial courts and appellate courts are replete with confusion concerning the notion of a “directed trustee.” The confusion seems to arise from sloppy analyses which mix up an ERISA 403(a) Trustee with a trustee- custodian holding the assets of a qualified retirement plan in trust. The two roles could not be more different: one is a named fiduciary under ERISA with “exclusive authority and discretion over the management and control of plan assets” while the other is simply a trustee-custodian holding plan assets with no discretionary authority under ERISA.
Certain plan providers that are custodians of plan assets love to leave plan sponsors with the impression that they are a “plan trustee” or a “trustee of the plan” when, in fact, they are no such thing. I will cover this kind of deception in a column this summer titled “I, Robot: The Directed Trustee (Which is Not a Directed 403(a) Trustee Under ERISA With Discretionary Authority But is Actually a Directed Trustee-Custodian of a Trust Holding Plan Assets Under State Banking and Trust Law With No Discretionary Authority Whatsoever Under ERISA).” Or something like that.
4. An ERISA Section 3(38) Investment Manager: A Fiduciary Investment Expert
An ERISA section 3(38) Investment Manager is not typically named in the plan document. Instead, it is appointed via a written contract either directly by the plan sponsor–or if the plan sponsor has delegated its 3(21) duties to the 3(21) Named Fiduciary–by the 3(21) Named Fiduciary. A 3(38) has sole responsibility and liability to select, monitor and replace a plan’s investment options. The plan sponsor or the 3(21) Named Fiduciary, as the case may be, has the duty to ensure that the initial decision to appoint a 3(38) was prudent and that such decision continues to be prudent through a monitoring function.
When appointed by an authorized fiduciary, an ERISA section 3(38) Investment Manager assumes an ascendant position over the 403(a) Trustee and, as a result, becomes the entity with discretionary control over plan assets. The 403(a) Trustee then becomes “directed” by the 3(38). A 3(38) ensures that the plan’s investment management environment is prudent. It hires and monitors investment service providers, and holds other fiduciaries and service providers accountable as it pertains to their scope of responsibility and interaction with the plan. A 3(38) ensures that all fees paid for investment services are reasonable. It also leads meetings such as investment committee meetings and fiduciary board meetings, and implements metrics to verify that the investment objectives of the plan are being met. In addition, a 3(38) delegates responsibility as necessary. For example, a 3(38) could delegate authority to another fiduciary to perform a specific function based on that other fiduciary’s unique insight concerning some particular situation. It can also delegate authority to others for practical reasons such as easing the 3(38)’s time limitations.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. The author’s views expressed in this article do not necessarily reflect the views of Morningstar.