Navigating Common ERISA Pitfalls: Insights from Fiduciary Wise

By Kathleen McBride, AIFA, CEFEX Analyst

Employers sponsoring a retirement plan for their employees may be surprised to learn that they can delegate some of their fiduciary risks, tasks, and legal and financial liabilities to professional ERISA fiduciaries. And, if it’s done correctly, this will improve their employee’s plan and reduce the employer’s risk substantially.

Every 401(k) retirement plan has a Named Fiduciary. This is the person, or persons, named in the plan’s documents. The Named Fiduciary has responsibility for running the plan properly, hiring service providers, and making sure the plan is managed solely in the highest fiduciary interest of participants and beneficiaries of the plan. They sign the IRS Form 5500 (unless they’ve delegated that). The Named Fiduciary also needs to make certain that the plan’s service providers are working in the best interest of plan participants, and that investments are appropriate, and cost-efficient. That’s because plans are forbidden from wasting participants’ retirement savings.

But employers don’t have to do everything themselves. In fact, the law governing retirement plans, the Employee Retirement Income Security Act (ERISA), says:

“The duty to act prudently is one of a fiduciary’s central responsibilities under ERISA. It requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions.”

Not all employers know that they can hire and delegate most of the plan’s Named Fiduciary responsibilities to an independent 402(a) Named Fiduciary, such as Fiduciary Wise.

What does that mean? It means an employer can delegate 92% of their plan responsibilities to us. Fiduciary Wise becomes the plan’s 402(a) Named Fiduciary, named in the plan document. We don’t select the investments or do the record-keeping. We take the employer’s place as the Named Fiduciary and work with the plan’s investment, record-keeping, TPA and other service providers. We relish bringing a plan in and implementing fiduciary best practices and working with the plan’s service providers to make improvements when necessary. The employer keeps only a handful of tasks – ones the employer cannot delegate.

Once an employer delegates responsibility for running the plan to us as the 402(a) Named Fiduciary, we work with the plan’s other prudent experts on the different aspects of the plan.

One of the many important tasks plan sponsors face is making sure that the plan’s core investment line-up is appropriate, high quality, cost-efficient, and safe. For most employers this is a task they know very little about. That’s understandable, because most employers are, understandably, focused on running their own firm’s business – which is typically not the investment business!

Selecting, monitoring, and when necessary, replacing the mutual funds in the plan’s investment menu is one of the plan functions that demands the special expertise of prudent experts. These prudent experts can take additional risk from the employer as they select appropriate funds that have been vetted for quality, cost efficiency and safety. To delegate this responsibility and liability to prudent experts requires an understanding of the different ways prudent experts can work with the plan.

How can you find prudent experts to help select investments?

This is where understanding how delegation works is really important.

Some plans hire an investment consultant. A Consultant may or may not be a fiduciary. They may be a broker or insurance agent, (generally not fiduciary and not taking any fiduciary risk off the plan sponsor’s shoulders). They may be a Registered Investment Adviser (a fiduciary by law). Or they may be all the above, in which case it can be difficult to tell whether or when they are a fiduciary or not. Any of them can recommend a group of funds that a plan sponsor can choose from for the plan. But to be protected from fiduciary liability, an employer/plan sponsor must know the difference and understand the protections offered, if any.

Here’s how to tell the difference. There are generally three types of ERISA investment contracts, and it’s vitally important to know exactly which type you’ve engaged: Consultants, 3(21) Investment Advisors, and 3(38) Investment Managers.

Consultants can recommend an investment line-up to a plan sponsor. They may have the employer pick from a big menu of funds. They may also help monitor and may recommend replacements. But they typically do not take any delegation of fiduciary responsibility for selecting which investments to include, or any fiduciary liability. And mutual funds are not all equally good. That’s on you, the employer sponsoring the plan. When working with a Consultant, you choose which investments to include in your plan’s investment menu. The consultant may also provide periodic reports on how the investments are performing and recommend replacing some. But the employer has the last word, and all the ERISA Fiduciary responsibility and liability, for selecting, monitoring and replacing plan investments that are not performing as expected, or are not cost efficient. That means if the funds offered in your plan are not cost efficient, or high quality, or safe, the plan sponsor bears all the risk, including that of lawsuit. There have been more than 450 lawsuits brought by plan participants against employers for excessive costs of plan investments and service providers since 2016.

An ERISA 3(21) co-fiduciary Investment Advisor is a co-fiduciary with the employer plan sponsor. The “3(21) co-fiduciary” name comes from the part of ERISA code where this is described. A 3(21) Investment Advisor co-fiduciary will typically recommend investments for the plan, monitor them, and recommend changes if the investments do not perform as expected. But since they are co-fiduciaries, the ultimate decisions about which investments to include in the plan’s investment menu, and decisions about when to replace a plan investment, and all the liability rests on the employer’s shoulders. So, if there’s a lawsuit because plan investments did not perform as anticipated or they were high-cost or they were not monitored, and if necessary, replaced in a timely way, it’s the employer plan sponsor who has liability. And if there’s a lawsuit, it’s the employer’s plan fiduciary who is sued.

Delegating to an ERISA 3(38) Investment Manager: When plans have delegated the responsibility – and liability – for the selection of the investments, monitoring the investments, and replacement of the investments, when necessary, to what’s called an ERISA 3(38) Investment Manager, the picture is clearly, meaningfully different. When an employer properly delegates to an ERISA 3(38) Investment Manager, this act lifts fiduciary responsibility and liability from the plan sponsor’s shoulders. This is a BIG DEAL. How big? Well, this demonstrates the power of delegation. If the employer contractually delegates responsibility for selection, monitoring and replacement of the plan’s investment menu, to the ERISA 3(38) Investment Manager, as long as the employer has chosen that ERISA 3(38) Investment Manager via a prudent process, has a contract with that delegation in it, signed by both the employer and the ERISA 3(38), then the liability about the investment menu rests with the ERISA 3(38). The 3(38) Investment Manager then reports to the plan sponsor on what they have selected, whether the funds are performing as expected – (monitoring), and if any need to be replaced, and makes those replacements. The employer does have to be informed but is not responsible for those investment decisions.

Typically, an ERISA 3(38) Investment Manager will be a Registered Investment Adviser, a fiduciary by law under ERISA and the Investment Advisers Act of 1940 and registered with the Securities and Exchange Commission.

Now, sometimes for an employer sponsor of a retirement plan, giving up the control and responsibility of selecting the mutual funds to be made available on their plan’s menu, delegating it to an ERISA 3(38) Investment Manager might feel like giving up control. But, unless you are an investment expert, ask yourself: do you have the training and expertise to select these funds? DO you want to be financially responsible for funds you’ve selected to include in the plan? If no, prudently find an ERISA 3(38) investment Manager and delegate your way to a better plan for your employees. And while you’re at it, think about delegating your 402(a) Plan Fiduciary responsibilities to Fiduciary Wise. That’s meaningfully different.