Investment Manager

By Jason Roberts

Introduction
Recent trends in regulatory enforcement and ERISA litigation are leading plan sponsors to examine ways to shift or “outsource” fiduciary risk. The market losses of 2008 have served to underscore this risk, particularly as it relates to investment-related losses in participant accounts. As a result, increasing numbers of sophisticated plan sponsors are asking their advisors to serve as an ERISA 3(38) investment manager and/or conducting searches for those who do. Significant opportunities are emerging for advisors that are equipped to serve in this capacity, but it is a decision that must be carefully evaluated and prudently implemented.

Background and Legal Discussion
ERISA provides plan sponsors with four primary tools to shift or mitigate risk for investment-related losses in participant accounts: 1) qualified default investment alternatives (QDIAs); 2) participant investment advice; 3) 404(c) compliance; and 4) delegating authority to a Section 3(38) investment manager. The first two options only provide protection to plan sponsors if utilized by participants, and the plan fiduciaries remain liable for the selection and monitoring of the plan’s investment options. And while compliance with Section 404(c) may provide additional protection, the plan fiduciaries remain responsible for selecting core investment options that meet the requirements of 404(c) and for providing exhaustive disclosures and notifications.

Section 3(38) makes it possible for plan fiduciaries to delegate primary authority for plan investments to an “investment manager” who: (1) has the power to manage, acquire, or dispose of any asset of a plan; (2) is a registered investment adviser (RIA), bank or insurance company; and (3) has acknowledged in writing that he is a fiduciary with respect to the plan. The plan fiduciaries are relieved from their obligation to invest or otherwise manage any assets of the plan which are subject to the management of the 3(38) manager, but they must show that a prudent process was followed relative to selecting and monitoring the performance of that manager.

Emerging Service Arrangements
In working with our adviser clients, we are seeing three primary business models emerge: plan-level only; participant-level only; and both plan and participant investment management services. Plan level investment managers take on discretionary responsibility for the selection and monitoring of the “core” investment and may or may not allocate among those options to create model portfolios or managed accounts. Advisors serving as investment managers at the participant level generally limit their activities to creating and managing accounts that are allocated among core investment options selected by an unrelated fiduciary. Depending upon the resources and the expertise of the adviser, it may be advisable to partner with another adviser to fulfill one or more of these functions. Some clients are providing turnkey, comprehensive services by coupling investment manager functions with participant-level investment advice, thereby providing protection for their plan sponsor clients at all levels of service.

Important Considerations
There are three primary factors an adviser should consider before becoming a 3(38) manager. First, advisers should evaluate their respective resources and expertise to determine whether and in what capacity they are comfortable assuming discretion over plan assets. Advisers that are experienced in selecting and monitoring plan-level investments should consider the degree to which they are comfortable exercising discretion over participant accounts. Conversely, advisers who are experienced in developing and managing model portfolios or managed accounts may be more inclined to provide only participant-level services and leave the selection and monitoring of the core funds to an adviser with more experience servicing ERISA clients at the plan level.

Next, advisers should evaluate any compliance-related concerns. Many broker-dealers, for example, do not permit their affiliated investment adviser representatives (including independent RIAs) to exercise discretion over investments that are subject to ERISA. If the adviser is truly independent and/or has obtained approval to serve as a 3(38), he/she should undertake a review of the relevant service agreements and disclosure documents to ensure that the responsibilities and limitations on the proffered services are fully-disclosed and that the documents are compliant with ERISA and Department of Labor regulations. Lastly, the adviser must determine whether such services are covered under their existing errors and omissions policy or whether they need to obtain additional coverage.

Conclusion
Serving as an ERISA 3(38) manager may provide significant opportunities for advisers seeking to retain and/or grow their assets under management. It may also provide advisers with opportunities to partner with other advisers to offer complementary and/or supplementary services. Given the number and complexity of compliance-related concerns, however, advisers that are seeking to become 3(38) managers are advised to proceed cautiously and to keep abreast of the ever-changing legislative and regulatory landscape.

© 2009 Reish & Reicher, A Professional Corporation. All rights reserved. THE ADVISER REPORT is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish & Reicher does not warrant and is not responsible for errors or omissions in the content of this report.

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