The number of discretionary consulting arrangements used by plan sponsors has more than doubled since 2011.1 The trend, also called outsourced chief investment officer (OCIO) or a 3(38) arrangement (referring to the applicable section of Employee Retirement Income Security Act of 1974 (ERISA), has increased as plan sponsors look for ways to reduce fiduciary liability, increase decision-making efficiency, and rely on their investment consultant’s expertise. What is the difference between a traditional, or 3(21) consulting arrangement, and a 3(38) discretionary arrangement, and why would a plan sponsor choose to go discretionary?
ERISA provides for two standards of conduct with respect to those who manage an employee benefit plan and its assets within sections 3(21) and 3(38). Under both arrangements, the consultant acts as a fiduciary, but the scope of responsibilities and liability is wider under a 3(38) discretionary arrangement. The biggest difference between them is who is ultimately responsible for final decisions regarding investments. For example, in a 3(21) arrangement, the investment consultant provides recommendations, but the plan sponsor is ultimately responsible for making all final decisions. In a 3(38) or OCIO arrangement, the investment consultant is responsible for all final decisions regarding investments, while the plan sponsor retains responsibility for monitoring the advisor.
Why would a plan sponsor change from the more limited scope of the 3(21) arrangement to a discretionary 3(38)?
Utilizing an OCIO model provides an additional layer of fiduciary protection compared to a 3(21) arrangement. Many clients see the decision to go discretionary to be more strategic, as the shift allows them to focus on their plan objectives instead of focusing on investments. It also provides governance and structure in addition to reducing fiduciary liability (see table below). The plan sponsor may spend fewer internal resources managing the plan, while benefiting from more timely or efficient investment decision-making. A discretionary arrangement may relieve a burden for those who find they don’t have the in-house expertise required to oversee investment decisions. Sponsors should consider whether they want to manage the complexities of the investment program internally or rely on the investment consultant to identify and execute best-in-class investment ideas.
If you’d like to explore whether a discretionary consulting arrangement may be right for you, contact your Arnerich Massena consultant.
1 “3(38) vs. 3(21) investment fiduciary services: the pros and cons for 401(k) advisers” by Greg Iacurci; InvestmentNews; April 7, 2017