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Supervising Your Plan’s Investment Manager and an Atmosphere of Misinformation

Plan sponsors have a lot on their plate. Not only is the list of Administrative responsibilities exceptionally long, the Trustee side (where investment decisions are made) can be overwhelming when managed properly. Fortunately, the law which governs Retirement Plans - the Employee Retirement Income Security Act, or ERISA - allows plan sponsors to delegate their responsibility to outside professionals. Not only does delegation save the sponsor time and effort, the icing on the cake is that delegation, to certain providers, also removes any potential liability for the role.

One such service, which is becoming increasingly popular with plan sponsors, is that of Fiduciary Investment Manager (FIM). In this role an investment manager will assume the Trustee’s responsibility for selection and monitoring the fund line up. In some cases, they will also provide model portfolios or other managed account services to the plan participants. The FIM service is frequently referred to as “3(38)”, although there are what I call “3(38) lite offerings” as well. We’ll save a discussion of the latter for another day.

When a plan sponsor hires a Fiduciary Investment Manager, they have minimized their effort regarding plan investments and maximized their liability protection. However, they haven’t eliminated their potential liability. The sponsor must continue to monitor the service provider. If the sponsor fails to monitor their FIM, and the FIM makes a mistake, the sponsor can be ultimately held liable. This is where misinformation may come into play.

I have witnessed occasions where plan investment advisors who offer a different, lower level of liability protection commonly referred to as a 3(21) service, may try to disparage the level of liability protection offered by the FIM by reminding the sponsor that the FIM cannot eliminate all investment fiduciary risk for the plan sponsor. While this is a true statement, it can be subject to much over-exaggeration.

ERISA does require a plan sponsor to monitor all plan service providers including a FIM. However, supervision of a FIM is not time-consuming or burdensome, especially when compared to the amount of effort it would take to retain the responsibility to be the ultimate investment decision-maker for all plan investments, which is the case when hiring any non-FIM investment service provider, including a 3(21).

To supervise your FIM, utilize the following checklist on at least an annual basis.

1. To qualify to be a FIM under ERISA section 3(38), your provider must be a Registered Investment Advisor (RIA), Bank, or Insurance Company. Ensure that they continue to operate under their applicable capacity.

2. Ensure that the FIM agreed to take “discretion” over your plan’s investment decisions in writing. Review your service agreement to ensure discretion is clearly stated.

3. Ask the FIM about changes in their investment philosophy, if any.

4. Ask the FIM about changes in control of the firm or significant personnel, if any.

5. Ask if there have been any regulatory actions taken against your FIM.

6. Create a control for the manager’s investment selection. A simple method is to compare the FIM’s investments against pre-agreed upon investment benchmarks (Indices). Any investments that significantly under- or over-perform their benchmark should be addressed by the manager to your satisfaction. You’ll likely find that this situation is rare.

7. Does the FIM execute the investment changes at your recordkeeper on your behalf?

8. Does the FIM maintain the necessary fidelity bond, and errors and omissions insurance?

9. Does the FIM have any conflicts of interest with your other service providers?

10. Are costs reasonable for the value provided?

11. Are there any other responsibilities listed in your Investment Policy Statement to which the FIM must adhere? If so, confirm they have been met.

A good FIM will build the aforementioned responsibilities into your Investment Policy Statement on your behalf, and show up annually with documentation addressing each item to your satisfaction. Remember that you must have a process for supervising all plan service providers, so the review process in the case of your FIM is not extra work.

If you properly supervise your FIM and document your review in meeting minutes, or otherwise, then you will have met your responsibility under ERISA and will be protected from mistakes made by your FIM, if any. This model affords the highest level of plan sponsor investment protection available under ERISA, and is not difficult to comply with. The next time a non-FIM advisor tells you their service offers as much liability protection as 3(38), or that it is difficult to comply with the requirement of monitoring a 3(38) FIM, you’ll know it’s misinformation.

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