3(21) or 3(38). Whatever it Takes. Understanding Fiduciary Responsibility.


In the 1983 film Mr. Mom, Michael Keaton plays a downsized auto engineer named Jack who tends the homefront while his wife, Caroline, goes to work as the family breadwinner. When Caroline’s boss arrives to pick her up for a business trip, Mr. Mom, chainsaw in hand, leads him to the renovations ongoing in the house. He asks Jack if he’ll be wiring the house for 220 volts, and Jack replies with the movie’s signature line: “Yeah, 220, 221—whatever it takes.”

ERISA plan management is increasingly complex (and sometimes litigious). It’s no wonder a plan sponsor might say their investment adviser is serving as a fiduciary—yeah, a 3(21) or 3(38) fiduciary. Whatever it takes. The understanding of the two may be unclear, but it’s not unimportant.

When you say “Fiduciary” do you mean…?

That’s the problem. The distinction between a 3(21) and 3(38) fiduciary and your ultimate legal responsibility as a plan sponsor can be confusing, especially because a retirement plan adviser can serve in either a 3(21) or 3(38) fiduciary capacity—and in some cases, in both. The needs of the plan sponsor and their desire for control of investment menus, administration of investment portfolios and their concern regarding liability will determine if and how much fiduciary responsibility is shifted to an investment adviser. The degree to which the plan sponsor maintains “discretion” over all investment decisions defines the sponsor’s (and the adviser’s) role and responsibility.

Simply put, investment advisers fall into two camps, serving as either a 3(21) or 3(38) fiduciary, both defined and governed by specifics in ERISA – the Employee Retirement Income Security Act of 1974.

  • 3(21) advisers serve in a co-fiduciary role, whereby an adviser offers advice to an employer with respect to funds on a 401(k) investment menu, and the employer (or plan sponsor) retains the discretion to accept or reject the advice.
  • 3(38) advisers have been assigned the discretion to make fund decisions. The plan sponsor has less day-to-day responsibility in this relationship, because they delegate (or outsource) fiduciary responsibility for investments to the adviser. But not so fast! Employers are not completely dismissed from their responsibilities in this relationship. They still carry a fiduciary duty to monitor the adviser (and prove that they have), and may still face fiduciary risk if they do not properly monitor the adviser.

It’s also worth noting that a 3(38) fiduciary can only be an insurance company, a bank or a Registered Investment Adviser (RIA). RIAs accept the following charge under the Securities and Exchange Commission: “You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations.”  For reference, Highland is an RIA.

In 2017, Investment News reported research showing “the 3(21) relationship to be the most common – 82% of retirement plan specialist advisers, whose primary business focus is workplace retirement plans, offered a 3(21) service in 2016, while 47% were willing to serve as a 3(38)… “However, there’s been a clear upswing over the past five years toward offering 3(38) services, with the number more than doubling, from 20%, since 2011, while the co-fiduciary service has remained flat.”

Why the Shift?

Employers, and non-profit trustees, may find the delegation of fiduciary responsibility necessary if:

  • Their staff is too small, spread too thin, or lacks the expertise to manage investment strategies well; or
  • Their investment committee meets too inconsistently, or may be unable to come to consensus for responsive management of retirement plan investments.

In these kinds of situations, a 3(38) fiduciary adviser can lift the burden, and, for example, take immediate action if there’s a need to add or remove a fund. A co-fiduciary (under 3(21)) can only advise, make a recommendation, and wait for client decision and consent. Given increasingly complex investment markets, the pressure employers feel to help their employees close retirement savings gaps, together with greater legal attention being paid to fiduciary responsibility and negligence, it stands to reason that plan sponsors are interested in outsourcing more of their ERISA investment responsibilities.

The Buck Still Stops with the Employer

As the trends lean in the direction of more outsourcing, some industry experts worry the shift is leading to plan sponsor “disengagement.” We suspect it might be less a matter of disengagement, and more a matter of role confusion. In a study on fiduciary awareness conducted by  AllianceBernstein, among 1,000 executives (who, by title and by definition were, in fact, fiduciaries), almost half (49 percent) did not consider themselves a fiduciary. Another 6 percent had no idea what their status was.

Unfortunately for these respondents, unless the employer ceases being a fiduciary, they cannot ever entirely eliminate fiduciary liability. Moreover, retirement plan committees need to be highly engaged so that they understand the duties of the fiduciary, the decisions being made, and the rationale for those decisions. Plan sponsors can delegate responsibility, but they still have a duty to monitor their adviser—even in a 3(38) fiduciary relationship.

What Do You Know about Your Adviser? Lowe’s Knows.

Many organizations don’t realize that their investment adviser may also be a broker-dealer, or a captive firm of a broker-dealer, able to recommend their firm’s proprietary funds. And that’s not illegal—so long as the broker acts in the best interest of the client and discloses any potential conflicts of interest. Even so, having any vested interest in a retirement plan’s investment choices can be problematic.

Take Lowe’s and their defined contribution plan as a recent example. A class action suit filed in in a North Carolina federal court challenged Lowe’s decision (and Aon Hewitt’s advice) to move more than $1 billion in 401(k) assets into the Hewitt Growth Fund. Previous to this move of Lowe’s plan assets, the fund had no large retirement plan investors and only $350 million in assets. The growth fund performed worse than the funds previously in the company’s 401(k) plan.

Both Lowe’s and Aon Hewitt, which provides investment consulting services to the Lowe’s plan, are accused of breaching their fiduciary duties under ERISA. The Lowe’s retirement plan recorded more than 262,000 participants. The suit filed on their behalf alleges that the decision to move funds into the Hewitt’s Growth Fund caused more than $100 million in investment losses. The outcome of the dispute is still being resolved, but it serves as a warning that working on a plan sponsor’s behalf, motivated only by their success, is far easier to accomplish and prove when you sit on the same side of the table.

Is Your Organization Wired for a 3(21) or a 3(38)?

There’s no easy answer to the question. (But you knew that.) Whether you assign full discretion to your investment adviser in a fully “outsourced chief investment officer” (OCIO) relationship, the fundamental question is whether you are working with the best adviser for your retirement plan.

The quality of the advice you receive in a 3(21) advisory relationship shouldn’t change when you grant a 3(38) fiduciary relationship. The advice should be the same. But the relationship with your adviser could and should be even closer with a 3(38) adviser, characterized by high degrees of engagement, understanding, and responsiveness.

In any case, your adviser should demonstrate their ability, willingness and worthiness to earn your trust in the role you’ve assigned: 3(21), 3(38)—whatever it takes.


Highland Consulting Associates is celebrating 25 years of serving our clients with objective, conflict-free counsel. Call us if you’d like to discuss your fiduciary responsibilities.


Joel Baker CFA