Plan litigation looks poised to set new records in 2020, and DOL enforcement recoveries are on the rise. A recent DOL enforcement report indicates that DOL recoveries increased by 310% from fiscal 2016 to fiscal 2020. Investment News just reported that fiduciary liability premiums are skyrocketing.
Fiduciaries are personally liable for losses caused by their fiduciary breach, and advice from their plan vendors about investments is not fiduciary advice required to be in their best interests. There is nothing wrong with this business model, but vendors receive fees from their proprietary investments and aren’t required to warn you away from their funds that lag behind peers. Plan sponsor fiduciaries who take a do-it-yourself approach to plan investments face huge potential exposure for underperforming investments and excessive plan fees.
If you are a plan sponsor fiduciary who is losing sleep over all of this, it may be time to consider outsourcing your investment responsibilities to an investment manager or outsourced chief investment officer (OCIO).
ERISA Provides Protections
If plan sponsors seek help by engaging an investment advisor described in Section 3(21) of ERISA, that advisor will make recommendations but won’t have decision-making responsibility. That means that even if the company fiduciaries always follow the recommendations, they remain co-fiduciaries responsible for the decisions. However, ERISA provides two mechanisms for company fiduciaries to actually pass on most of their responsibility and potential liability. The first is if a bank, insurance company or registered investment adviser agrees to assume responsibility for investment decisions as an investment manager and acknowledges fiduciary status in writing as required by Section 3(38 ) of ERISA. If the company fiduciaries prudently select and oversee the manager, the manager, not the company fiduciaries, is responsible for day-to-day investment decisions. Section 402 of ERISA also permits the company fiduciaries to delegate investment responsibilities to a “named fiduciary” pursuant to their plan documents. Some OCIOs prefer to be a named fiduciary for investments.
Neither of these choices delegates 100% of fiduciary investment responsibility, but they delegate most of it. Company fiduciaries remain responsible for prudently selecting and monitoring the performance of these outside fiduciaries.
What’s the Difference between a 3(38) Manager and an OCIO?
Put another way, what does an OCIO do that an investment manager doesn’t do? An investment manager will select your investments and may construct model portfolios for the plan to use. OCIOs will tell you that they can help the plan obtain institutional quality investments, such as custom target date funds, and they can leverage assets to obtain lower fees. OCIO arrangements vary, but an OCIO may also take over plan design and communications and plan governance activities, such as documenting plan investment decisions, in its “named fiduciary” role.
Many Are Already Outsourcing
A recent survey by Callan indicates that 21.6% of surveyed plans hired an investment manager described in Section 3(38) of ERISA to manage plan investments. The percentage of surveyed plans hiring investment managers was up from 15.9% in 2018. A different survey by PGIM indicates that 15% of defined contribution plans and 24% of mid-sized defined contribution plans had outsourced chief investment officers (OCIOs). There is a trend towards outsourcing, and the surprise is that more plan sponsors haven’t chosen an outsourcing option in light of their potential liability if they adopt a “do-it-yourself” approach.
Is Delegation for Everyone?
Some company fiduciaries and owners can’t get comfortable giving up control, and if that is the case, outsourcing may not be a good fit. An investment adviser will give professional advice while leaving the actual decision-making in the hands of the company fiduciaries, at the cost of their remaining responsible as co-fiduciaries for investments.
Some may feel that a new plan without significant assets doesn’t yet need the types of services outsourced investment fiduciaries provide.
Participating employers in multiple employer plans may have access to fiduciary investment services through their plans, particularly if they participate in pooled employer plans (PEPs), a new type of multiple employer plan created by the SECURE Act that will become available in 2021.
How to Find the Right Fiduciary
Outsourcing investments may not be right for some plans, but it is probably appropriate for many more plans than have considered it. If you didn’t draft your own will or serve as architect for your own home, maybe you should ask yourself why you aren’t also tapping professional expertise to manage your plan investments. If you do decide to do so, do an rfp to find the best candidates and make sure to review and understand their qualifications, experience with ERISA plans, which are subject to special investment rules, and fees. There are even professionals who can be hired to take charge of your outsourcing rfp. Given the level of litigation and enforcement actions, hiring the right professional is crucial. Failure to do a good rfp or opting to hire social connections without investigating their qualifications could be a costly mistake.