A 401(k) Dirty Little Secret: Brokers Can Easily Dodge Liability
It's a cozy deal for the employer, the broker and the mutual funds. The employer gets a "free" plan. The broker gets to pick the investment options in the plan and to receive "revenue sharing" payments from mutual funds eager to be included, and the mutual funds get a captive audience for their expensive, underperforming funds. The only losers are the employees, and who cares about them?
That game may be over. Last month, the Eighth Circuit Court of Appeals held that a class-action complaint against Wal-Mart Stores (WMT) could proceed. The complaint alleges that Wal-Mart's 401(k) plan included high-cost funds when less-expensive ones were readily available and that subsidies given to the plan's trustee might violate ERISA, the federal statute governing retirement plans. Law firms are rushing to notify their employer clients about the import of this decision.
Here's the dirty, dark 401(k) secret that brokers and insurance companies keep from employers: Brokers and insurance companies are fake fiduciaries. If their clients are sued by plan participants (as was the case in Braden v. Wal-Mart, the class action), these advisers have no legal responsibility. They avoid it by designating their roles in their Investment Management Agreements as "3(21)" ERISA fiduciaries -- advisers who make investment recommendations only for which they have no legal liability.
In contrast, a "Registered Investment Adviser" who accepts "3(38)" ERISA fiduciary status, is legally liable for the investment options in the plan because it has the discretion to make decisions concerning those options.
The distinction is critical and much misunderstood. It's the difference between faux liability (brokers and insurance companies) and real liability (Registered Investment Advisors who so consent) for investment decisions. The 3(38) status gives employers significant cover from liability. The 3(21) status provides none.
No Longer a Trivial Distinction
If employers understood the difference, they would only retain advisers who would agree in their Investment Management Agreements to be 3(38) ERISA fiduciaries. All employers who offer a 401(k) should ask their advisers to confirm in writing that they are 3(38) ERISA fiduciaries. If they won't do so (and most will not), they should find advisers who will.
Before the Wal-Mart decision, brokers and insurance companies trivialized this critical distinction. Now, employers should be worried that their "free" plan could become really, really expensive.