2021 Best Practices Conference: Outsourcing and What to Expect From Providers

The third panel discussion at the virtual 2021 PLANSPONSOR Best Practices Conference focused on the critical topic of fiduciary outsourcing and what plan sponsors can expect from service providers.

The speakers included Spencer Goldstein, principal and chief investment officer (CIO) at StoneStreet Equity, and Joan Neri, counsel at Faegre Drinker. As the pair explained, plan sponsors have a responsibility for the compliance of their plans, but their recordkeeper and other service providers—such as investment advisers and third-party administrators (TPAs)—can decrease the burden. Ultimately, selecting a provider is itself the plan sponsor’s fiduciary responsibility, and the duty to monitor outsourced service providers is a serious one.

According to Neri and Goldstein, the types of outsourcing available to plan sponsors vary dramatically in their scope, with service providers willing to deliver 3(16) plan administration, 3(21) investment advice and 3(38) investment management, among other types of assistance. As Neri pointed out, these types of outsourcing services get their obscure-sounding names from the sections of the Employee Retirement Income Security Act (ERISA) that govern the actions of providers and their plan sponsor clients, a fact that can confuse novice plan sponsors.  

“When clients come to us for outsourcing, it is for a few different reasons,” Goldstein explained. “First and foremost is the fact that retirement plans are not their core business. Plan sponsors are finding themselves spending a tremendous amount of time and resources to build out valuable retirement programs for their employees, but they eventually come to feel they don’t have the necessary resources or expertise to continue to oversee these benefits.”  

When a plan sponsor reaches this point, as a fiduciary to the retirement plan, there are typically two types of responsibilities they will look to outsource, Goldstein noted. The first is related to investments and the second to plan administration.

“On the investment side, they seek help with the picking of the investment menu and the monitoring of the funds therein—and the communication of what is going on in the menu to participants,” Goldstein said.

Broadly speaking, these types of responsibilities are going to be supported by a 3(21) fiduciary investment adviser, which has a more limited scope and merely provides advice upon which the plan sponsor may choose to act, or oversight of the investment menu is going to be supported by a discretionary 3(38) fiduciary investment manager. As Goldstein explained, the 3(38) manager takes on the actual burden of making decisions and proactively managing the investment menu, having been delegated the authority to do so by the plan sponsor.

When it comes to plan administration outsourcing, Neri and Goldstein said, the provider getting involved is likely to be a TPA, or potentially the plan’s recordkeeper. This provider may take on such tasks as filing the plan’s Form 5500, sending mandatory notices and disclosures to plan participants, ensuring that employee/employer contributions are made in a timely fashion, and more.

Beyond these discretionary outsourcing choices, Neri pointed out, there are actually some functions related to plan operations that must be outsourced—namely the plan’s financial statement audits.

“The other piece I would add is that there are legal considerations underpinning all aspects of outsourcing,” Neri said. “As a plan sponsor, you really need to understand the allocation of responsibilities. You must understand who is doing what and avoid any gaps—and everything needs to be spelled out very clearly in service provider contracts.”

Neri emphasized the importance of diligent monitoring to any successful (and legally secure) outsourcing decision.

“First, you must prudently select the service provider, and then you must prudently monitor that service provider’s performance,” Neri said. “That always remains part of the plan sponsor’s fiduciary obligations. If the plan sponsor has delegated fiduciary functions either on the investment side or on the administration side, the monitoring process must ensure the service providers are indeed living up their promises. So, outsourcing of responsibilities can be very helpful to plan sponsors, but it’s not a simple write-off of responsibilities.”

Goldstein agreed with that sentiment and highlighted the critical role that “process” plays in successful outsourcing.

“Remember, ERISA does not require that you have the best-performing funds or to have the lowest-cost plan administrator or recordkeeper working for you,” Goldstein explained. “What you are required to do is show a prudent process is in place in terms of how you are selecting and monitoring your investment fiduciaries and all your other plan vendors, if they are fiduciaries or not.”

Responding to this point, Neri emphasized that special attention should be paid to the 3(16) fiduciary marketplace, because there are providers in this space that do things very differently from one another.

“Not all 3(16) fiduciary service providers are the same—they really fall into three flavors,” she said.

First is the group of 3(16) supplemental service providers who do not actually take on contractual fiduciary responsibility. They are merely involved with distributing notifications and sending enrollment forms and processing plan transactions—meaning they are not getting involved at all in any type of discretion or decisionmaking. Neri called this “3(16) light.”

Next is the group of “limited scope” 3(16) administrators. This group agrees to take on some fiduciary responsibilities, but not all of them—an arrangement that Neri said can be “tricky” but potentially very efficient.

“This is a case where the plan sponsors really need to make sure they understand what is being done by the outsourced provider and what is not,” Neri said. “In particular, plan sponsors have to pay attention to how nondiscrimination tests are being carried out. There are often gaps, in my experience.”

The third group is the “broad scope” 3(16) fiduciaries who are willing to take fiduciary responsibility for all the plan’s administration processes, leaving the plan sponsors more or less with only the duty to monitor this provider carefully. Neri said each approach has its merits, with the third category becoming increasingly popular and affordable, thanks to technology developments and other factors.

When all parties are living up to their responsibilities, the speakers agreed, all the different types of fiduciary outsourcing can save plan sponsors a lot of time and can potentially insulate them from liability in certain circumstances. Yet plan sponsors always maintain a duty to “kick the tires” and remain cognizant of what is happening in the plan. Indeed, federal court judgments have concluded that retirement plans working with outsourced fiduciaries have a duty to not just unequivocally accept the advice or opinion of fiduciary service providers who pledge to do the right thing.