Considerations for Outsourcing Fiduciary Duties

The paper, “When Did Defined Contribution Get So Complex? Outsourcing Certain Functions of Your Defined Contribution Program,” was written by Christine A. Loughlin, a partner of NEPC LLC, a Boston-based investment consulting firm.

“Increasingly, every decision a fiduciary makes is under the microscope,” says Loughlin. These decisions can cover plan design, investment manager selections and the adequacy of employee retirement savings. Fiduciary liability is also a growing concern among plan sponsors, she says, with the dollar settlements for lawsuits relating to 401(k) plans reaching into the tens of millions.

As a result, plan sponsors are looking at whether they should outsource certain fiduciary duties. According to Loughlin, plan sponsors need to start by deciding whether they want to truly outsource such duties or simply employ specialized consultants to help them make fiduciary decisions. Under Section 3(21) of the Employee Retirement Income Security Act (ERISA), plan sponsors can use consultants to provide them with data and recommendations, which the plan sponsors can then review and use to make and implement plan decisions.

However, if plan sponsors want to truly outsource, Loughlin explains that ERISA Section 3(38) offers them the option of transferring fiduciary responsibility, and some degree of liability, to a consultant with discretionary authority. The plan sponsor would still be required to monitor the overall processes though.

Once the plan sponsor has chosen a 3(21) or 3(38) path, Loughlin recommends examining the following areas to determine what fiduciary duties can be outsourced:

• Investment policy and/or investment menu;
• Investment policy implementation, as well as investment manager selection and replacement;
• Custom multi-manager fund management;
• Custom target-date fund management; and
• Plan administration and compliance.

In considering the option of outsourcing fiduciary duties, Loughlin suggests plan sponsors ask whether doing so would answer questions such as:

• Which asset classes should be offered?
• What is the appropriate default investment?
• How should we think about alternative investments?
• Is the plan large enough to support custom target-date funds?
• Are we compliant with our own Investment Policy Statement?

Loughlin tells PLANSPONSOR, NEPC sees demand for 3(21) or 3(38) services at both the small and large ends of the market. "A discretionary investment relationship for a defined contribution plan, a 3(38) relationship, is new ground for the consulting industry," she adds.

According to Loughlin, need is the fundamental factor in determining whether to outsource fiduciary responsibility. "The questions are ‘Does the company or committee need help?’ and ‘Are retirement plan matters overwhelming their internal resourcing?’” she says.

Loughlin adds: “We don’t think deep pockets will give one provider an advantage over another in winning discretionary mandates. The type of provider that sponsors will, and should, choose is the one with knowledge of custom and practice among similarly situated ERISA plans and institutional investors. Operationalizing a defined contribution plan to include best practices and institutional investments, unbundled recordkeeping, and white-label, custom multi-manager investments are areas of great specialty. If outsourced, you have to go with a provider with experience.”

A copy of Loughlin’s paper can be downloaded from here.