ERISA vista | PLANADVISER January/February 2015

Managed Account 3(38)s

Questions advisers are asking

By Fred Reish and Joan Neri | January/February 2015
Art by June Kim

ADVISER QUESTION: As an adviser for 401(k) plans, I use asset-allocation models to help participants invest. I want to be able to manage the models, but I don’t want to have to comply with all of the reporting requirements for designated investment alternatives. So, I plan to treat them as managed accounts, and I’ll be the 3(38) investment manager. What do I need to consider?

ANSWER: There are several things to keep in mind.

First, determine whether the managed accounts will be used as qualified default investment alternatives (QDIAs) for participants who do not direct their investments. If so, the accounts must be managed in a manner consistent with generally accepted investment theories—for example, modern portfolio theory—and the strategy must be based upon the participant’s age, target retirement date or life expectancy. Also, to qualify as the managed account QDIA, a fund must invest in the plan’s designated investment alternatives.

Second, we recommend that, for risk management purposes, participants be provided with sufficient information about the investment objectives and strategies of your managed accounts. This will allow them to understand how the accounts will be managed and what risks are involved.

As to what additional information you need to provide to participants, you must give them your Form ADV, Part 2, or an equivalent brochure. We also recommend that participants be given a 408(b)(2)-type disclosure that acknowledges registered investment adviser (RIA) and Employee Retirement Income Security Act (ERISA) fiduciary status and that describes the managed account service and fee.

You need to consider the requirements of Rule 3a-4 of the Investment Company Act as well. That rule provides you a safe harbor from being defined as an investment company—e.g., from the requirement that certain investment arrangements be organized as mutual funds—for investment advisory programs where similar portfolio management services, such as model portfolios, are provided to clients. The thrust of the rule is that each client—here, each plan participant—should receive individualized investment treatment. For instance, the safe harbor requires that the adviser contact the individual at least annually to determine if there have been changes to his investment objectives. Following the rule is not required in this context; it is merely a safe harbor. However, for risk management purposes, advisers who manage participant accounts using asset-allocation models may want to implement those criteria in the safe harbor that are consistent with managing participant accounts in 401(k) plans.

A third consideration is the potential for prohibited transactions. If you are a fiduciary adviser to the plan as well as a participant investment manager, there are rules you need to follow to avoid prohibited transactions. While a discussion of these rules is beyond the scope of this article, we refer you to our last column (“A Fiduciary Adviser and Manager?,” PLANADVISER, November–December 2014).

And fourth, remember the participant disclosure rules. If the plan sponsor is selecting you to offer investment management services to participants, you are a “designated investment manager,” or DIM, under Field Assistance Bulletin (FAB) 2012-02R. Under that guidance, a DIM’s services are not considered a designated investment alternative, subject to detailed participant disclosures about expense ratios, performance history and more. Instead, a more limited disclosure applies to a DIM.

The FAB requires that the ERISA plan administrator, usually the plan sponsor, identify you to the participants as a DIM and describe your services and fees. This disclosure must be given to newly eligible employees and annually to all participants. Note: “Participant” covers everyone with an account balance and includes eligible employees who have not enrolled in the plan as well as beneficiaries who have the right to direct investments. Also, participants’ quarterly statements must show the DIM fees charged against their accounts. You may need to help the plan sponsor develop the disclosure language and coordinate with the recordkeeper to make sure the disclosures are delivered in a timely fashion.

Fred Reish is chair of the Financial Services ERISA practice at the law firm Dirnker, Biddle & Reath. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on the Employee Retirement Income Security Act (ERISA), Internal Revenue Service (IRS) and Department of Labor (DOL) audits, as well as pension plan disputes. Joan Neri, who has been associated with the firm since 1988, is counsel on the Employee Benefits and Executive Compensation Practice Group. Her practice focuses on all aspects of employee benefits counseling.