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
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
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.