1. INVESTMENT ADVISOR SERIES
ERISA 3(38) Fiduciary Status
Managing Liability for Investment Managers through
Errors & Omissions Insurance and required Bonding
By Gary Sutherland, CIC
Presented by
North American Professional Liability Insurance Agency, LLC (NAPLIA)
161 Worcester Road, Suite 504, Framingham, MA 01701 Tel 866.262.7542 Fax 508.656.1399 WWW.NAPLIA.COM

2. This paper provides an overview of Errors & Omissions insurance and
related coverage specific to ERISA 3(38)
 What do you need to know and what concerns you
may have regarding proper coverage for your
services as an ERISA 3(38) Investment Manager
 Overview of the requirements under ERISA
section 412 bonding
The information provided in this paper is intended solely for general educational purposes. It is not intended for the
purpose of providing specific legal, insurance, or other professional advice to any particular recipient or with respect to any
particular jurisdiction. The author, publisher, and distributor of this document (1) make no representations, warranties, or
guarantees as to its technical accuracy or compliance with any law ( federal, state, or local) or professional standard; and,
(2) assume no responsibility to any recipient of this document to correct or update its contents for any reason, including
changes in any law or professional standard. You should formally retain the counsel of an attorney knowledgeable as to
your industry, your practice, and the laws of any jurisdiction(s) within which you conduct your practice to ensure the
document’s maximum usefulness and compliance with applicable laws and professional standards.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

3. Introduction
A plan sponsor can delegate both significant responsibility and liability to an ERISA section 3(38)
investment manager for the selecting and monitoring of investment options, including full
discretion.
Under ERISA section 402(C) (3) a named fiduciary may appoint a 3(38) investment manager(s)
to manage plan assets. In other words, the plan sponsor may hire an ERISA 3(38) investment
manager to accept the fiduciary responsibility (and legal liability) for the investment options
offered to plan participants.
However, the plan sponsor can never delegate away its fiduciary responsibility (and legal
liability) for the “selection” of the 3(38) investment manager.
Through the acceptance of a written contract, the advisor becomes an independent fiduciary to
the plan via ERISA s 405(d)(1). In this capacity, the advisor is solely responsible, and liable, for
investment decisions concerning the selection, monitoring, and replacement of plan investment
options.
As an ERISA 3(38) fiduciary, the advisor has legal “discretion” in making these decisions. In Fact,
the plan sponsor has transferred their liability for such decisions to the advisor.
3(38) advisors are required by ERISA to state in writing that they are fiduciaries.
This action creates potential coverage issues within your Errors & Omissions
policy.
What steps then does an Investment Manager who has elected ERISA 3(38) status need to take
to manage this liability?
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

4. Overview of Errors & Omissions Insurance
An Errors & Omissions (E&O) policy protects advisors and consultants against losses due to an
actual or alleged negligent act, error or omission committed in the scope of their duties as
investment counselors/advisors. Historically, E&O policies excluded an advisor’s acts as a
fiduciary. Times have changed and today there are four ways that an E&O policy may address
third party fiduciary coverage:
1. The policy contains an absolute exclusion. The intent is clear to exclude any claims as a
result of the policyholder’s capacity as a fiduciary.
2. The policy is silent in reference to fiduciary coverage. As the policy does not affirmatively
provide, nor exclude, fiduciary coverage it is difficult to determine the intent of the policy.
3. The policy provides limited or modified coverage. In this scenario, the policy may provide
coverage as a limited 3(21) fiduciary but exclude discretionary authority over client funds.
4. The policy provides affirmative coverage for fiduciary activity. This is the most preferable
scenario, and recognizes the policyholder’s fiduciary duties to clients and provides a clear
statement of the policy’s coverage intent.
When an advisor takes on the role of an ERISA 3(38) investment manger it is important to make
sure that the advisors current E&O insurance policy is not included in the first three types of
coverage mentioned above. It is most common for affirmative fiduciary coverage to be
included specifically in the body of the policy, or added by endorsement. In either instance, it is
policy language that specifically states coverage’s for ERISA fiduciary services for others for a
fee that is crucial.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

5. A standard, and acceptable, exclusion is when an advisor is a fiduciary for their own plan or
where an advisor is a plan participant.
An advisor should also make sure there are no limitations upon discretionary authority and that
the policy covers “the advisor” for all discretion over ERISA plans, other than the advisor’s own
plan(s).
In addition to the above, a significant concern with an advisor’s E&O insurance policy is the
contractual liability exclusion and how it may relate to contracted services as an ERISA 3(38)
investment manager. A standard exclusion might read like the following:
(This policy does not apply to) The liability of others assumed by any
of you (the advisor) under any contract or agreements unless the
liability would have attached to you “the advisor” even in the absence
of such contract or agreement.
Specifically, the agreement or contract of a 3(38) advisor is a written fiduciary
acknowledgement given to the plan sponsors. The intent of the foregoing exclusion is to avoid
claims were the advisor is contractually obligated (and thereby, the insurance company) to
assume risks beyond the scope of their areas of practice and or outside the scope of their
applications and supporting documentation.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

6. Because the 3(38) advisor accepts the risk of the plan
Using Insurance as a
sponsor for the selection and monitoring of investment Marketing Tool
options, including the full responsibility to control and
In a recent poll, clients cited
dispose of plan assets, the contract exclusion may apply. trust, or lack thereof, as the
major factor (60%) for leaving
This then becomes a grey area of coverage intent that could
their Investment
lead to a coverage dispute, or worse, a denial of coverage. Advisor. In fact, trust ranked
higher than the actual
Acceptable modification of this exclusion might read as: performance of their investment
assets.
The liability of others assumed by any of you So, how can you as an advisor
gain the trust of your clients and
(the advisor) under contract or agreement prospects, so that you can
continue to grow your business?
except for any written fiduciary agreements
Proactively using your insurance
or contracts given to clients other than you coverage as a marketing and
education tool will help you:
:the advisor” for a fee unless such liability
Demonstrate your Knowledge
would have attached to you ‘the advisor” and Added Value
even in the absence of such agreement or Create "Peace of Mind"
contract Confirm "Fiduciary" Coverage
Raise the Bar for your
This clarifies the intent of coverage and lessens the potential Competition
for misinterpretation. When possible it is prudent to make Read NAPLIA’s White Paper;
sure that the definition of professional services is broadly Using your Insurance as a
Marketing Tool for more
worded to specifically address services as a 3(38) as defined information.
by ERISA s402(c)(3).
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

7. It is important for the advisor to understand that all polices designed for investment
professionals are not standardized, so the full policy including all endorsement needs to be
analyzed and matched to the advisor’s firm’s activities and business model.
Case Study:
We recently reviewed a policy form (without endorsements) that appeared to provide
broad coverage intent for the investment advisor. However, upon full review of the
policy’s endorsements, it was obvious that the endorsements negatively modified
coverage. In fact, one endorsement contained a “discretionary authority exclusion” that
effectively removed coverage for more than 50% of the advisor’s areas of practice. The
advisor had this policy in place for several years and clearly the insurance agent was not
familiar with the advisor’s business.
ERISA Investment Bonds / Fidelity Bonds
The fidelity bonding requirements of ERISA, is often misunderstood and produces significant
questions and concerns among advisors.
ERISA bonds protect plans from losses due to theft and fraud of plan funds. ERISA Section 412
requires every fiduciary of an employee benefit plan and every person who handles funds or
other property of such plan, to be bonded.
The responsibility for ensuring bonding requirements falls to the plan officials.
Under ERISA section 412(b) it states that is unlawful for any plan sponsor to
permit any others to receive, handle, disburse, or otherwise exercises custody or
any control over plan funds or other property without being bonded in
accordance with ERISA section 412.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

8. An ERISA section 3(38) advisor is required to be bonded Definition of “Handling”
for each plan that they service up to $500,000 per plan, and relation to bonding
or up to $1,000,000 if the plan has company stock. The
The term “handling” carries a
Department of Labor (DOL) has confirmed this coverage broader meaning than actual
physical contact with “funds or
requirement and plan sponsors are obligated under other property” of the plan. A
ERISA to confirm bonding from each advisor that has any person is deemed to be
“handling” funds or other
discretionary authority over plan assets. This means if property of a plan so as to
require bonding whenever his
the advisor is paid directly from plan assets they are duties or activities with respect
required under ERISA section 412 to be bonded. to given funds or other property
are such that there is a risk that
such funds or other property
could be lost in the event of
Exceptions: A person that provides investment fraud or dishonesty on the part
of such person, whether acting
advice, but does not exercise, or have the right alone or in collusion with others.
to exercise, discretionary authority with respect
According to ERISA Attorney,
to purchasing or selling securities or other Marcia S. Wagner, “the primary
standard to determine whether a
property for the plan and does not collect fees person should be bonded is
whether plan funds could be lost
directly from the plan, is not required to be as a result of that person’s
dishonesty”>
bonded solely by reason of providing such
investment advice for others for a fee.
In some instances we have seen an advisor added to a plan’s required ERISA bond; However,
this is not recommended as it may be a breach of fiduciary duties of the plan sponsors in the
event that ultimately a loss is not covered due to an erosion of limits of coverage. Remember,
the Bond caps losses at $500,000; whereas a plan may purchase increased aggregate limits of
coverage if the advisor were provided with individual bonds. In addition, some plans require
more than the minimum bonding requirements under ERISA section 412.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

9. Bonds can be written several ways. The most common formats are “blanket” and “individual”.
Blanket bonds are designed to cover all the plans an advisor has at the inception of the policy.
Each plan is rated based on the current assets of the plan up to the required 10% and the
premium is based on the cumulative totals. Any new plans added during the policy period are
automatically covered and at renewal a new schedule of plans and plan assets are reported to
the insurance carrier for the premium calculations. Certificates of insurance can be issued to
plan holders meeting the notification requirements for plan sponsors
Individual bonds are unique to a particular plan and often will have to provide protection in
excess of the minimum ERISA bonding requirements. Such plans are usually the mid-to-larger
size plans. Most insurance carriers will offer up to $25 million in bonding capacity, and
additional coverage is available by requested excess coverage.
Conclusion
It is an axiom that not all fiduciaries are alike; the same can be said for insurance policies. It is
essential for an advisor to understand their exposure, identify potential gaps in coverage, and
take the necessary steps to ensure proper coverage including:
1. Identify the fiduciary coverage in your existing policy
2. Identify the contractual exclusion in your existing policy
3. Identify your need for an ERISA Investment Advisor Fidelity Bond
The importance of these items cannot be understated, but they do not represent all of the
potential coverage concerns for any one particular practice or policy. Whenever possible work
with an insurance specialist who is familiar with investment professional’s insurance policy
language and has the experience of negotiating coverage enhancements.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.

10. Contact
Gary Sutherland is the Chief Executive Officer of North American Professional Liability Insurance Agency,
LLC (NAPLIA). He can be reached at garys@naplia.com or 508-656-1350.
About NAPLIA
Established in 1998, North American Professional Liability Insurance Agency, LLC (NAPLIA) specializes in
providing professional liability insurance, errors and omissions insurance and related products to the
financial industry. Our focused approach makes us leaders in the industry. NAPLIA has been named to
the INC 5000 list of the fastest growing private companies in America every year since 2008.
Additional Resources
Using your Insurance as a Marketing Tool (for Investment Advisors)
http://www.investmentadvisorinsurance.com/white_papers/index.htm
How to inform your clients about Fiduciary Insurance
http://www.investmentadvisorinsurance.com/fiduciary-insurance/why_fiduciary_insurance.htm
The information provided in this paper is intended solely for general educational purposes. It is not intended for the
purpose of providing specific legal, insurance, or other professional advice to any particular recipient or with respect to any
particular jurisdiction. The author, publisher, and distributor of this document (1) make no representations, warranties, or
guarantees as to its technical accuracy or compliance with any law ( federal, state, or local) or professional standard; and,
(2) assume no responsibility to any recipient of this document to correct or update its contents for any reason, including
changes in any law or professional standard. You should formally retain the counsel of an attorney knowledgeable as to
your industry, your practice, and the laws of any jurisdiction(s) within which you conduct your practice to ensure the
document’s maximum usefulness and compliance with applicable laws and professional standards.
Copyright 2012 by North American Professional Liability Insurance Agency, LLC. All rights reserved.