But, first, let’s define our terms. The industry uses a variety of labels for these accounts: for example, brokerage windows; mutual fund windows; brokerage accounts; self-directed brokerage accounts (SDBAs). For our purposes, I will use SDBAs. These SDBAs can be limited to a large number of mutual funds or can also include individual securities and other non-diversified investments. The investments can be managed by the participant or, in most cases, the participant can engage an adviser to help. If the adviser provides ongoing discretionary investment management or nondiscretionary investment advice, the adviser will be a fiduciary under ERISA. 

But, what about the plan fiduciary (usually a committee) who decides to include a SDBA feature in a 401(k) plan? Is that a fiduciary act? Yes. Must it be done prudently? Yes. Are the investments in the SDBA considered to be DIAs (designated investment alternatives) which must be prudently selected and monitored? No. Is the provider of the SDBA a service provider? Yes.

Let’s look at those questions and answers.

 

Is it a fiduciary act to include a SDBA in a plan? Must it be done prudently? 

In Department of Labor (DOL) Field Assistance Bulletin (FAB) 2012-02R, Q&A 39, the DOL explained that:

Also, fiduciaries of such plans with platforms or brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan are still bound by ERISA section 404(a)’s statutory duties of prudence and loyalty to participants and beneficiaries who use the platform or the brokerage window, self-directed brokerage account, or similar plan arrangement, . . .

That’s pretty clear. The selection of a SDBA is a fiduciary act, subject to ERISA’s duty of care and loyalty. But it begs the question of, what should a fiduciary consider to make a prudent decision. The DOL continued, in that same sentence, to add:

. . . including taking into account the nature and quality of services provided in connection with the platform or the brokerage window, self-directed brokerage account, or similar plan arrangement.

Nothing remarkable there; as with other fiduciary decisions, a committee must look at the nature and quality of the services to be provided. And, of course, costs must always be taken into account. In FAB 2007-01, in a general discussion of the selection of plan service providers, the DOL gave a little more detail:

With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. 

Realistically, the well-known providers of SDBAs should have the competitive costs and services needed to pass this fiduciary “test.” When it comes to monitoring, the same criteria must be considered, as well as the experience of the plan in working with the SDBA provider, any changes in the costs or services, and any participant complaints.

The 2007-01 FAB focuses on the selection and monitoring of fiduciary advisers for participants. To illustrate how these rules actually apply, here’s what the DOL said about those advisers:

In applying these standards to the selection of investment advisers for plan participants, we anticipate that the process utilized by the responsible fiduciary will take into account the experience and qualifications of the investment adviser, including the adviser’s registration in accordance with applicable federal and/or state securities law, the willingness of the adviser to assume fiduciary status and responsibility under ERISA with respect to the advice provided to participants, and the extent to which advice to be furnished to participants and beneficiaries will be based upon generally accepted investment theories. 

In monitoring investment advisers, we anticipate that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries was based upon generally accepted investment theories. Fiduciaries also should take into account whether the investment advice provider is complying with the contractual provisions of the engagement; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participant comments and complaints about the quality of the furnished advice.

While there are obvious differences between SDBAs and investment advisers, this quote illustrates the need to gather the information relevant to making an informed decision about a service provider and then reasonably evaluating that information.

 

Are the investments in the SDBA considered to be DIAs (designated investment alternatives) which must be prudently selected and monitored? Is the provider of the SDBA a service provider?

In its 404(c) regulation, the DOL defined a DIA as:

A designated investment alternative is a specific investment identified by a plan fiduciary as an available investment alternative under the plan.

A reasonable conclusion from that definition is that the hundreds or thousands of investments in a SDBA aren’t designated as investment options for the participants. On a practical level, it would be virtually impossible for plan committees to monitor thousands of investments on a regular basis. Consistent with that thinking, the DOL, in its 404a-5 disclosure regulation, acknowledged that SDBAs offered investments beyond the DIAs, when it said that participants must be given:

A description of any “brokerage windows,” “self-directed brokerage accounts,” or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan.

Just to make sure that there wasn’t any confusion about that, the 404a-5 regulation went on to provide:

Designated investment alternative means any investment alternative designated by the plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts. The term “designated investment alternative” shall not include “brokerage windows,” “self-directed brokerage accounts,” or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan.

That raises our final question. If the investments in a SDBA aren’t designated investment alternatives that must be prudently selected and monitored, what is the SDBA when viewed from a legal, fiduciary perspective?

It’s a service to the plan and participants. The broker-dealer offering the SDBA is a service provider to the plan. This brings us full circle and back to FAB 2012-02R, where the DOL said that fiduciaries must consider: “the nature and quality of services provided in connection with the platform or the brokerage window, self-directed brokerage account, or similar plan arrangement.”

 

Parting Thoughts

When SDBAs were first introduced to the 401(k) marketplace, there was some nervousness about adding this new feature. However, with the benefit of years of experience we now know that they are, by and large, commonly accepted and frequently used. To confirm the role of SDBAs in 401(k) plans, we need to look no further than the DOL guidance cited in this article. 

As far as I’m aware, there has not been any litigation claiming that SDBAs have been imprudently included in plans or that SDBAs are being misused. That may, at least in part, be due to the fact that many participants who elect to invest through SDBAs are working with advisers. While providing ongoing and individualized advice on investments in SDBAs will result in the adviser becoming a fiduciary, those responsibilities can be properly managed through selecting good quality investments and appropriately diversifying.

Where a participant picks his or her own adviser for a SDBA, the DOL has provided relief for plan sponsors in Interpretive Bulletin 96-1:

The Department also notes that a plan sponsor or fiduciary would have no fiduciary responsibility or liability with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide such services.

With brokerage accounts, what was once unusual has become the norm. The responsibility is to prudently select and monitor the provider. That is a fiduciary duty that has been around for a long time; for example, fiduciaries have become comfortable selecting and monitoring recordkeepers and advisers. With help from advisers, plan committees can also prudently select and monitor providers of SDBAs.