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Self-Directed Brokerage Accounts in 401(k) Plans Part II: DOL Threatens 401(k) Plan Self-Directed Brokerage Accounts

As a 401(k) plan sponsor, have you met your 408(b)2 fiduciary responsibility? Now that July 1 has come and gone, the ball is in your court. Your plan’s covered service providers had until that date to provide you with the following information:

  • A description of the services they provide your plan
  • Their fees (direct and indirect)
  • Whether they are a fiduciary to your plan

Now it’s your turn. You must:

  • Ensure that you’ve received this information from each provider
  • Document that you understand the information provided

Depending on how the required information has been disclosed, that second point about understanding it is often easier said than done! We’ll say more about that in a moment. First, let’s go over what that information is, and what to do if it’s missing entirely.

Fiduciary Insight #1: Are your plan fees reasonable?

It’s important to note that your fiduciary duty to ensure reasonable plan fees is nothing new. It’s an age-old ERISA responsibility placed on fiduciaries. But now that you are supposed to have fee-disclosure information in brighter black and white, we expect that regulators will be considerably less sympathetic to any excuses along the lines of “How could I have known?”

Fiduciary Insight #2: Do your service providers have troublesome conflicts of interest?

In my opinion, significant conflicts of interest are sleeping ogres, beginning to stir in their slumbers. More providers have conflicts of interest than don’t. Unfortunately the final version of 408(b)2 does NOT require them to fully disclose their conflicts, as did the prior version. I discussed this regrettable eleventh-hour revision in my previous blog, “Connecting the Dots Among Conflicts of Interest.” This leaves you, the plan sponsor, with certain facts provided, but also with the burden of interpreting what they really mean.

For example, your investment provider must tell you if it receives indirect compensation when your participants are directed to one fund family over another. But you must judge whether the conflict is okay with you, as a fiduciary, whose plan participant interests are paramount. If not, you must fix the problem. If so, then you should document the conflict and why it is acceptable to you.

Fiduciary Insight #3: Are they really acting as a fiduciary to your plan (or just hoping you’ll think so)?

The truth is, far fewer plan providers are acting in a fiduciary capacity than you have been led to believe. Under 408(b)2 requirements, your service providers must now state when they are serving in a fiduciary role. This requirement was created in response to the frequent smoke and mirrors that providers used to imply they were acting as a fiduciary when they were not. This would leave all responsibility and liability (personal liability, by the way) on unwary plan sponsors who mistakenly believed they had transferred their fiduciary duties. Increased disclosure requirements are a step in the right direction – but beware. As I covered in my previous blog about fiduciary relationship disclosure, the final version of 408(b)2 only requires that service providers state when they ARE a fiduciary. Silence on the subject implies they are not, and vague language may still leave you guessing.

Missing or Misinformation: No Excuse

As touched on above, among your remaining fiduciary duties is to report and act if a service provider fails to provide you with the required 408(b)2 disclosures. Specifically you must request missing information in writing. If it is not received within 90 days, you must notify the Department of Labor (DOL) and terminate the relationship. If you instead remain silent, continue to work with them and allow them to bill your plan, then a prohibited transaction will take place and the plan will have to be reimbursed for any fees paid to the service provider.

It is my opinion that those who are using a broker for their plans face the biggest risk of incomplete disclosure. Brokers are very likely receiving indirect compensation – not from the plan, but from the providers whose investments they recommended. If they receive more than $1,000 during the course of their agreement with the plan (i.e., not just annually – but during the course), they are a covered by these new regulations and must comply by providing you with disclosures. Considering that “during the course” could cover many years of ongoing activity, I am concerned that noncompliance may occur, simply due to ignorance, oversight or miscalculations.

Concerns About Consistency

Further aggravating a plan sponsor’s fiduciary burden, the DOL did not require a specific template for disclosing 408(b)2 information, which invites less consistent “apples to apples” disclosures than I would have preferred to see. Frankly, it puts those providers who are fully and clearly disclosing all fees and relationships at a bit of a disadvantage compared to those who are following the letter but not the spirit of the law. Just because you can’t as readily see the costs and conflicts within a muddy 408(b)2 disclosure, does not mean they aren’t there … and potentially in much larger amounts than those being clearly disclosed in other reports.  

I have reviewed a number of 408(b)2 disclosures from various firms. Happily, I’ve found most are clear and relatively consistent. But I’ve also reviewed one provided by a major brokerage firm that seemed to go disturbingly out of its way to be as unhelpful as possible. For example, rather than simply stating plan investment option fund costs and provider relationships like most providers have done, this provider:

  • Directed the sponsor to a web site, where the sponsor would have to enter the ticker symbols for each and every plan investment option to figure out fund costs
  • Pointed the sponsor to the mutual funds’ dense Prospectus and Statement of Additional Information to uncover any other costs
  • In describing indirect compensation received from mutual fund providers, stated the compensation “may vary from case to case” and offered yet another pointer back to its web-based database o’ confusion.  

Good luck figuring out that one. My advice to plan sponsors currently reviewing their 408(b)2 disclosures is to avoid the temptation of assuming any report is a sufficient report. Stuff that rubber stamp of approval back in the drawer and take a good, close reading of your 408(b)2 disclosures. Do they provide you with everything you need -- upfront and without further ado -- to make fair, solid judgments about your plan’s costs and provider relationships? Or does the message-between-the-lines seem to read more like this: “You (and your participants) are on your own”?

If the latter, I recommend you take that message to heart. Declare your independence and start shopping around for a better provider.

In my last blog, we discussed some of the weaknesses I feel are inherent to Self-Directed Brokerage Accounts (SDBAs) … and that’s before we even got into what the Department of Labor has said about them.

First a little background. When a retirement plan fiduciary selects an investment such as a mutual fund, exchanged traded fund, insurance contract or company stock to include in its 401(k) plan, the fiduciary has identified each as a designated investment alternative (DIA), from which the plan participants can choose to invest. A Self-Directed Brokerage Account (SDBA), which allows the participant to invest in anything that the broker sells (and which the plan fiduciary approves), is not a DIA.

However, a May 7 DOL Field Assistance Bulletin No. 2012-02 introduced the concept that the investments available inside an SDBA might need to be treated as a DIA without the fiduciary ever having designated it. Within its 23 pages, the Bulletin says:

Although the regulation does not specifically require that a plan have a particular number of designated investment alternatives, the failure to designate a manageable number of investment alternatives raises questions as to whether the plan fiduciary has satisfied its obligations under section 404 of ERISA. … Unless participants and beneficiary are financially sophisticated, many of them may need guidance when choosing their own investments from among a large number of alternatives.

Basically the DOL further states, if a significant number of participants are selecting the same investment options through the SDBA, then the fiduciary has the obligation “to examine these alternatives and determine whether one or more such alternatives should be treated as designated for purposes of the regulation.”

My interpretation of the DOL guidance is as follows:

- If a plan has 25 or fewer unique investments (including those the participants choose inside an SDBA), then only the investment alternatives the sponsor has selected will be “designated” and subject to the fiduciary due diligence and monitoring requirements.  The sponsor will not have to include the participants SDBA investments in its prudent process.

- However, if a plan has more than 25 separate investments (sponsor-selected DIAs plus participant-purchased SDBA investments) then the sponsor may need to treat some or all of the participant-purchased SDBA investments as DIAs.  The number of DIAs can be limited if the fiduciary:

  • Makes the required disclosures for at least three of the investment alternatives that meet the “broad range” requirement under ERISA 404(c) regulation.
  • Makes the required disclosures with respect to all other investment alternatives on the platform in which at least:
    • Either five participants or beneficiaries have invested
    • Or, in the case of a plan with more than 500 participants and beneficiaries, at least 1% of all participants and beneficiaries are invested on a date that is not more than 90 days preceding each annual disclosure.

Got it? That’s assuming the rules don’t continue to evolve. My advice would be to simply avoid all of this review, monitoring and disclosure aggravation and, if you have an SBDA, close it. Review your core DIAs according to participants’ best interests and expand them if necessary so that the participant can adequately diversify among them. Offer your participants the tools they need to invest for their retirement in a sensible way, and they should not miss the complexities of the SBDA.

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Comment   |  5 years, 9 months ago from Woodbridge, VA