Many participant-directed 401(k) plans these days include a self-directed brokerage window option as a way to supplement the plan’s menu of designated investment options. While the plan’s menu may be limited to 10–25 investment alternatives, depending on the particular plan (for this purpose, counting a target-date fund suite as a single alternative), a brokerage window can provide access to several thousand mutual funds as well as—depending on the particular arrangement—the ability to trade in individual stocks, bonds, options, or other securities.
One might think that there is a lower level of liability risk for plan fiduciaries where a brokerage window is available, particularly where the window supplements a menu of selected investment options, because it gives plan participants greater choice without any expectation that the fiduciaries are responsible for each and every investment available through the window. In fact, the presence of a brokerage window has been helpful in reaching a good outcome for plan sponsors and fiduciaries in some of the “excessive fee” cases over the last 12 years. However, there can still be fiduciary obligations related to offering the brokerage window that, if not met, could trigger liability.
First, regardless of whether the decision to include a brokerage window feature is itself a fiduciary decision (while there is nothing directly on point, our view is that it should not be), regulatory guidance indicates that the choice of the broker, and negotiation of the broker’s fees and other charges, may very well be a fiduciary act. Thus, the selection of the broker, and negotiation of the brokerage window arrangement, should be undertaken in a prudent manner and documented accordingly.
Second, it is less clear whether the fiduciary rules apply to the decision as to the scope of the investments available through the brokerage window. One question that comes up from time to time is whether the plan sponsor and plan fiduciaries should consider the sophistication of the plan participants in deciding whether to provide a brokerage window and what investments to include, and whether to exclude higher-risk investments. There is no guidance on this specific issue, but these types of concerns are the reason why many plans limit their brokerage windows to mutual funds. Also, the ERISA Section 404(c) exception to fiduciary responsibility for participant-directed plans excludes from its relief certain types of investments, in particular those where there is a risk of a loss that exceeds the participant’s account balance. This limitation may be a reason to exclude, for example, certain types of partnership interests and options. Plan sponsors often seek to address sophistication issues in part by obtaining representations from plan participants who decide to use the brokerage window, in which a participant acknowledges his or her responsibility for the risks of his or her brokerage window investments.
Third, and related to the second point, the US Department of Labor (DOL) has raised the question of whether there should be some responsibility for plan fiduciaries to at least monitor the usage of investments through the brokerage window. In 2012, following the finalization of the participant-directed plan disclosure rules, DOL issued guidance indicating that the investment disclosure portion of those rules could apply to brokerage window investments that attract over a certain percentage of plan participants’ investments. Because of concerns raised about the administrative burdens of monitoring and tracking brokerage window investments, this guidance was withdrawn, but with a note that DOL would be considering further guidance in this area. While DOL issued a request for information about brokerage window practices in 2014 in anticipation of further rulemaking, it has not taken any further action.
Fourth, while the participant-directed plan disclosure rules may not require any disclosures about specific investments available through brokerage windows, they do require that disclosures regarding the brokerage window arrangement, and the related fees and charges, be provided to all plan participants eligible to use the window, not just those actually using it. This creates a fiduciary disclosure obligation for plan administrators.
In sum, there are a number of obligations that may require plan fiduciaries to look inside the window when offering a brokerage window option. While there are some uncertain areas, those could be further clarified and defined by future DOL guidance, so fiduciaries of plans that currently offer—or are considering offering—brokerage windows will want to monitor ongoing developments.