By Jeffery A. Acheson
Jeffery A. Acheson, CPWA®, CFP®, CPFATM, AIF®, CEPA® has 40+ years in the financial services and retirement plan industries, creating a value proposition that is an exceptional and diversified integration of credentialed education, experience-based knowledge and industry leadership. His fiduciary based business model focuses on enhancing his ability to be a trusted advisor to high-net-worth individuals, families, businesses and their mission critical employees, retirement plan sponsors and their participants through his private practice, Advanced Strategies Group. Mr. Acheson also serves as the Chief Business Development Officer for Independent Financial Partners headquartered in Tampa, Florida. He also volunteers within the National Association of Plan Advisors having served as the Chair of the Government Affairs Committee, a member of its Leadership Council and as President of the organization. He currently is an active member of the American Retirement Association’s Board of Directors and is Chairman of NAPA’s nonqualified plan certificate program and annual conference.
SDBAs have been panned, extolled, dismissed and even
regulatorily feared by different voices with varying perspectives from within the retirement plan industry. Some even consider them simply a necessary evil while others see them as having untapped potential which is a perspective this column will explore.
The Paradigm Shift Continuum
In my Summer 2020 column [Journal of Pension Benefits, Vol. 27, No. 4] I pontificated about why a paradigm shift in 401(k) menu construction was needed to help restore optimism around the ability to create a secure retirement. I built on that thesis with my Winter 2021 column [Journal of Pension Benefits, Volume 28, No. 2] detailing how Managed Accounts could play an important role in the previously outlined paradigm shift. The column focus then shifted in the Summer 2021 edition [Journal of Pension Benefits, Volume 28, No. 4] to exploring how annuities could help address the complex issues inherent in retirement planning specific to longevity risk by assuring income security for those concerned with being on the long end of the normal mortality tables. Finally, this four-part series will conclude with a focus on Self-Directed Brokerage Accounts (SDBAs) and their past and current positioning, utilization to date, ever-present regulatory trapdoors and liability exposures a Plan Sponsor should always be cognizant of and finally, their untapped potential going forward.
“To be, or not to be, that is the question”
While SDBAs have not been around as long as Hamlet, there is history to analyze about a plan feature that has been known by various names (e.g., Brokerage Window, Mutual Fund Window, Brokerage Accounts). The scrutiny was particularly heightened in 2012 when the DOL published FAB 2012-02, specifically Q&A-30 regarding brokerage windows and other similar arrangements that enable plan participants to select investments beyond those designated by the plan. The industry raised concerns about the guidance provided by Q&A-30 which resulted in the DOL addressing those concerns by issuing FAB 2012-02R with a new Q&A-39, which proved more palatable to the retirement plan community. In a layman’s language summary (i.e., not intended to be a definitive legal interpretation or specific advice to any Plan Sponsor), Q&A-39 gave guidance that an SDBA was not considered a “Designated Investment Alternative” (DIA) unto itself, did not change the ERISA 404(c) regulation or the requirements for relief from fiduciary liability specific to investments selected by the participant beyond those selected, monitored and made available by the Plan Sponsor. Select language from ERISA §404(a)(5) states:
Designated investment alternative means any investment alternative designated by the plan into which participants and beneficiaries may direct the investments 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.
However, the responsible Plan Fiduciary is still bound by ERISA §404(a)’s statutory duties of prudence and loyalty to the participants and beneficiaries related to vendor selection quality, access to platform information and transparency, disclosure of all fees, expenses and trading restrictions. In addition, the DOL states in FAB 2012-02R the 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 arrangement.”
While this guidance from the DOL has provided reassurance to the industry and Plan Sponsors, it should not be construed as absolute guidance or bulletproof in terms of litigation as evidenced by past lawsuits (e.g., Moitoso v. FMR and Ramos v. Banner Health). While every lawsuit has its own unique facts and circumstances, the two cited focused on fees and restricted investment options. It appears there may be a higher level of fiduciary risk with respect to arrangements that offer proprietary funds or even a limited selection of options. Regardless, both lawsuits are worthy of review with legal counsel by any Plan Sponsor offering or thinking about offering an SDBA option.
Would Shakespeare say this discussion is “Much Ado About Nothing?”
There are both proponents and critics of offering SDBAs to participants with solid arguments on both sides. Before exploring the future possibilities for SDBAs, let consider a few data points and observations specific to current utilization to see if there is much ado about nothing. Conveniently, this topic was the focus of the DOL’s ERISA Advisory Council hearings held on June 24-25, 2021, with testimony provided by industry experts as reported on by Ted Godbout in his article entitled “Cold Water Thrown on Need for New Brokerage Window Guidance”, posted in NAPA-Net Daily on July 13, 2021. The witness consensus concluded participants using SDBAs are sophisticated investors familiar with the risks involved and existing disclosures are sufficient. Some testimony highlights of note detailed in the article were:
- Kent Mason, Partner at Davis & Harmon, noted that he was heavily involved in the 2012 fore-mentioned policy discussions regarding Q&A-30 in FAB 2012-02 and Q&A-39 in FAB 2012-02R. His testimony included the following statement: “In brief, I believe that the DOL has already provided sufficient guidance on brokerage windows to serve the needs of plan sponsors and to protect participants.”
- Kevin Mahoney, Business Development Officer at FinDec, cited data from the Plan Sponsor Council of America’s 63rd annual survey of Profit-Sharing and 401(k) Plans documenting that nearly a quarter (23.2%) of all plans offer a self-directed brokerage account and nearly 40% of those plans with more than 5,000 participants do. But he further noted that only 1.5% of the plan assets of the latter were invested via the SDBAs.
- Frank Porter, a Relationship Manager for Empower Retirement who currently serves as President of the American Society of Pension Professionals and Actuaries (ASPPA), gave testimony explaining that SDBAs are typically used by “astute investors” who have been provided disclosures that provide a solid basis of costs and risks.
To quantify some of these observations, let’s look to the Charles Schwab 2020 SDBA Indicators Report which provided the following statistics drawn from analyzing approximately 161,000 Schwab Personal Choice Retirement Accounts (PCRA) with balances between $5,000 and $10 million.
Average Account Balance:
| Overall | $331,664* |
| Advised Accounts | $517,849 |
| Non-Advised Accounts | $288,513 |
Investment Allocation Breakdown
| Equities | 35% |
| Mutual Funds (Top Three Categories) | 31% |
| U.S. Large Cap Equity | 32% |
| Taxable Bond | 20% |
| International Equity | 16% |
| ETFs (Top Four Categories) | 18% |
| U.S. Equity | 49% |
| U.S. Fixed Income | 15% |
| Sector ETFs | 13% |
| International Equity | 12% |
| Cash | 14% |
| Fixed Income | 2% |
Generational Breakdown
| By Age | % | By Balance | $ |
|---|---|---|---|
| GenX | 44% | Baby Boomers | $493,129 |
| Baby Boomers | 34% | GenX | $282,494 |
| Millenials | 16% | Millenials | $94,872 |
The Devil is in the Details
So, what are we to make of these statistics? What story do they tell? Is it all sunshine and rainbows due to enhanced investment flexibility or are advised accounts the key to success with SDBAs?
Perhaps some additional insight might be helpful. Gregory Kasten, founder and CEO of Unified Trust Co., warns in a PLANSPONSOR magazine column entitled “Considering New Uses for SDBAs” on August 2, 2021, that his firm’s extensive study of SDBAs found approximately 70% of time the participant using the SDBA under-performed the rest of the participants in that particular plan. He said a variety of factors contributed to the underperformance with one of the most prominent being the allocation to cash for extended periods of time. This factor is exacerbated by “cash” in an SDBA typically being in the form a money market fund, while the plan’s core menu provided access to a higher yielding Stable Value option. For this reason, he says, he has always viewed SDBAs with skepticism.
Avoiding Pitfalls
The first step in ERISA pitfall avoidance is understanding that offering an SDBA is still a fiduciary act without clear guidance. On September 24, 2019, PLANSPONSOR magazine quoted a whitepaper written by Drinker Biddle & Reath, LLP Partners, Fred Reish and Bruce Ashton, “Fiduciary Considerations in Offering a Brokerage Window,” which stated;
“..deciding to offer a brokerage window is a fiduciary decision, [but] there is little guidance on the considerations a fiduciary should use in making the decision. The considerations for deciding whether to offer a brokerage window have not been specified in the law or by the Department of Labor (DOL).”
Perhaps the following checklist will provide a foundation for perspective and a starting point for analysis:
- Do the demographics of the plan indicate an SDBA would be properly utilized?
- It is important to note that the SDBA must be offered to all participants, not just those the SDBA is deemed to be the most appropriate for by the plan’s fiduciaries.
- Can the SDBA investment options be restricted in scope to limit the potential harm less sophisticated participants might inflict on themselves (e.g., mutual fund only versus allowing stocks, bonds, ETFs, etc.)?
- Should a maximum balance transfer percentage to the SDBA be imposed (i.e., 10%, 25%, 50%) to also mitigate risk?
- Do the plan fiduciaries have the expertise necessary to prudently select the SDBA provider and competently evaluate their cost structure and reasonability of fees?
- Are the plan fiduciaries confident they can properly monitor the SDBA provider after initial selection?
- How will the plan fiduciary provide all the needed disclosures?
- How will the SDBA provider assure the plan fiduciaries that it can preclude participants from making investments that might trigger Unrelated Business Income Tax, be unable to provide a fair market value readily determined on a recognized market thus negating the need for an independent appraisal or finally, deemed to be an investment in intangible personal property characterized by the IRS as collectibles other than U.S. Government or State issued gold and silver coins?
- Does the SDBA provider have safeguards in place to ensure no unapproved distributions? How will the SDBA provider flow account information back to the plan’s fiduciaries, administrator and auditor, if applicable?
- How will the SDBA provider flow account information back to the plan’s fiduciaries, administrator and auditor, if applicable?
Untapped Potential — Is the Juice Worth the Squeeze?
With the “pitfall assessment” in hand, “what’s a fiduciary to do?” The first suggestion would be to do what they have always done, follow a documented process of analysis in the decision-making process. Where to start? Start with the “why.” Why would your plan participants benefit from the potential of an SDBA window?
Do you have participants who might want, appreciate,
and benefit from:
- More aggressive investment options than you are willing to include on your core menu of DIAs?
- Investing in individual stocks, bonds and ETFs?
- The ability to trade intra-day?
- Access to sophisticated or personalized investment or risk management strategies both pre and post retirement?
- Potential access to an outside investment advisor?
- A more diverse list of ESG options beyond those made available as DIAs?
- An alternative to In-Service distributions in pursuit of expanded investment options? The ability to leave a large account balance within the plan post-retirement for enhanced creditor protection?
Once you have identified the breadth, depth and positives of the “why” analysis, weigh it against your “pitfall assessment” to document the pros and cons that lead to a final decision. As commonly accepted, fiduciary risk management is not dependent upon perfection but instead, documented adherence to prudent process and procedure. Assessing SDBAs is just another execution of this exercise.
Conclusion
As I suggested in my first column in this series [Journal of Pension Benefits, Summer Edition, Vol. 27, No. 4], active, terminated and retired plan participants in the future are going to continue to demand more convenience, choice, customization and cost concessions from Plan Sponsors and their service providers. Thoughtfully constructed SDBAs can deliver a value proposition that can potentially simplify peoples lives, save them time and money and improve their outcomes all under the watchful eye of the DOL, enforcing the best parts of ERISA designed to protect retirement nest eggs and enhance retirement security. ■
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Reprinted from Journal of Pension Benefits, Winter 2022, Volume 29, Number 2, pages 61–64, with permission from Wolters Kluwer, New York, NY, 1-800-638-8437 www.WoltersKluwerLR.com