Assessing the Legal Risks of Brokerage Windows

Why limit plan participants’ investments to a handful of managed funds when they can have an unlimited selection using a “brokerage window”? The answer might depend on the plan sponsor’s legal risk tolerance.

Brokerage Windows Explained

Brokerage windows allow participants to establish an account that gives them access to virtually any investment under the sun — whether it be a “safe” blue chip stock, or some exotic leveraged commodity-based exchange-traded fund (“ETF”).

Brokerage windows are traditionally added to retirement plans at the request of senior executives who have considerable investment experience with their personal portfolios. Those participants would like the flexibility to invest in a wide range of investment options.  Some participants believe they can do a better job on their own, or working with their own investment advisor, than when limited to standard 401(k) plan core options like target date funds.

Available to All

If a highly compensated employee has access to a brokerage window in the 401(k) plan, this option must be afforded to all plan participants. Rank-and-file employees are less likely to select this option. The U.S. Department of Labor (“DOL”) is concerned that brokerage accounts may expose participants to undue risks and the fact that they are not monitored by plan committees.

Designated investment alternatives (“DIAs”) are the standard investment choices in a 401(k) plan. They’re subject to performance and other reporting requirements. Investments available through a brokerage window aren’t subject to these same requirements — although the DOL has shown interest in regulating this area.

For example, in Field Assistance Bulletin 2012-02, the DOL indicated that some investments available through a brokerage window might be covered by DIA requirements, based on the number of plan participants who chose them. The DOL subsequently revised this bulletin, backing off that assertion. Yet the relevant section of the revised document, Q-29, didn’t leave plan sponsors off the hook entirely.

Still on the Hook

ERISA regulations absolve plan sponsors of responsibility for the performance of certain DIA categories identified in those regulations, so long as the process for selecting the investments was prudent. The same principle applies to a sponsor’s decision to offer a brokerage window.

The DOL acknowledged that brokerage accounts aren’t DIAs, and therefore are not subject to the same disclosure requirements. According to the DOL, a plan fiduciary’s failure to designate investment alternatives, such as by offering a brokerage option to avoid investment disclosures under the regulation, raises questions under ERISA’s general statutory fiduciary duties of prudence and loyalty. In August 2014, the DOL published a request for information on the use of brokerage windows in 401(k) plans. There is clearly interest in this topic from a regulatory standpoint and interested parties should keep an ear to the ground.

How’s Your Appetite?

Notwithstanding possible future DOL regulation, fiduciaries’ duties when offering a brokerage window option should be taken seriously. If offering a window option harms enough participants such that doing so could be deemed a failure to safeguard plan participants’ interests, you may want to think twice.

© 2016