A recent report from Charles Schwab might give retirement plan sponsors reason to think about offering their participants a self-directed brokerage account (SDBA), particularly one that offers the participants the service of an adviser.Schwab’s “SDBA Indicators Report” found that while only 20% of participants in a brokerage window worked with an adviser as of the second quarter, their average balance of $448,515 was nearly twice as much as the $234,673 held by non-advised participants. In its first quarter report, Schwab found those participants who used advisers displayed a more diversified asset allocation mix and had a lower concentration of assets in particular securities. According to the 2018 PLANSPONSOR Plan Benchmarking Report, 20.3% of all employers offer a self-directed brokerage account (SDBA).
However, many retirement plan advisers are not in favor of SDBAs because they think retirement plan investors are not sophisticated enough to make successful individual trades. In fact, Eric Droblyen, president and CEO of Employee Fiduciary LLC in Saint Petersburg, Florida, worked at Schwab in the 90s, when it was the first financial services firm to offer its workers a brokerage window, he says. And even though the market was rising during those years, “those in the brokerage window were the ones who lost money, even when the market was going gangbusters,” Droblyen says.
So, what should sponsors consider before offering a brokerage window? According to a paper written by Drinker Biddle & Reath, LLP partners Frederick Reish and Bruce Ashton, “Fiduciary Considerations in Offering a Brokerage Window,” “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).”
That said, the lawyers say the brokerage window should be made available to all participants and the sponsor should “consider the investment sophistication of the employee population and/or whether any employees desire to work with investments advisers who could assist them in investing through a brokerage window.”
Reish and Ashton say sponsors should also ask their participants to honestly consider their investment sophistication before participating in a brokerage window and to tell them that the plan’s fiduciaries will not be selecting or monitoring the investments available in the window.
As to the selection of a brokerage window provider, the DOL has been specific, the lawyers note, citing a DOL Field Assistance Bulletin in 2007 that states, “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. The process also must avoid self-dealing, conflicts of interest, or other improper influence.”
So, for whom might a brokerage window be appropriate? Droblyen says it is typically professionals such as doctors and lawyers who are highly paid. However, says James Veneruso, a senior vice president at Callan in Summit, New Jersey, “We find utilization of brokerage windows tends to be very low, and even when it is offered, they account for a mere 5.3% of plan assets.” The reason some sponsors offer brokerage windows is they don’t want to have too large of a fund lineup, he says.
Best practices sponsors should consider when offering a brokerage window include that the window should comply with Employee Retirement Income Security Act (ERISA) requirements of section 404(c), according to Droblyen. “This absolves fiduciaries from being liable if the plan participant makes bad investment decisions,” he says. “If an employer is considering brokerage accounts, they should ensure the core funds meet 404(c) requirements.”
It is also common for sponsors to set limitations on the percentage of a participant’s balance that they can invest in the brokerage window, like 10%, 25% or 50%, says Andrew Oringer, a partner at Dechert LLP in New York. “This gives participants the flexibility they are yearning for, yet limits their risk to an extent.” Sponsors may also limit the types of investments that can be used in the window, perhaps excluding them to only traditional stocks, he adds.
Constantine Mulligan, a partner and director of investments for the retirement plan services group at Cerity Partners in Chicago, says his clients typically restrict the investors in brokerage windows to only invest in mutual funds and they are also careful to ensure that investors in the window are not investing in the same product available at a lower cost on the investment menu. And it is very common for a publicly traded company to restrict the percentage of the company stock that participants can purchase “to make sure they are not putting their entire nest egg in an over-concentrated allocation.”
Lastly, sponsors should ensure that investors in brokerage windows are paying separate fees, and they should consider having participants sign an indemnification agreement stating that they understand the risks of investing in a brokerage window, the experts say.
Mulligan says he sees two scenarios where a sponsor might decide to offer a brokerage window. “The first is where the retirement plan committee knows they have participants who need options outside of the core menu,” he says. “The second is where high-level executives who are sophisticated investors ask for it. These are the two ways that I see this happening in an appropriate fashion.”
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