Self-directed accounts in peril

As the Aug. 30 deadline for 401(k) fee disclosures to particpants approaches, financial advisers are fielding calls from anxious plan sponsors about self-directed brokerage accounts.

Specifically, employers are fretting about a May bulletin from the Labor Department that they say assigns plan sponsors more fiduciary responsibility for investments an employee selects via a brokerage account.

In that case, advisers contend, sponsors may stop offering such accounts.

Because self-directed brokerage accounts provide workers with a wider array of investments to choose and manage, they are generally intended for savvier investors.

Mutual funds offered in retirement plans are subject to review for their suitability as investments for participants and must meet fee disclosure requirements. Brokerage accounts are typically not considered a “designated investment alternative” and so initially were thought to be unaffected by the new rules.

The Labor Department bulletin, however, raised the possibility that individual funds obtained through a brokerage window could be deemed designated investment alternatives if enough participants invest in them.

“Plan fiduciaries have a general duty of prudence to monitor a plan’s investment menu,” the bulletin said. “If … nondesignated investment alternatives available under a plan are selected by significant numbers of participants and beneficiaries, an affirmative obligation arises on the part of the plan fiduciary to examine these alternatives and determine whether one or more such alternatives should be treated as designated for purposes of the regulation.”

The bulletin spurred a huge lobbying effort from groups, including the Financial Services Roundtable and SPARK Institute, that are fighting the requirements.

Phyllis Borzi, the assistant secretary of labor who heads the Employee Benefits Security Administration, has said that plan fiduciaries have a responsibility to select and monitor service providers carefully.

“We wanted to make sure that people understood that the fiduciary’s duty extends to and includes the decision as to whether you have this brokerage account and how you monitor what’s going on with it,” Ms. Borzi said.

The industry expects the DOL to address these matters in a future bulletin.

Advisers are talking to plan sponsors about mitigating the fiduciary risk and about the applicable disclosures.

“We’re talking with clients about it and trying to help them comply with fee regulations to the best of our abilities, but we’re still waiting on further clarity from the Labor Department,” said Jim O’Shaughnessy, managing partner of Sheridan Road Financial LLC.

Employers are worried that participants are picking funds sponsors have not vetted, and plan service providers said that could keep them from making such accounts available to employees.

“Some think that this might deter people from offering brokerage accounts in the first place,” said Ann L. Combs, who once held Ms. Borzi’s post and is now head of government relations at The Vanguard Group Inc. “But the plan sponsors want to comply with the law, and they’re concerned on how to go about that.”

According to some advisers, curbing access to the accounts isn’t necessarily a bad idea, especially if employers are concerned about liability.

Michael Francis, president of Francis Investment Counsel LLC, usually doesn’t recommend adding brokerage accounts, because “it seems like a bigger can of worms than most plan sponsors can really appreciate.”

Mr. Francis recalled a sponsor client that was sued by an employee who was retiring and had taken a big loss in a brokerage investment. The plaintiff argued that, though he was educated, he knew nothing about investing and that the sponsor should have intervened. The employer settled the suit.

“Our advice is don’t do it — it’s not worth it,” Mr. Francis said, adding that only a handful of his clients offer the option. They are all law firms that have expertise in ERISA and are already dealing with self-directed brokerage disclosures.

Some advisers are mulling a waiver for plan sponsors to distribute to workers who want to invest through brokerage accounts, to at least acknowledge the person is aware of the risks. Whether such a waiver would hold up in a lawsuit is an open question, however.

“Employers have given employees a statement that if you leave the fiduciary safety of the core funds, you do so at your peril,” said Michael J. Malone, managing director at MJM401k LLC. “But I don’t know if the court would look at it and say that there is no fiduciary liability associated.”

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