Self Directed Brokerage Accounts: The Good, the Bad & the Ugly

Self Directed Brokerage Accounts: The Good, the Bad & the Ugly

15 October, 2007

401(k) plan self-directed brokerage accounts, or SDBAs, have quickly become the most popular way for plan participants to invest their plan assets. In fact, about 20 percent of all retirement plans now offer SDBAs. So what’s the buzz about?

Participants hear about an opportunity to invest in a seemingly limitless menu of choices, ranging from mutual fund shares to individual stocks and bonds. Brokers also promote SDBAs to plan sponsors as the best way to alleviate their fiduciary liability for selecting prudent investments.

It all sounds too good to be true – and it very well may be.

The unfortunate truth is that, on average, SDBAs earn a lower rate of return than other plan portfolios because plan participants are not professional investors; they lack the knowledge and time to properly monitor investment performance. Additionally, administrative and investment fees associated with SDBAs are generally higher than traditional retirement plan accounts, further eroding a participant’s return on investment.

So what does all of this have to do with the responsibilities of a retirement plan sponsor? Under ERISA section 404(a)(1)(A) & (B), plan sponsors have basic fiduciary responsibilities, two of which directly affect their decision regarding allowing self directed brokerage accounts in retirement plans.

First is the duty of loyalty, more commonly known as the Exclusive Benefits Rule. A qualified retirement plan must be operated for the exclusive benefit of participants and their beneficiaries – not the sponsor. Cost is an important part of this exclusive benefit. Plan sponsors are responsible for monitoring higher investment transaction fees and additional administrative costs associated with SDBAs.

A second responsibility to review is prudence, most notably in selection and retention of investment choices. Common interpretation of investment prudence requires the plan fiduciary to review all available investments. A prudent review of all SDBA investments is a much more difficult and time-intensive task than most plan sponsors would knowingly want to undertake.

How can plan sponsors allow SDBAs and still reduce their fiduciary liability?

• Create a plan investment policy which prohibits higher risk investments, such as partnerships, non-publicly traded stocks or real estate.
• Select one or more designated brokers and require all SDBAs to be invested through them.
• Choose brokers and service providers who can work together when performing their duties.
• Educate all plan participants about the SDBA options, risks and fees.
• Regularly monitor costs associated with SDBAs.
• Review SDBA investment at least once per year – either by the plan designated broker or plan sponsor.

While there is a growing participant expectation for self-directed brokerage options, keep in mind the plan sponsor has the largest risk and therefore the right to say no. Before allowing SDBAS, discuss the option with your plan service provider or broker – and remember, the final liability lies with the plan sponsor. Taking the time to make informed plan decisions may be your best decision yet.