Brokerage Windows: Know the Risks Before Offering Benefits

Retirement plan sponsors and fiduciaries should always look at any decision they make through the lens of ERISA law. That includes if and how to offer self-directed brokerage accounts (SDBAs) or “windows” as options for plan participants. Opening a brokerage window does not close the door on breach of fiduciary duty lawsuits. The selection of a provider for the brokerage window is a fiduciary decision. Costs and services need to be evaluated. Fleming v. Fidelity Management Trust is one such lawsuit that was brought because of cost. (Read more here: flemingvfidelitymanagementtrustcomplaint)

What’s Behind SDBA Popularity?

For inexperienced investors, fewer and simpler investment options are contributing to better outcomes. That’s why slimmer investment menus are a growing trend. With fewer options to choose from, plan sponsors can help reduce the confusion or inertia participants feel around making investment decisions.

But many experienced and knowledgeable participants have a higher preference for more choices and would typically find brokerage windows appealing.

More large retirement plans are including self-directed brokerage accounts as benefits to plan participants—40% in 2015 according to Aon Hewitt, up from 12% in 2001. But while more plans may be offering brokerage windows, uptake of these benefits by participants has been limited. Charles Schwab reports just 4% of participants in the plans they administer make use of brokerage windows.

Participants who like brokerage windows tend to be more highly compensated employees. They also have larger account balances on average. Vanguard found the median SDBA balance in their defined-contribution plans was over $262,000. For all Vanguard-administered plans, the median participant account balance is just $30,000.

With SDBAs, plan sponsors may be seeking to make all participants happy at the same time. That’s hard when investment knowledge and experience can differ widely among individual investors. One of the dangers of a SDBA is that inexperienced investors may chase performance or make decisions without understanding the risks involved.

What are the SDBA Risks?

First, participants who choose to invest through a brokerage window will likely incur higher costs. Naturally, these costs will affect their overall investment returns. Costs include administration fees, trading costs and higher retail fund expense ratios.

Many plans include an account maintenance fee for participants who use brokerage windows. This is typically a flat, annual fee that comes directly from participants’ SDBA accounts. Participants with larger balances may not be too bothered with this flat fee, although frequent traders may be hit by higher transaction costs for each move in or out of a stock position.

Then there are the risks for plan sponsors and fiduciaries. Brokerage windows do not absolve plan sponsors or fiduciaries from responsibility or potential liability from breach of fiduciary duty.

Additionally, plan sponsors offering a brokerage window to participants may find it more difficult to comply with the ERISA disclosure requirements on investment expenses (from section 404(5)(a)) and fees paid to service providers (ERISA section 408(b)(2)).

With the heightened concerns over fees and outcomes, self-directed brokerage accounts are getting more scrutiny from the Department of Labor. That can increase the likelihood of a DOL audit and open the door to future liability concerns.

Are SDBAs Worth It?

Plan sponsors must weigh the risks and costs of brokerage windows with the potential benefits they would provide to participants. To determine whether a window is an appropriate offering, participant needs and the provider of the brokerage window must be evaluated. Usage of brokerage windows can vary widely from plan to plan. Plans with larger populations of experienced or knowledgeable investors may see more uptake in SDBA accounts. They may also prove to be more popular in plans with more highly-compensated employees. These participants may also be more likely to work with financial advisors, who would want the flexibility of a wider universe of investment choices.

Open Windows are Not Without Risk

Don’t forget that offering SDBAs is a fiduciary decision. Participants who use brokerage windows do so to assume greater control and direction over their investments. But plan fiduciaries still bear responsibilities for following a process of prudence in offering SDBAs as options.