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NAGDCA Note: Brokerage Window Basics: Things to Consider…

A brokerage window (also known as self-directed brokerage account or SDBA) is an investment alternative that can be used by defined contribution plans as a way to provide participants additional investment choices and flexibility. The SDBA can allow plan participants to invest in numerous mutual funds, exchange traded funds (ETFs), and in some cases, individual stocks and bonds that are not offered as core investment options. A SDBA may also be a good investment choice to plans that are reducing the number of core investment options offered through their plan.

Adding a SDBA, however, presents the plan sponsor with a number of decision points and responsibilities. This article gives a brief overview of things to consider before adding a brokerage window.

First and foremost is the responsibility to accurately detail and disclose all relevant information about the SDBA to plan participants. A SDBA is not designed for all plan participants but rather for the more sophisticated investors who are willing to take the time to research the investment options offered through the SDBA and make informed decisions about their investments in the SDBA. The plan should take appropriate steps to inform participants about the risks of investing in the SDBA, as well as the administrative, investment and trading fees associated with investing in the SDBA.

Plan sponsors often require participants to sign an agreement or disclaimer upon entry into a SDBA indicating that they understand the fees, restrictions, and risks involved in using the brokerage window.

Public employer plans are not subject to the Employee Retirement Income Security Act (ERISA), but that law is often an excellent resource for guidance. ERISA requires defined contribution plans to offer a broad range of investment alternatives, which is defined as at least three core investment options. These investment options must have different risk and return characteristics, allow participants to create a suitable portfolio, and allow for risk minimization. It would be prudent for a public plan sponsor to provide such a minimum core investment structure prior to implementing a SDBA. It would not be prudent to use a SDBA as the only investment option available to participants.

Many times there is confusion about fiduciary responsibilities around offering an investment brokerage window. At a minimum, the plan sponsor should conduct a due diligence process in the selection of the SDBA provider which would include an examination of the experience and reputation of the SDBA provider, the fees and trading expenses, the ability of the provider to distribute funds prospectuses and other related investment materials, the process in which assets are invested and any waiting periods upon a transfer of monies to the provider, and transaction notifications and account statements provider to participants. The plan sponsor should monitor the SDBA provider to assure that the provider is maintaining its procedures that were examined in the initial selection of that provider. As with any investment option, the plan sponsor is not responsible for losses that result from the actual investment decisions made by participants. 

The plan sponsor may exercise a number of options when implementing a SDBA. Among those options that should be considered include:

·         A minimum account balance before a plan participant may use the SDBA.
·         The minimum dollar amount that may be transferred to the SDBA to open the account and for subsequent transfers.
·         A maximum percentage of a participant's total account balance that may be invested in the SDBA. Many plans limit this to 50% at the time of initial of subsequent transfers to the SDBA.
·         Whether or not deferrals may be directly invested in the SDBA.
·         The types of investments that the plan participant may invest. SDBA offer mutual funds, ETFs, individual stocks and bonds, REITs and other investments. The Plan sponsor should determine which investment options that will be available to plan participants. 
·         Whether or not core investment options will be available through the SDBA. Generally, core investment options are excluded from the SDBA.

The investment policy needs to clearly outline criteria for the selection and ongoing due diligence of the brokerage window accounts. The investment policy should also address expense issues such as brokerage fees, trading costs, directed brokerage arrangements, execution, and mutual fund revenue sharing payments. The plan sponsor should be aware of any changes to the procedures that the SDBA provider uses and fees that are charged. It is recommended that the plan sponsor disclose to participants the basic fees for participating in the brokerage window and the potential for additional fees and transaction costs.

Participants in an investment brokerage window must be able to give investment instructions to a brokerage account fiduciary who is obligated to follow those instructions. If participants do not give investment instructions in writing, they should be given an opportunity to receive a written confirmation of their instructions. Most brokerage providers automatically send paper confirmations unless advised otherwise by the participant.

Some reasons that plan sponsors limit the trades in and out of the brokerage window would be to:
·         Assure that there are proper assets in the core options to collect the plan's administrative fees
·         Assure that there are sufficient assets to administer loans or unforeseeable emergencies in the event the participants requests one of these in service withdrawals.
·         Assure that funds are available for ordinary withdrawals when distributions are being made. Some plans provide that it has the ability to liquidate the funds in the SDBA to cover distributions and Required Minimum Distributions (RMDs) when there are insufficient assets in the core investment options. Where the plan does not reserve this authority, it is important that participants understand that they may required to transfer assets to the plan's core investment options to assure that these distributions may be made.

Sufficient information must be available for employees to make informed investment decisions. The SDBA provider is required to make available to participants a description of each investment alternative, including a general description of investment objectives and risk/return characteristics, and information about the type and diversification of assets in the investment alternative. Participants should be provided a description of the costs, rights, and procedures, along with any limitation on those rights. On request, the following information must be made available from the SDBA provider: a description of the annual operating expenses of each investment alternative which reduces the rate of return to participants and the aggregate amount of these expenses.
The SDBA provider must also make copies of any prospectuses, financial statements, reports, and other materials about the investment alternative must also be made available to participants upon request. Brokerage providers typically send prospectuses to participants on an annual basis.
A SDBA may be an appropriate investment tool for some participants. As seen, there are a number of issues and considerations that a plan sponsor should examine before offering a SDBA and that should be followed after it is implemented. The issues presented here are not meant to be an exhaustive listing of those issues but a primer on the types of issues that should be considered.  
Neither NAGDCA, nor its employees or agents, nor members of its Executive Board, provide tax, financial, accounting or legal advice. This memorandum should not be construed as tax, financial, accounting or legal advice; it is provided solely for informational purposes. NAGDCA members, both government and industry, are urged to consult with their own attorneys and/or tax advisors about the issues addressed herein.

Reference Materials:

More plans offering self-directed brokerage accounts as an option: 

Self Directed Brokerage Windows: Should Your Plan's Window Be Open or Shut?:

Retirement Plan Fiduciary Liability and Its Abatement under ERISA Sec. 404(c):

(k)Plans: Windows Dressing:

Miller, Jeffrey M., The 401(k) Plan Management Handbook, Probus Publishing Company, 1993


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