Plan offers brokerage to only those with substantial balances - discri

[MR]

OK, this is not a new question, but I'm looking for other folks' experience. Lets say you have a 401(k) that permits self-direction among a group of mutual funds. Additionally, if your balance exceeds, say $20,000, you can invest through a brokerage account, where you can buy individual securities. My feeling is that the ability to invest through an individual brokerage account is a BRF and by attaching a condition such as a rather high minimum you've probably got a discrimination problem. Nevertheless, there are investment institutions that are suggesting this approach and contending that it shouldn't be a problem. I don't agree, but I am not aware of a case or DOL or IRS opinion that specifically speaks to this issue.

What do you think?

[KJohnson]

My recollection is that there were "dueling" IRS statements made a different ASPA conferences. In one, the IRS said it was o.k. as long as the broker set the minimum. In the other the IRS said it did raise a BRF issue. Personally, I wouldn't think the identity of the person who set the minimum would be relevant to whether it is a BRF. You may want to look at the following where this was discussed previously.

http://www.benefitslink.com/boards/index.p...=ST&f=20&t=4558

[MoJo]

I think a distinction can be made between a broker imposed minimum and one imposed by the plan. In the former, the requirement is one of profitability and operational efficiency (in the same manner that bundled providers require a certain minimum number of funds in a line-up to be proprietary, etc.) and the latter is one of a sponsors motivation (either discriminatory, or paternalism, etc.). The ultimate question really is: Is the plan sponsor (and the plan) discriminatory by virtue of selecting a vendor with a brokerage product that contains those minimums? That is tougher question, and one that can't be answered in a vacuum, and is dependent on all of the criteria used for selecting the vendor. If the vendor were the best choice, but for the brokerage requirements, is it then impermissable to allow some of the participants to partake of the brokerage option when others cannot as a result of the minimum requirements?

Let me ask another relted question: Would it be a BRF discrimination issue if the vendor charged a fee if the brokerage account did not maintain a minimum balance (ie the account would be charged $10 if at any time during the month the brokerage account balance was less than $10,000)? Or how about a fee if there were less than 5 transaction per month?

[KJohnson]

MOJO---What if an insurance company selected by a Plan to provide annuities only wanted to write those annuities for balances of over $50,000. Do you think that you could offer an annuity distribution option on this basis without testing the BRF because it was a condition imposed by the insurance company rather than the Plan sponsor?

[MoJo]

Good question, KJohnson - but there may be a distinction as well there. The distribution of benefits is an ERISA "right," and the selection of a provider that will only provide distribution options to certain large account balance participants may be a breach of a fiduciary duty, as well as discriminatory. Selection of a provider that offers outstanding services, but with a restrictive brokerage option (which is certainly far from an ERISA "right") does not cause one to consider the fiduciary implications - just the discrimination ones. The question still remains - is it discriminatory for a sponsor to select a provider knowing that certain restriction prevent all participants from the same level of service? Let me -put it another way - would it be appropriate (philosophically) to select a mediocre provider over a superior provider just because the mediocre provider could offer all the bells and whistles to all participants, and the superior provider restricted certain high cost options to those with minimum balances? I would think not. The question then becomes whether under current law, it is discriminatory. I've seen IRS officials as well answer that question in different ways, at different times. Just to play devils advocate (which is my forte'!) - there are MANY instances I've seen where it is in fact practically impossible to provide a plan specified distribution option as a result of the size of the balance - specifically annuity distribution options. I don't beleive it is uncommon for insurance companies to refuse to bid on a single life, or joint life annuity for a participant's distribution, if the amount involved is small. Is it discriminatory because one cannot find an annuity provider that will write a $1.50 per month annuity.

[Jon Chambers]

The consensus I'm aware of is that the brokerage account is a BRF. I know of one sponsor that does a coverage test on eligibility for brokerage, despite a relatively low minimum ($2,000). I'd be leery of info from the brokerage firm--many firms just don't understand the ERISA issues.

[MoJo]

I don't disagree that a brokerage account is a BRF - the question is, is it discriminatory if the requirement for opening one are not plan or plan sponsor requirements, but are rather imposed by a brokerage house? Let me pose another hypothetical - a provider allows use of any brokerage account within the plan. Smith Barney and Merrill Lynch both participate - but SB requires a minimum balance while ML does not. Is that discriminatory because some participants can't get SB as a broker (but can get ML)?

[Jon Chambers]

That's a good logical question MoJo. Unfortunately, the IRS may not be concerned with logic. They might ask why the plan sponsor didn't negotiate a waiver of minimum from SB, or for the minimum to be satisfied at the plan level. Or conversely, they might not. We just don't know. Let me pose another question. In the scenario you present, let's assume that ML's brokerage charges are WAY above market costs, SB's are at or below market. All participants have availability of brokerage option, but small balance participants must pay exorbitant charges. This looks like a discriminatory benefit in favor of higher balance participants. It may also be a breach of fiduciary responsibility to make ML accounts available even though they charge exorbitant fees (my apologies to any ML folks reading this--this is an example only.)

In the absence of clear regulatory guidance, I advise my clients offering brokerage options that they should offer one brokerage firm only, that the minimum account size should be low or waived, and that they should do some reasonable cost/service benchmarking. Some clients offer multiple brokerages anyway. I recommend that they benchmark each brokerage independently.

[MoJo]

I agree that you advice is certainly sage - and I do the same. This raises the ultimate issues: (1) what fiduciary implication are involved in selecting one provider over another (knowing that the selected provider has somewhat of a different product offering, or some restrictions on parts of the product set) and (2) what will be the IRS' position on non-fiduciary imposed restrictions which may have a discriminatory effect. Brokerage is but one BRF that is impacted here. Others may be less apparent, but all service providers restrict product set based on various economic criteria (although not necessarily based on a per participant basis).