Self-Directed Profit Sharing Accounts

[DP]

I have a very small Profit Sharing plan (7 participants) where everyone has their own self-directed account set up with various brokers. The plan has operated in this fashion for many years without a problem.

The Plan Trustee would like us to create a letter for the participants to sign yearly saying "he (the participant) has reviewed the investments in his self-directed account and is satisfied with his investment choices". Also he wants a statement added to the letter saying that the participant is reponsible for his investment gains/losses.

Has anyone else prepared a letter to this effect? Or can anyone offer any advice?

Thanks.

[E as in ERISA]

In an ERISA 404© you would generally have the equivalent of the second statement (e.g., you would say that the fiduciares are not responsible).

But what if an employee looks at his choices and finds he isn't happy? And he decides not to sign the letter? Etc., etc. What happens? I'm guessing neither the employer or employee will end up happy....

The current theory is to make sure that the employees have access to the tools so that they can do well and be happy.... (e.g., investment education or advice...)

[mbozek]

DP: There is no need for such a statement since the trustee is not the fidiuciary under ERISA for the participants' investment decisions in a self directed account under 404c. Under DOL reg 2550.404c-1(f) example 9, where a plan participant directs a plan fiduciary to appoint an investment manager selected by the participant in a plan which provides participants with total discretion in choosing an investment manager, the plan fiduciary has no fiduciary liability to the participant for imprudent management of the participant's account by the manager and the plan fiduciary has no duty to determine the suitability of the investment manager because the plan does not designate him as an investment manager. The investment manager is only a fiduciary to the participant under ERISA. The lack of a letter does not create some implicit risk of fiduciary liability to the trustee or plan fiduciary.

[Bird]

As Katherine noted, asking for a statement annual is just asking for trouble. We have participants sign an enrollment form, once, that includes this language (cobbled together from various sources; change as needed - this was from a 401(k) plan):

3. INVESTMENT ELECTION

I will provide investment direction through the broker selected by the Trustee.

404© statement

It is the trustees' intent that your opportunity to self-direct your investments complies with Section 404© of the Employee Retirement Income Security Act. This means that by directing the investment of your account balance, you assume responsibility for the investment performance of your account and absolve the plan fiduciary (generally, the trustees) of any liability for losses that may result from your exercise of control.

By signing this authorization you:

a. Acknowledge that you have received a Summary Plan Description.

b. Authorize your employer to deduct from your compensation the amount stated in item 2. above.

c. Authorize your trustee(s)/plan administrator to deposit your contributions in a brokerage account where you will self-direct the investments.

d. Certify that you have the power and authority to establish this account and give the instructions stated herein, you release the Funds and their agents and representatives from all liability and agree to indemnify the same from any and all losses, damages, or costs for acting in good faith in accordance with the privileges selected herein. All terms shall be binding upon your heirs, representatives and assigns.

[Jon Chambers]

I've seen many problems with this structure. The issue is generally that the trustee is dependent on the competence of the brokerage firm establishing the account. Where the account is properly structured as a qualified plan asset, and the brokerage firm knows how to run qualified plan accounts, problems are minimal. However, not all brokerages know what they are doing. I've seen participants close accounts and withdraw all funds, with no qualifying event for a distribution. I've seen accounts established with margin capabilities, where the plan does not permit such an approach. Under this type of structure, you should expect that a broker will eventually disqualify your plan. And the letter suggested is essentially worthless. As others have noted, it may help with your 404© compliance, but I bet you don't have that anyway.

I would strongly recommend consolidating all accounts with one brokerage that has been appropriately screened by the trustee. Otherwise, the plan is a ticking time bomb.

[mbozek]

Jon: Having the trustee screen the broker who can invest participants' assets makes the trustee a fiduciary with regard to the suitability of the broker to manage the participant's accounts under the DOL regs which is not in the interest of the plan sponsor or the fids. There is no liability to the plan fid if the participant directs the plan fid to appoint an investment manager selected by the partaicipant. Any broker selected by the participant needs to sign the appropriate agreement with the plan admin spelling out what are the limits on investments selected by the broker including no PTs, prohibition on withdrawals, no margin accounts as well as indemnification by the broker for negligence.

All of the documents need to be drafted by counsel before being signed by the plan.

[Jon Chambers]

mbozek--I agree with your points. And all that you say doesn't change the fact that brokers regularly can and do violate both plan terms and IRC 401(a) through their conduct (it's generally inadvertent, but uninformed behavior). Some brokers simply shouldn't be handling qualified plan assets. I'll take the potential 404© issues over a qualification problem any day.

[mbozek]

Violatons of qualification rules by third parties are discoverable only in the unlikely event that the plan is audited by the by the IRS. Violations of the fiduciary rules are subject to expensive lawsuits by disgruntled participants and require the services of expensive lawyers.

[WDIK]

expensive lawyers

No need to be redundant.

[MoJo]

Pardon my jumping in here, but I've read through the posts and find it somewhat disenchanting to think that such atrosities can occur - if you consider that 1) the "owner" of the brokerage account HAD BETTER BE THE TRUST and not the participant, and 2) the broker HAD BETTER NOT do anything except take participant direction for INVESTMENTS (i.e. only the owner - the TRUST - can close the account and transfer assets), and if the broker does, the Trustee need only go to the brokerage house (or the NASD) and make them put the money back.... It'd be up to the broker to go after the participant to get their funds back

Furthermore, I don't see how such an arrangement NECESSARILY complies with 404©.... While you certainly are giving a "broad array of investment choices," you may not be complying with the other informational requirements of that section. I believe the DOL has unofficially said that merely offering brokerage windows without an appropriate core line-up of funds would not be 404© compliant.

[Jon Chambers]

OK, I'll get a bit more specific with an example of an "atrocity". Company funds a profit sharing plan with annual contributions. Contributions are subject to vesting schedule, and aren't eligible for in-service withdrawal. Participants are allowed to select whatever brokerage they want. Numerous participants choose to invest with friendly broker from major wirehouse firm. Each participant completes account application form, doesn't indicate that accounts belong to the plan. Broker establishes accounts as participant owned rather than trustee owned--earns large bonus for exceeding goal for establishing new relationships. Company funds contributions, making deposits to each individual brokerage account. Participants visit broker, ask to withdraw funds. Broker submits paperwork, closes accounts, participants leave brokerage firm with checks in hand.

IRS audits plan--claims plan has violated 401(a) and its own terms. Threatens disqualification. Brokerage firm disavows responsibility for its actions--indicates plan sponsor should have known that the brokerage accounts weren't owned by the trust, and notes that participants completed invalid account applications. Further, brokerage is explicitly not a fiduciary. IRS doesn't care who is at fault, but sees a disqualified plan. Plan engages ERISA counsel to negotiate with IRS. IRS agrees that plan can reinstate accounts for participants who withdrew their funds by making an additional contribution, plus imputed earnings. Plan sponsor out enormous costs for ERISA counsel and duplicate contributions. Sure, they could pursue their employees for the duplicate account, but they don't want to incur more legal costs. Could pursue claims against brokerage firm, but they have top law firms representing them, and indicate that they have no willingess to settle. Plan sponsor is basically stuck with the problem, and all costs of resolving problem.

Did this happen? Yes. Have I seen other similar situations? Yes (but admittedly, this was the worst). Do I buy mbozek's argument that plan sponsor's shouldn't worry about qualification violations by third parties. No.