Open Brokerage and 404(c)

[Randy Watson]

It's fairly common for a self directed plan to have an "open brokerage" feature that allows participants to direct investments into literally hundreds of different investments. The truth is that it's impossible for plan fiduciaries to review all of these investments to make sure that they are appropriate, but I never hear talk about maintaining 404© compliance with an open brokerage feature. Does 404© protection extend to an open brokerage feature?

[Kevin C]

It can. There is language in the preamble to the 404© regs addressing compliance for brokerage windows.

My opinion is that having a brokerage window does not completely remove all fiduciary liability. Others here will disagree. I think the fiduciary who decides that a brokerage window is an appropriate investment option for the plan has some liability for that decision and the fiduciary duty to monitor the use of the brokerage window to ensure that it remains an appropriate investment option for the plan. The DOL has repeatedly made it clear that 404© protection does not apply to the selection and monitoring of investment options.

There was an article that addresses a DOL Q&A question about prohibited transactions in brokerage accounts posted in the Benefits in the News section on 8/8/2008.

8/8/2008: DOL Staff Members Provide Informal Views on ERISA 404© Plans, Fiduciary Liability, and Plan Expenses (Employee Benefits Institute of America (EBIA))

http://www.ebia.com/WeeklyArchives/401k/Statutes/19475

If the link doesn't work, you can access the article in the older benefits in the news area.

[J Simmons]

Look for the upcoming decision of the 7th Circuit Court of Appeals in Hecker v Deere. It is one of the EE class action suits against 401k plans/fiduciaries for excessive, hidden investment fees. The federal district court dismissed Hecker v Deere on motion made by Deere. The rationale was that the brokerage window gave 2600+ investment options, although about 18 or 19 were prominently suggested for employees' consideration. The trial judge dismissed noting that among those 2600+ investments available through Fidelity, there had to be some low fee ones. Ergo, the higher fees were the result of employees choosing the higher fee investment options.

The Hecker employee class has appealed to the 7th Circuit and the DoL has filed an amicus brief in that appeals process. The DoL is arguing its position as set relayed by Kevin C in his post.

It will be interesting to see if the 7th Circuit accepts or rejects the DoL position.

In the meantime, they are the DoL... .

[Guest Sieve]

John -- I don't understand the DOL's position as amicus. Is it that the employer/administrator must continually monitor the open brokerage availability to see that it continues to best serve the participants? If so, I don't find that any different than the continuing fiduciary obligation to monitor investment availability that the employer/administrator can never get away from, whether there's an open brokerage or just 6 investment options. Or is it that an open brokerage architecture without some kind of education is a breach of the administrator's fiduciary obligation to effectively make self-direction meaningfully available--i.e., that such an open availability effectively gives the participant so many choices that he/she really has no choice at all without education? Or is the DOL position something else entirely? (I'm obvioulsy lazy & do not want to research the history of the case or read the brief . . .)

[J Simmons]

Ah, Larry, lazy? I doubt it.

DoL amicus brief in Hecker v Deere

The 3 subheadings of the argument portion of the DoL's brief read:

I. ERISA Section 404© Does Not Provide a Defense to Plaintiffs’ Allegations that the Defendants Imprudently and Disloyally Selected Investment Choices with Excessive Fees

II. Fiduciaries' Duties to Disclose Material Information Can Arise From Their Core Statutory Duties of Prudence and Loyalty, Not Just From Specific Reporting and Disclosure Requirements

III. The District Court Erred in Holding that the Fidelity Defendants Were Not Fiduciaries With Respect to the Selection of Funds Based Solely on the Plan Documents Without Regard to the Fidelity Defendants' Actions

[Guest Sieve]

Well, John, one of the DOL's position is my first suggestion and the caveat pointed out by Kevin C earlier: that whether or not an open brokerage architecture is selected, and even if ERISA Section 404© applies, it is the continuing duty of the fiduciary to monitor those investment alternatives (including pricing) on an ongoing basis to make certain that the participants' interests are being served. This is, in fact, nothing more than the age-old (after all, isn't ERISA from the dark ages by now?) fiduciary rule, which the DOL thinks the Court got wrong. Of course, I don't think that the fiduciary obligation stretches so far as to require the fiduciary to look only at price--rather, it is only one of a number of issues which the fiduciary must consider. The DOL's argument does not suggest to what extent price should be part of the fiduciary "mix", but just states over and over the mantra that 404© does not protect the fiduciary from liability for breach of its own duties but only protects the fiduciary from the results of the investment decisions made by participants. Still, in the big picture, I guess the DOL feels it has to protect its/participants' interests, even to the extent of painting with an overly-broad brush--it is, as you suggest, still the DOL. (Time to read the new fee disclosure regs, ehh?)

Thanks for referencing the case and sending a link to the amicus brief . . .

[J Simmons]

In my simple way of thinking, the DoL is wrong on this one. In plans where the trustee and/or plan administrator makes the investment decisions or limits to a dozen or two options what choices the employees may choose from, it makes sense to impose a fiduciary standard to the way the trustee/plan administrator makes those decisions and chooses those limitations.

Where as with the Deere and Co plan the employees have a wide open or virtually wide open choice (2600+ choices in the Deere situation), the investment decisions are being made by the employees and not the trustee/plan administrator. All the DoL's position does is to reduce plan trustees/administrators to being a potential punching-bag for litigation by employees that make poor investment choices or are disappointed that the investment markets have turned downward as those employees near or are in retirement.

Is the public policy truly that if an individual's employer wants to open up tax-advantaged retirement savings to its employees, beyond the limited amount that can be placed into IRAs that the employer must expose itself and/or its officers to liability for decisions they allow the employees?

It should be the purpose of the SEC (and fee disclosure required by the SEC or the DoL) to make sure that the proper information is presented in a readable, accessible format for investors, not the DoL to insist that employers be placed in a precarious position because they accommodate employees' desire for tax advantages when saving for retirement and respect those employees to make their own investment decisions.

That's the way it looks from my perspective.

[K2retire]

Your comments are thoughtful and right on, as usual John. Sadly, regulators live in a different world than the rest of us.

[J Simmons]

K2retire, true enough that regulators live in a different world than the rest of us. But at least one 3-judge panel of the 7th Circuit lives in the reality we do.

The court decided the appeal of Hecker v Deere in a 33-page decision handed down on February 12, 2009. You will recall that Deere's plan offered EEs the choice of 26 funds and BrokerageLink (a look-through investment vehicle) to 2,500+ investment options. The asset based fees ranged from 0.07% to 1%. "Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition."

The court basically found that the range of investment options that Deere (in agreement with Fidelity) offered to its EEs for directing the investment of their 401k benefits was sufficiently broad that control over the risk of loss was shifted to the EEs. "If particular participants lost money or did not earn as much as they would have liked, that disappointing outcome was attributable to their individual choices. Given the numerous investment options, varied in type and fee, neither Deere nor Fidelity (assuming for the sake of argument that it somehow had fiduciary duties in this respect) can be held responsible for those choices."

Earlier in the opinion, Judge Wood wrote that "[e]ven if § 1104© [ERISA § 404©] does not always shield a fiduciary from an imprudent selection of funds under every circumstance that can be imagined, it does protect a fiduciary that satisfies the criteria of § 1104© and includes a sufficient range of options so that the participants have control over the risk of loss."

The 7th Circuit rejected the notion that under existing ERISA law that revenue sharing had to be disclosed. That is "not information the participants needed to know to keep from acting to their detriment." The info provided about total fund-level fees of each investment option, by referring EEs in the SPD to read and glean that fee information from the prospectus for each fund, was all the information that the EEs need to 'keep from acting to their detriment'.

The court also rejected the notion that Fidelity was a functional fiduciary for merely playing a part in Deere's fund selection, since Deere retained the final authority to decide which funds would, and which would not, be offered under the plan to the EEs.

In whole or in part, the 7th Circuit rejected the three main positions taken by the DoL in its amicus briefing, set forth in post #5.

[J Simmons]

Another interesting point from the 7th Circuit's decision in Hecker v Deere is how the court dealt with the claim that Deere had misled employees that Deere was paying the cost of plan administration. Over a 16 year period, Deere and Fidelity amended their agreement 27 times, gradually shifting payment for the services provided by Fidelity from payments up front by Deere to where Fidelity was recovering its costs from the employees through assessing asset-based fees.

The employee plaintiffs claimed that "the SPD supplements left them with the impression that Deere was paying the administrative costs of the Plans, even though in reality the participants were paying through the revenue sharing system". The 7th Circuit explained that those same SPD supplements referred employees to the fund prospectuses for detailed information on fund-level expenses, which the prospectuses were provided by the funds.

"The fact that there were no additional fees borne by Deere is immaterial. While Deere may not have been behaving admirably by creating the impression that it was generously subsidizing its employees' investments ... when it was doing no such thing, the Complaint does not allege any particular dollar amount that was fraudulently stated." So, since the SPD supplements did not specify an amount that Deere was claiming to be paying toward plan administration, no foul to the employees that Deere was paying nothing although its SPD supplements suggested it was bearing some administrative costs.