Self Directed Plan

[Gary]

My understanding of a self directed plan is that the plan participants invest their money as opposed to the plan sponsor/employer controlling and making the investments. Is that correct?

With that said my understanding is that a profit sharing plan can be either self directed, or not self directed. Is that correct?

What about a 401k plan. Same question. Can it be non self directed, where the employee makes deferrals and the employer pools and invests the money and does record keeping?

Thanks.

[ERISAnut]

Yes

Yes

&

Yes

Any or none of a qualified plan may be self directed or not. There is no rule that states the employer must allow participant to self direct any part of any qualified plan.

[J Simmons]

Hi, Gary,

Expanding on ERISAnut's first "yes" answer, there are levels of employer control depending on how the self-directed plan is set up.

If the employer selects an investment menu of several options from which the employees choose, the employer is controlling what is on the investment menu.

An employer may instead just identify one or more acceptable brokerage houses through which the employees may choose any investments that may be effected by that brokerage. Ergo, the term brokerage window(s). Here, the employer controls what brokerages may be selected.

Third, the self-direction can be even broader, open architecture, where the employees may pick any brokerage where the plan will then set up an investment account for the employee's plan benefits.

To the extent the employer controls the matter, it may be held responsible for not acting prudently. The DoL believes that the employer has an affirmative decision to control matters and thus may be liable for an employee's choosing an investment not appropriate for that employee, through open architecture or brokerage windows. This DoL notion is currently being litigated in the 7th Circuit Court of Appeals in a case called Hecker v Deere.

[Guest mjb]

Hi, Gary,

Expanding on ERISAnut's first "yes" answer, there are levels of employer control depending on how the self-directed plan is set up.

If the employer selects an investment menu of several options from which the employees choose, the employer is controlling what is on the investment menu.

An employer may instead just identify one or more acceptable brokerage houses through which the employees may choose any investments that may be effected by that brokerage. Ergo, the term brokerage window(s). Here, the employer controls what brokerages may be selected.

Third, the self-direction can be even broader, open architecture, where the employees may pick any brokerage where the plan will then set up an investment account for the employee's plan benefits.

To the extent the employer controls the matter, it may be held responsible for not acting prudently. The DoL believes that the employer has an affirmative decision to control matters and thus may be liable for an employee's choosing an investment not appropriate for that employee, through open architecture or brokerage windows. This DoL notion is currently being litigated in the 7th Circuit Court of Appeals in a case called Hecker v Deere.

Where is there a requirement under ERISA that an employer allowing self directed accounts is liable for an employee choosing an investment that is not appropriate for that employee? Under that logic an employer cound not offer index funds which track the S & P 500 because the volatility of such an investment would not be suitable for certain retireees who need investments with a stable fmv. Limiting investment options of certain participants would violate the BRF rules under the IRC.

[J Simmons]

mjb,

I agree. I think the 7th Circuit should reject the appeal and the DoL's amicus position. DoL's amicus brief in Hecker

[GBurns]

Look at it from another perspective.

The vast majority of employees are "low information" persons. They have no training or experience in selecting, monitoring or directing investments. Many are not able to do even basic research. Then there is the expectation that their employer used their superior resources to have researched, evaluated and negotiated the best possible choices for the menu.

Add to this that the employer delegated such responsibility to staff with various titles, with the expectation of that being done but not realizing that the selected staff members were just like the regular employees, but who mainly relied on sales pitches from providers and provider reps.

Add to this the questionable merits of relying on a sales rep who is trying to make a sale.

Someone has to be responsible for causing the employee to be faced with the choices on the menu. Someone has to be responsible for misplaced reliance. Who?

IMHO, the responsible party is the one with the ability to control the quality of the offerings. The employee is powerless, whereas the employer has the resources etc. The employer also is the one with the most to gain. That is my opinion as to why the DoL takes such a position. Just to help the helpless.

[J Simmons]

Hi, George,

I wholeheartedly agree with you if the employer chooses to set an investment menu.

To a lesser extent, I agree that the employer that decides to limit what brokerage window(s) will be open to the employee should be held to account for making prudent decisions in what brokerages are made available (and which are not). If only high fee brokerages are allowed, the employer should be responsible for the adverse impact vis-a-vis lower fee brokerages. If the brokerages chosen do not, for one reason or another, allow certain investments otherwise available to private investors, I think the employer ought to be responsible if the investments allowable through the selected brokerage window(s) are substandard vis-a-vis those not allowable.

In those two contexts, the employer is filtering and making decisions that the employee may not him/herself go beyond. The employer should be the responsible party to the extent it has so filtered and limited matters.

But when an employer chooses open architecture, the employer is opening the world of investments up to the employees. The employer is stepping back and allowing the employees to make their own choices, just as they would if the investments were held in IRAs. The employees are not limited by actions (or inactions) of the employer.

I agree with you that someone needs to be responsible. But I do not think it should be the employer that chooses to respect the employees by allowing them to make the same investment decisions they could with their savings outside of a qualified plan. In the open architecture context, the responsible party should be the employee--who could file suit against a salesman of questionable merit for losses or bad advice.

The DoL takes the position that the employer should take a paternalistic view and limit the investments to only those that are in the best interests of the unsophisticated employees. But I think the helpless could be helped much more by the DoL identifying more clearly and distinctly which types of investment options ought not be allowed to unsophisticated employees and which types should not. For example, risky margin trading in a qualified plan is discouraged by UBTI. There are statutory limits on the amount of employer stock. Both are helpful. But those and a handful of others do not amount to much help to an employer that is, per the DoL, stuck between a rock and a hard place for trying to help its employees use the company's payroll to get greater tax relief than an employee could do on his/her own with just an IRA, and/or company contributions eartagged for retirement savings.

Not all employers are themselves in the financial industry, as you pointed out by describing those who company's select to make these types of decisions for plans. Just because a company has more resources than an employee does that justify obligating the company. That same employee had the choice between an adjustable rate mortgage (ARM) and a fixed-rate one when buying a home. The employee was in essence committing his future earnings from the employer to pay whichever mortgage. Should his/her employer's accounting department be obligated if the employee chose wrong?

I certainly understand and have respect for the paternalistic sentiment that you and the DoL have expressed, but I think that the federal judge in Wisconsin got it right. Where the choice lies is where the responsibility lies as well. I hope the 7th Circuit agrees.

[Guest mjb]

Look at it from another perspective.

The vast majority of employees are "low information" persons. They have no training or experience in selecting, monitoring or directing investments. Many are not able to do even basic research. Then there is the expectation that their employer used their superior resources to have researched, evaluated and negotiated the best possible choices for the menu.

Add to this that the employer delegated such responsibility to staff with various titles, with the expectation of that being done but not realizing that the selected staff members were just like the regular employees, but who mainly relied on sales pitches from providers and provider reps.

Add to this the questionable merits of relying on a sales rep who is trying to make a sale.

Someone has to be responsible for causing the employee to be faced with the choices on the menu. Someone has to be responsible for misplaced reliance. Who?

IMHO, the responsible party is the one with the ability to control the quality of the offerings. The employee is powerless, whereas the employer has the resources etc. The employer also is the one with the most to gain. That is my opinion as to why the DoL takes such a position. Just to help the helpless.

Are you saying that an S & P index fund is not a suitable choice for an employee to select as an investment in a 401k plan?

Would it be suitable for the employer to select it in a pooled account?

Or are you saying that employees should not be given choices and should be put in a default investment such as a target date fund because they cannot be trusted to select the correct investments?

What do you mean by saying that someone has to be responsible for causing the employee to faced with choice on the menu? I though 404c expressly permitted the employer to allow employees to choose their investments?

I thought it was understood that employees have a responsibility to learn about investments before they make their selections and for that reason investment education is promoted by the DOL.

And I thought that the IRS does not permit plan fiducaries to limit choices to cetain groups of employees.

What am I missing?

[K2retire]

What am I missing?

The reality that most employees (as well as many employers) will not take the time to learn about investments and then will want to blame someone when their choices don't turn out well.

[ERISAnut]

Look at it from another perspective.

The vast majority of employees are "low information" persons. They have no training or experience in selecting, monitoring or directing investments. Many are not able to do even basic research. Then there is the expectation that their employer used their superior resources to have researched, evaluated and negotiated the best possible choices for the menu.

Add to this that the employer delegated such responsibility to staff with various titles, with the expectation of that being done but not realizing that the selected staff members were just like the regular employees, but who mainly relied on sales pitches from providers and provider reps.

Add to this the questionable merits of relying on a sales rep who is trying to make a sale.

Someone has to be responsible for causing the employee to be faced with the choices on the menu. Someone has to be responsible for misplaced reliance. Who?

IMHO, the responsible party is the one with the ability to control the quality of the offerings. The employee is powerless, whereas the employer has the resources etc. The employer also is the one with the most to gain. That is my opinion as to why the DoL takes such a position. Just to help the helpless.

I agree with this; and with no caveats. I think it is perfectly stated.

A simple case in point we can all relate to; if any employee were to choose to invest in a limited partnership offering inside a brokerage platform, then that would create an issue for the employer when having to value the plan at least once annually; especially when the valuation is more frequently than annually.

This is merely supporting the argument that while the brokerage account is allowed, the employer still has a fiduciary responsibility to restrict the types of investments the brokerage account may offer the employee.

Also, suppose the employer restricts the available brokerage account offereing to Brokerage X instead of Brokerage Y, this would be a fiduciary breach in the event Brokerage X is proven to be sub-par.

These are just principles to reinforce what GBurns is stating.

[Guest Sieve]

Except that the fiduciary standard does not reach merely "sub-par". It takes much more than that. Remember, the fiduciary is never a guarantor that the investments offered are the very best that are available nor must the fiduciary make a change when it is determined that they are not the very best that are available.

I would argue that there would be no question of an employer meeting its fiduciary responsibility when offering open architecture if the employer also offered investment education (not necessarily investment advice) at the same time. I don't think anyone is suggesting here that it's the mere availability of open architecture that is the problem--as I see it, it's offering the investments without any education that opens the door to fiduciary liability issues.

[J Simmons]

Larry,

Years ago, I defended a truck stop against a product warning case. A man had refilled his 20-lb propane tank at the truck stop. Then he took it to a camp site, hooked it up to 28 year old, recently purchased propane space heater and left it running all night in the tent. Next morning, he awoke in the cold as the heater had stopped (apparently the catalytic heat plate had been flooded by cold propane, lowering it to a non-functioning temperature). Before going out of the tent, he lit a cigarette as well as a flash fire of the unburned propane in the tent interior.

He sued everyone from Phillips Petroleum to the maker of the propane tank to Natural Gas Odorizer to the propane distributor to the maker of the space heater and, yes, to my client, the truck stop.

Under oath, the man admitted he had seen but did not read warnings plastered on the tank and the heater. He further acknowledged that had he read the warnings he noticed, he would not have left the heater operating while he and his family slept in the tent. His claim was nevertheless that more warnings should have been provided him than had been. The 9th Circuit Court of Appeals forced the truck stop alone to stand trial. It was the only defendant that had not provided some warning. All the others were let out of the suit without having to go to trial. They had each provided some warning and that, according to the 9th Circuit, was enough despite the man claiming those warnings were inadequate and they all ought to be held liable.

Two weeks of trial in the federal district court, the jury found for the truck stop. The jurors later each explained that the opening statements were enough. Two weeks of trial--expensive vindication.

Your comment about providing some investor education, not advice, reminded me of how the appellate court reasoned in the propane warning case the my truck stop should stand trial, but not the others. Everyone involved with the investment of retirement funds, even the employer who merely provides the tax-savings vehicle, can buy themselves some peace of mind by providing some investment 'warning' even if it is not heeded.

[Guest Sieve]

John --

Your story shows how warnings can help a great deal--that's why we now see some pretty absurb ones today.

So as not to lead people to think that a mere warning is sufficient, I think fiduciaries have to meet a greater standard than just issuing a warning comparable to, e.g., "Investing for retirement requires specialized decision-making that you might want to leave to a professional" or "Contact your tax or investment professional before acting with regard to investing your account or taking a distribution". Certainly the warnings help, but if there is a fiduciary duty (and there is not with regard to distributions, I believe)--especially if that fiduciary duty arises from ERISA--then more than a mere warning is called for.

By the way, how did a PI attorney ever get into ERISA, anyhow? (It would be scary if you said that it gave you some sense of security because you found the rules to be predictable . . .) And another thing your story did was confirm my fear of propane!!

[GBurns]

Larry

I am surprised that a lawyer would think that warnings or attempted education would suffice. Consider the many product liability lawsits involving labeling/warnings and directions for use. Consider 401(k) fees lawsuits. Consider the Spitzer bid-rigging lawsuits. Remember hot coffee bought at the drive thru ?

People in general no longer use any common sense. And unfortunately our juries are made up of those same people. So the consumer, no matter how stupid, quite often shares no responsibility for any of his/her actions.

To me, the DoL is just mirroring the society in general.

[ERISAnut]

Well, it basically breaks down into two categories; criminal and civil. Fiduciary breach cases are typically civil in nature. Therefore, I can sue anyone I choose for any damages I suffer (regardless of whether or not they were a result of my own ignorance). Also, my case, since it is civil and not criminal, will be decided on the preponderance of the evidence and not decided on whether someone is negligible beyond a reasonable doubt.

So, in this system we are speaking of, people tend to sue 'deep pockets' in civil court for any losses, damages, or pain they suffered. One of the main responsibilities of someone with deep pockets is to eliminate as many avenues for such suits to get filed against them. Therefore, it would not be responsible to presume that any reasoning is dominant; especially when someone just suffered a loss.

[Guest Sieve]

George --

Of course we all know that I did not say that warnings would suffice (nor did John)--although, as John pointed out, there clearly are cirumstances in which warnings will be found sufficient. (By the way, part of the hot coffee case was that the coffee was significantly hotter than necessary--and, remember, state law is at issue in PI cases, not federal law.) What I did say is that warnings will help, and, in fiduciary situations, that more will be required. Sometimes we do not read carefully, or only digest what we expect to see, and therein lies the problem with warnings--or writings--of any kind.

I'm not going to be drawn into the "no one uses common sense anymore and is always looking for a scapegoat" argument -- as true as it might be at times. The DOL clearly takes the participant's side, and wants to pull the pendulum as far as it can in favor of the participant. That's what I would expect under ERISA, and that's usually what we get. I once had a significant high-level DOL type tell me, with regard to a potential PT, that, if the DOL felt that there should be a PT violation, then a PT argument certainly could be crafted. Sounds pretty pro-participant to me. And, when another high-level DOL type was asked, with regard to the then newly-revised SPD regs, whether he really expected that an administrative determination with regard to a severe medical condition (or whatever it's called under the SPD regs) had to be made within a couple of days even when there was a 3-day weekend due to a federal holiday, and he answered "Of course that's what I expect", it was no surprise--there are lots of people out there who are looking to do little other than stick it to partcipants as much as possible, and it's the DOL's job, in the ERISA context, to protect participants to the full extent permitted by law & regs.

On the other hand, courts determine the interpretation of these rules, and I would hope--but not necessarily expect--that courts will see that offering open architecture should NOT be a per se breach of fiduciary duty. A fiduciary breach under certain facts?--perhaps. But per se?--NO. How in the world could/should it be? If you are saying that 404© can never work to protect the employer/fiduciary when there is open architecture, even if all 404© protections are in place (although I wonder if there can be a true 404© plan, in practice--but that's another issue for another day), then I say that is a BAD result, and makes no sense to me--although I can accept that with it may come additional fiduciary requirements, under the circusmtances, to do a little bit more on the education side. But, I don't see how a court can overturn a 404© plan which, in fact, meets all requirements, whether it's open architecture or not. Of course, if all 404© requirements are not met, then we have to look at other fiduciary obligations and whether they were met.

When I said "I don't think anyone is suggesting here that it's the mere availability of open architecture that is the problem", it appears I was wrong. But I don't see why open architecture should be off the table without any consideration of the extent to which fiduciary protections--including 404© protections--are in place.

[J Simmons]

John --

Your story shows how warnings can help a great deal--that's why we now see some pretty absurb ones today.

So as not to lead people to think that a mere warning is sufficient, I think fiduciaries have to meet a greater standard than just issuing a warning comparable to, e.g., "Investing for retirement requires specialized decision-making that you might want to leave to a professional" or "Contact your tax or investment professional before acting with regard to investing your account or taking a distribution". Certainly the warnings help, but if there is a fiduciary duty (and there is not with regard to distributions, I believe)--especially if that fiduciary duty arises from ERISA--then more than a mere warning is called for.

By the way, how did a PI attorney ever get into ERISA, anyhow? (It would be scary if you said that it gave you some sense of security because you found the rules to be predictable . . .) And another thing your story did was confirm my fear of propane!!

But Larry, isn't "Security" what the S in ERISA stands for?

Your question might better be phrased, how did an ERISA attorney get into defending a propane case? When with a firm, I supervised a young associate that went on to become general counsel for a company that owned truck stops. He thought my analytical skills would come in useful in defending a products liability/warning case and we both wanted the opportunity to work together again. The case took 8 years, and he had moved on before the trial. I convinced the federal magistrate and district judge to give all defendants summary judgment arguing that the man's testimony belied the possibility that a jury could reasonably find proximate cause. After all, he'd said he saw the warning stickers but chose not to read them--but if he had, he would have acted in a way that would have avoided the flash fire. I've already noted what the 9th Circuit did on appeal to my summary judgment. I will say this, after practicing ERISA law for years, researching product warnings law made a lot more sense than the week or two we spent on it in 1st year torts class.

For trial, I brought in as co-counsel a propane litigator that had once been a securities lawyer preparing SEC filings. He had done securities filings and litigation for a petroleum company that offered him all its litigation defense work. He became a propane litigator.

As for propane, I hadn't been in that case long before I decided to get rid of my propane barbecue grill. Natural gas is so much safer.