self directed brokerage (high net worth investments)

[k man]

if a plan allows all participants the right to direct their accounts to self directed brokerage and one of the trustees wants to invest in an investment only available to very high net worth individuals would this be a rights and benefits issue or does the fact that the limits are not plan imposed make this allowed? I know there are quite a few older threads on this topic but not so many on investment imposed or broker imposed minimums.

[mming]

I would tend to say it's allowed. My reasoning would be that you could ask the same question about the many mutual funds that impose a $3,000 minimum initial purchase - it's likely that not every participant would be able to meet such a threshold.

[four01kman]

This was a regular question some time ago, and many threads dealt with it. My sense today is find a qualified ERISA lawyer, get an opinion in writing. The downside for making an incorrect decision is not good.

[mbozek]

We have had this discusson before and the question is whether the minmum asset requirement is a plan requirement or whehter it is a requirement of the investment fund. Some funds available in a directed brokerage are onhy available to accredied investors or require a minimum amount. I consider an eligibliilty rule set by the fund to be outside of the plan because the plan has no control over the eligibility requirement for the fund.

[John G]

Kman: the answer to your question is "it all depends".

Citizenship, geographic location, income and networth are some of the factors that may shape if an investor can participate in a specific investment. There may be more like criminal record!

From an SEC perspective, many investments are considered unsuitable for the average investor. Examples of these can include certain limited partnerships and unlisted stocks. Often the screening criteria involves the rules for "sophisticated investor" or "qualified investor". If you have never heard of these and are not familiar with the terms, then odds are you would not meet the standard. The theory here is that very high net worth individuals and high income individuals don't need standard everyday protection about investment choices. These folks can hire an investment advisor or lawyer...or more than one of each! Also, if they lose a quarter million, the wife and kids are not going to be out on the street and lacking food. The whole risk / reward balance is completely different from standard investing. I've seen great real estate partnerships with outstanding property and 97% occupancy crater due to external events ~ such as Lehman owning mezzanine loan coming due when that Lehman went belly up and the investment banking system was frozen up. That deal became essentially worthless in two months. On the other hand, I have seen many of these niche opportunities end up with IRRs in the 28 to 43% range, even after hefty "promotes" (the rake taken by the general partner)

Here are some unusual investment that are not offered to the public:

Example 1: A company in the US, regulated by the US, doing business in the US is however owned by an Indonesian family. Due to troubles at home, this family decides to do a quick sale via a boutique investment house. Because of the desire for an abbreviated process, the investment house elects to do an IPO where only sophisticated investors can participate. The stock will not be listed for a few years and will perhaps not even trade. In under three months, the investment house pulls off the deal and 400 individuals and institutional investors own the spun off company. Two years later, the company gets listed on the NASDAQ. {I was one of the participants in this investment. The shares were purchased inside a regular IRA, then transferred to a Roth IRA on a market dip. There were zero issues about SEC or IRS restrictions. It turned out to be a good investment.}

Example 2: While at Bane capital, Mitt Romney develops a plan to buy three Asian manufacturers and integrate the product lines. This "deal" might be presented to high net worth individuals in the form of a limited partnership. The investment would not be advertized to the public and the investor package might specifically say the deal was not subjest to specific securities laws, with multiple pages of disclaimers about suitability of the investment, and what is at risk. [Note this is closer to the world of venture capital rather than typical investments.]

Example 3: An associate of mine from consulting many years ago has jumped between financial posts, ending up at a hedge fund. He is an outstanding stock analyst who once said "I am surrounded by people who know how to babysit peoples money, but there are not many who actually know how to make money". {I agree} His fledgling hedge fund begins with a mix of sophisticated investors and institutional money. After a year, he approaches Fidelity Investment and is cleared for allowing Fidelity customers to participate. My wife elects to place a part of her IRA funds with this hedge fund with the position reported to Fidelity much like an outside mutual fund. Fidelity does not advertise or even list this investment option, but Fidelity investors who meet stringent criteria can place brokerage, IRA or other funds with the new firm via a letter of instructions. There is no trading, no monthly in/out transactions. The hedge fund runs on a multi-year basis. About 1/3 of the assets are short positions. A significant part includes preferred stock, warrants and options.

Summary ~ The rules and restrictions that govern an investment choice stem not just from the plan, but also include SEC or IRS regulations, custodian/brokerage requirements, and sometimes rules imposed by the group offering the investment. Lawyers and accountants may not agree on the applicability of these investments, so you sometimes have to do research to convince your own team that an option is allowed. Many of the rules are based on legislation and approved regulations. However, in my experience, some of the brokerage limitations are more driven by their internal marketing posture and perhaps administrative convenience. In years past, Fidelity and Schwab have both lost and gained customers based upon what they would allow in a retirement plan. They often did not agree on if a specific investment was allowed or not. Since these kinds of investments are pretty rare, the tax payer is often communicating with the back office at the brokerage Hdq rather than the local staff. They guy at the counter is unlikely to be knowledgeable about these special investments. There are lots of MBAs who are not trained in these instruments.