What are the difficulties of a brokerage window?

For an individual-account retirement plan with participant-directed investment that gets Ascensus’ recordkeeping services, the plan’s sponsor (which also is the plan’s administrator and trustee) is considering adding a Schwab Personal Choice brokerage window, restricted to mutual-funds-only.

Unlike other employee populations in which only a relatively few participants use a brokerage window, almost all participants would use the mutual-funds window.

The employer pays Ascensus’ fees for all still-employed participants, and likewise would pay Ascensus’ incremental fees for pulling the brokerage accounts into the recordkeeping.

The counts of participants, all of whom have a plan account balance, are such that the plan every year will require an independent qualified public accountant’s audit of the plan’s financial statements. An Ascensus-aligned trust company is the plan trustee’s custodian.

The plan does not use Ascensus or a TPA to test coverage, nondiscrimination, or top-heavy measures.

BenefitsLink neighbors, what difficulties should I advise this plan sponsor to consider in its decision-making about whether to add the brokerage window?
 

Peter,

2 hours ago, Peter Gulia said:

The plan does not use Ascensus or a TPA to test coverage, nondiscrimination, or top-heavy measures.

Who does the testing for the plan? The PS?

2 hours ago, Peter Gulia said:

Unlike other employee populations in which only a relatively few participants use a brokerage window, almost all participants would use the mutual-funds window.

That is both good and bad.  Its good because the availability and use will clearly be nondiscriminatory, but considering the number of accounts the admin of the plan will be more complicated.  

2 hours ago, Peter Gulia said:

Schwab Personal Choice brokerage window, restricted to mutual-funds-only.

Are they actually able to restrict the investments in the SDBA?  Unless the SDBAs are integrated with the RK platform, it may be difficult to restrict. Remember, they also have to monitor these accounts, and that may be difficult as well.

2 hours ago, Peter Gulia said:

would pay Ascensus’ incremental fees for pulling the brokerage accounts into the recordkeeping.

Sounds like they are "shadow posting", in other words, you will be able to see the balance of the SDBA in Ascensus, but probably not the activity.  If so, consider the added complications of tracking fees, g/l, dividends, etc. 

Also, you may want to consider the EBSAs not so favorable view of brokerage windows in general, and whether this approach will allow the plan fiduciaries to meet their obligations (fee disclosures, monitoring investments, etc).

It worries me that there is no TPA (unless they have someone in-house that can perform testing, prepare required disclosures, reporting, etc).  If they are simply shadow posting balances to Ascensus, reconciliation will be a headache.  

@RatherBeGolfing raises some of the operational issues that the client must understand fully and be able to set the expectations of participants on how the SDBAs will work inside the plan.  Ascensus and Schwab each have a lot of experience with SDBAs inside plans and they also have links to share data electronically.  While that sounds wonderful, there remain complications for recordkeeping the plan.

One of the bigger challenges stems from allowing multiple contribution sources to be invested in the SDBAs.  There is potential for a contribution source to be pre-tax or Roth.  Each source may have differing in-service withdrawal provisions, differing vesting, differing loan availability and other variances in features.

When recordkeeping a plan that uses a menu of mutual funds, each transaction be it a contribution, distribution, exchange, dividend, new loan, loan repayment... can be labeled with a plan account (deferral, NEC, match, rollover, ...) and the mutual fund in which the transaction occurs.  When there is what @RatherBeGolfing termed "shadow posting", the recordkeeping treats the SDBA as if it is a single investment.  The identity of the mutual fund is lost.

When recordkeeping with a menu of mutual funds, the price per share of each fund is known after market close and before market open.  Depending upon the frequency in which the market value of the SDBA is sent to the recordkeeping system, the "price" of the SDBA investment may not be known within the menu of mutual fund's time frame.

The plan should not allow participants to grant trading privileges to brokers or financial advisers that are not approved by the Plan Sponsor.  Allowing participants to choose advisers of their choice is a recipe for chaos, and could lead to questions over who is controlling the investment of plan assets.

The plan audit should not be dramatically impacted by the SDBAs.  Schwab and the trustee both should be issuing reports that include all of the detail needed by an auditor with experience auditing SDBAs.  The Plan Sponsor should vet the auditor to confirm that the auditor does have this experience of the cost of the audit could skyrocket.

I share @RatherBeGolfing's concern about who is providing compliance services although my concern is driven more by the competence of who is providing the services rather than by having SDBAs as an investment option.

Note that the proposed arrangement for the SDBAs is relatively simple compared to some of the plans I have recordkept.  For example, this arrangement:

• uses only one brokerage firm and participants do not get to open an account at the brokerage of their choice'
• restricts investments to mutual funds and participants cannot invest in stocks, bonds, CDs, ETFs, ETNs, gold, annuities...;
• does not allow trading in options;
• does not allow investing in assets that do not have a readily determinable value such as real estate, LPs, private placements, art...

The advice to the client is to know the details, prepare written policy (including dos and don'ts), and communicate clearly to participants.  Some plans go so far as to have a participant sign a representation that the participant understands the policy.

RatherBeGolfing and Paul I, thank you for helping me.

Schwab offers recordkeepers two formats for Personal Choice accounts; one of those is mutual-funds-only. In my experience with others, a recordkeeper calls a plan’s administrator to specify which version is selected. I’m guessing Ascensus lets its customer specify mutual-funds-only.

RBG, thank you for your note about the plan’s administrator not seeing transactions within a brokerage account.

Paul I, thank you for your suggestion that a plan or its administrator might forbid or limit an agent using a participant’s power to direct investment.

The plan’s administrator uses an accounting firm to test coverage and nondiscrimination, and a different accounting firm to audit Form 5500 reports and financial statements. That auditor firm has a distinct work group who do only employee-benefit-plan audits and lots of them, including many that require information from Ascensus. Also, the employer uses, beyond its internal accountants, three accounting firms for the employer’s financial statements and allocations, and a separate accounting firm for tax accounting. Some of these services involve checking another’s work.

For ERISA disclosures and related advice, the plan’s administrator uses Fiduciary Guidance Counsel.

My information for the decision-makers to consider will include EBSA lawyers’ and officials’ distaste for brokerage windows.

Do you think a plan’s fiduciary must monitor what happens inside participants’ brokerage accounts? And if so, why? (I ask because I respect your views.)

Or is the plan fiduciary’s duty only to find that Schwab is a reputable broker-dealer, that Schwab and Ascensus deliver information needed for the plan’s auditing, and that participants can get information to direct one’s own investments?

Am I right in guessing that a Form 5500 report shows the beginning-of-year and end-of-year balances held in the participant-directed brokerage accounts, but need not show details on which mutual funds the plan’s trust holds, except for those that are a 5% concentration (or involve a nonexempt prohibited transaction)?

My personal opinion is the tasks listed in your last 2 paragraphs are the minimal requirements for the plan fiduciaries and for plan reporting.

There are certain participant behaviors within the SDBA that can be detrimental to the participant's accounts.  For example, most mutual funds offer varying share classes of the same fund and each share class has a different fee structure.  A participant may be able to invest in a share class of a fund available in the plan's mutual fund menu that has the lowest fees, but the participant invests in the same fund in the SDBA in a class with higher fees.  A fiduciary may discern that this is happening by comparing the assets held in the SDBAs against the funds in the investment menu.  If this reveals that participants are paying the higher fees, the fiduciary may want to provide at least some notice or educational material to participants pointing out how to evaluate fund expenses.

Another example is when participants trade in funds that have fees for short-term trading.  Typically, funds that have these fees apply them when shares held less than 30 days.  Participants who behave like day traders can rack up fees solely based on their trading frequency.  There should be reporting about these fees that could alert the fiduciary that trading frequency is an issue and, again, the fiduciary may wish to provide some education.

While a plan fiduciary may not be held accountable for a participant's mishandling of their assets, some may argue that a fiduciary knowing these behaviors are occurring creates an obligation for the fiduciary to act.  As a reaction to this notion, some plans ask participants to take a test about the fundamentals of investing before they are allowed to have an SDBA.

Paul I, thank you for the further helpful information.

14 hours ago, Paul I said:

My personal opinion is the tasks listed in your last 2 paragraphs are the minimal requirements for the plan fiduciaries and for plan reporting.

I agree.  These are the minimum requirements, and a plan fiduciary may reason that more is required to discharge their duties and protect plan participants.

14 hours ago, Paul I said:

There are certain participant behaviors within the SDBA that can be detrimental to the participant's accounts.  For example, most mutual funds offer varying share classes of the same fund and each share class has a different fee structure.  A participant may be able to invest in a share class of a fund available in the plan's mutual fund menu that has the lowest fees, but the participant invests in the same fund in the SDBA in a class with higher fees.  A fiduciary may discern that this is happening by comparing the assets held in the SDBAs against the funds in the investment menu.  If this reveals that participants are paying the higher fees, the fiduciary may want to provide at least some notice or educational material to participants pointing out how to evaluate fund expenses.

Another example is when participants trade in funds that have fees for short-term trading.  Typically, funds that have these fees apply them when shares held less than 30 days.  Participants who behave like day traders can rack up fees solely based on their trading frequency.  There should be reporting about these fees that could alert the fiduciary that trading frequency is an issue and, again, the fiduciary may wish to provide some education.

While a plan fiduciary may not be held accountable for a participant's mishandling of their assets, some may argue that a fiduciary knowing these behaviors are occurring creates an obligation for the fiduciary to act.  As a reaction to this notion, some plans ask participants to take a test about the fundamentals of investing before they are allowed to have an SDBA.

Agreed.

@Peter Gulia, FAB 2012-02R removed some of the brokerage window guidance from the original FAB 2012-02 that got a lot of pushback from the industry.  The original FAB would have made compliance all but impossible when brokerage windows were offered.  Generally speaking, I think you always have a responsibility to monitor investments and fees, and I dont think that brokerage windows are any different.  If adding brokerage windows ends up with higher fees and poor investment performance compared to the Ascensus platform only, are they still appropriate for the plan, or could they be appropriate with changes?  What level of monitoring is needed in order to determine if they are or become an issue?  Those are issues a responsible plan fiduciary should consider.  

Im not against brokerage windows, but I believe they add complexity to the plan and for the plan fiduciaries.  Since they have hired you, it appears they already understand this and might be better situated than most for this type of plan design.  Many plans just add brokerage windows and move on. To me, it is just a matter of time until the DOL drops the hammer on plans that offer brokerage windows using the "set it and forget it" approach. 

RatherBeGolfing, thank you for helping me with your further thinking.

While recognizing complexities and risks about a brokerage window:

This plan’s sponsor+administrator faces circumstances in which removing some funds from the plan’s designated investment alternatives and instead allowing participants who want those funds to get them under a brokerage window could lessen fiduciary tensions.

Further, the plan’s administrator might welcome an opportunity to report investments made through the brokerage window as one asset on Schedule H’s line 1c(15) and line 2c, and so as one asset held for investment for that line 4i schedule. And participants who use the brokerage window might welcome that the schedules do not reveal any participant’s investment choices, or even an aggregate of participants’ investment choices, under the window.

My scope is to provide the decision-makers a detached explanation of potential advantages and disadvantages. And you both have helped me.

@Peter Gulia If it understand correctly, plan fiduciaries are considering removing funds from the plan's investment menu and implementing a brokerage window because some of the participants want to continue to own those funds.

Removing a fund from a plan's investment menu typically is a result two situations.  One situation is when very few participants choose to invest in a fund and the fiduciaries wish to replace the fund with a one that will be attractive to more of the participants.  This may be a very good reason to put in the SDBA to allow these few participants to continue to invest in their favorite fund.

The other situation is when a fund in removed for noncompliance with the plan's investment policy statement.  This has the potential to draw a complaint from a participant that continues to hold the fund in the SDBA and then experiences extensive losses in their account.  (I have seen this happen with mutual funds that focus on an industry sector.) This touches on the topic of what is the responsibility of the fiduciaries to inform participants if the fiduciaries have knowledge that something is amiss.

Hopefully the fiduciaries at least would communicate to employees the reasons why funds are removed from the plan's investment menu and could counter the complaint with that communication.

Paul I, thank you for your further thinking with smart logic.

In this situation, the reasons the plan’s fiduciary might consider moving funds from the main menu to the brokerage window don’t relate to either of those you describe.

I’m deliberately not describing the reasons because doing so could reveal my client’s identity and confidential communications.

Again, thank you both for helping me.