Thoughts on Self-Directed Brokerage Options in 401k Accounts

This post is inspired by the endless string of questions I receive each month regarding “in-service” 401k rollovers. As any competent financial advisor or retirement plan sponsor will reply: in-service rollovers before a qualifying event such as reaching retirement age or separating from service are rare and scarcely permitted. The underlying logic is that employers have a fiduciary responsibility and overall moral obligation to their employees when it comes to their retirement plans. Allowing a client to invest their nest-egg in individual stocks and/or other asset classes would present the possibility of that nest egg disappearing quickly. However, because 401k performance has been so dismal over the past six months anyhow, why not give employees the flexibility they so desire? A good solution may lie in a 401k feature which many people don’t talk about: self-directed brokerage accounts commonly referred to as an SDBA feature.


Although long-permitted by ERISA law, SDBAs weren’t particularly popular until the bull market of the 90’s sparked a major interest in stocks. Because so many people invest through 401k plans, this became the logical place to tap funds for speculation. While SDBAs are extremely flexible in terms of investment options, they don’t allow investors to lose more than the total value of their accounts. Options, short-selling and other products and practices which require margin privileges are strictly prohibited by ERISA.
The interesting part to me is how the financial services industry views SDBAs as a win-win-win situation for the brokerage firms, plan participants, and plan fiduciaries. I can certainly understand the benefits to the brokerage firms, but I’d be more cautious as to the benefits to both plan participants and fiduciaries. As we’ll get to below, recent litigation which has heightened the responsibility of plan fiduciaries would probably make SDBAs more of a liability than anything else. That beings said, they may still choose to offer it.
The complaints being waged by those looking for in-service rollovers of their 401k balances is that their employer-sponsored plans are either overly expensive, have limited investment options, or a combination of the two.
An article written by George Chimento on February 20th, 2008 sheds more light on the potential risks to employers offering SDBA and other increasingly flexible 401k arrangements. Chimento writes about the verdict in LaRue v. DeWolff, Boberg & Associates, Inc, et al., one of the more significant ERISA cases of late. The Supreme Court verdict was that if a participant in a self-directed 401k plan gives investment directions, and if a plan fiduciary ignores or botches those directions, the fiduciary should be liable for damages to the participant’s account. This may sound like common sense, but the federal courts repeatedly ruled that it would be unreasonable to hold fiduciaries responsible for mistakes made unless they harm an entire plan. In the case of James LaRue, he wasn’t even arguing about losses he sustained in his 401k account as a result of the error–he was arguing for lost profits he suffered due to the error.
The case can serve as an example of the increased liability placed on employers offering self-directed 401k plans (of which there are millions). This case didn’t deal with the specific issue of self-directed brokerage accounts, but one might logically conclude that the more flexibility you offer a participant over their investment decisions, the greater chance of financial losses and blame getting thrown around. It reminds me in some ways of the Social Security debate. While a true laissez-faire capitalist may prefer to self-invest their social security taxes (or eliminate them outright) we must deal with the greater issue of the masses. Investing requires education, discipline, and the ability to act without emotion. Many people–many very smart people–try their hand at investing and ultimately fail in frustration.
So is it beneficial to allow your employees to self-direct a portion of their 401k balances through brokerage accounts? My answer would be yes. It’s not like the majority of paid investment managers are crushing their benchmarks each year. In fact, most of them fall short over long periods of time and simply waste investment dollars in the process. So why not give employees increased access to better products and strategies? For the sake of employers, I might suggest an additional disclaimer document for clients who opt into the self-directed brokerage accounts. It may not hold up in court but it could at least prevent some liability in the short-run.
Please feel free to e-mail me with any questions or comments. If you have a 401k plan at work which you have questions about or feel may not be the best fit for your business, I’d be happy to discuss that as well.
Russell Bailyn

Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

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