Are SDBAs the Next Litigation Target?

Back in the 1990s, the ability to support a self-directed brokerage account (SDBA) capability was a widely utilized means of winnowing the field in a 401(k) search, and more recently, the option seemed to hold promise as a foil for excess fee litigation charges. But that could be changing.

The SDBA option allowed participants to make investment choices outside the standard retirement plan menu – a big deal at a time when you could count the number of choices on two hands. Vanguard’s 2017 “How America Saves” report notes that one in six (17%) plans offer the SDBA option, though nearly a third (30%) of plans with more than 5,000 participants do. And while this amounts to nearly 3 in 10 Vanguard participants having access to the option, only 1% of these participants used the feature in 2016, and in those plans, only about 2% of plan assets were invested in the SDBA feature that year. PLANSPONSOR’s 2017 DC Survey pretty well mirrors those findings: 18.7% of plan sponsor respondents have the option, with nearly half of plans with more than $1 billion in assets choosing to do so.

Of course, with SDBAs, it has never been about how many used the option, but who – and for the very most part, the option has its greatest appeal among those whose balances (or financial acumen, real or perceived) calls for it, particularly among closely held small businesses and professional practices, such as lawyers and doctors.

Fee Litigation

In the early days of the so-called excessive fee litigation, at least one court (the 7th Circuit, in Hecker v. Deere) found compelling the notion that the existence of the SDBA gave participants access to a sufficient variety of reasonably priced funds to refute excessive fee claims against a plan that had a “regular” fund menu comprised of nothing by the proprietary funds of its recordkeeper.

However, and while it hasn’t been a primary focus of recent litigation, several of the more recent suits do raise concerns with the existence of the SDBA, but more importantly, how it was managed.

About a year ago, in a suit brought by American Century participants against their own plan, the plaintiffs took issue with how the SDBA was administered, and while they acknowledged that usage of the SDBA is higher within than industry statistics would suggest, they went on to state that that result was “no doubt due to Defendants’ imprudence and self-dealing” (less than 7% of the plan’s assets are held in SDBAs).

In a 2015 suit involving PIMCO, the plaintiffs argued that “…those who choose to utilize an SDBA are typically assessed an account fee and a fee for each trade” — fees that they said “often make an SDBA a much more expensive option compared to investing in the core options available within the Plan.” Additionally, they claimed that because “employees investing in mutual funds within an SDBA must invest in retail mutual funds, rather than the lower-cost institutional shares typically available as core investment options,” those who do use the option again pay higher fees.

And then, just this year, in a suit brought against Schwab, the participant-plaintiffs charged that not only that Schwab received revenue sharing payments from third-party ETF and mutual fund providers whose funds were made available to via the platform, but that the SDBA’s “byzantine complexity and confusing schedule of fees alone make it inadvisable for all but the most sophisticated of investors.” The plaintiffs framed the availability of the option to all participants (rather than just more sophisticated participants) as an issue, and charged that Schwab made no effort to determine: (a) if the SDBA was a prudent option at all, or (b) if another provider’s SDBA might have been better.

All of which should remind us that plan fiduciaries have a responsibility to carefully select and monitor their SDBA provider and these services. That could include:

• the qualifications and qualify of the provider;
• the reasonableness of the fees; and
• the security of the account and stability of the provider.

And just like any provider of services to a qualified plan, if the brokerage window can’t be prudently selected, the plan should not offer that window.

Something on which the plaintiffs’ bar now seems to be focusing.

- Nevin E. Adams, JD