‘Window’ of Opportunity
Art by Tim Bower
Defined contribution (DC) plans covered by the Employee Retirement Income Security Act (ERISA) may include participant-level brokerage accounts. Such accounts may be used as a feature that allows all participants access to a greater array of investments than the plan’s core lineup. In other cases, they may be used as a tool to allow advisers to provide brokerage services or advisory services to the participants. Each of these scenarios raises its own issues with regard to compliance with ERISA and other applicable laws.
In the first instance, a plan fiduciary that allows participants to direct the investment of the assets in their plan accounts may make available brokerage accounts to participants through a feature often called a brokerage window. The fiduciary offers it alongside the plan’s core investment lineup. Through the window, the participant may invest in a host of options not otherwise available under the plan, including mutual funds and other securities such as, sometimes, unregistered securities.
Advisers generally maintain a client relationship with the plan’s named fiduciary rather than the individual participants. They can play an important role in advising that fiduciary on investment lineup construction and integrating the brokerage window feature into the plan, such as whether to make a window available in the first place or to restrict the investment options in which the plan participants may invest through it. For example, if a participant may invest in uncovered calls and puts, that person’s account balance could fall below zero, which raises compliance issues if the fiduciary intends to abide by ERISA Section 404(c).
Additionally, if the participant may invest in certain unregistered securities, ownership of such securities can result in the plan incurring taxable income called unrelated business taxable income. To the extent an adviser provides investment advice in connection with brokerage windows, he may very well be acting as a fiduciary for purposes of ERISA and thus must comply with it when advising the named fiduciary. Also, the adviser likely acts as a fiduciary under the Investment Advisers Act of 1940.
Another practice is that one or more plan participants in an ERISA-covered DC plan will establish brokerage accounts with a broker/dealer (B/D) so an adviser may provide brokerage services or advisory services to the participant with regard to that person’s plan account balance. In this case, the adviser’s primary relationship is with the participant. The brokerage account is the mechanism whereby the participant will invest his account balance. Therefore, the participant does not intend to utilize the plan’s core investment lineup, if any. Oftentimes, brokerage accounts are not established for all of the participants. Such accounts are held at the adviser’s firm or held away at another firm. The adviser likely must comply with the Securities and Exchange Commission (SEC)’s Regulation Best Interest when he makes recommendations regarding the participant’s trades in the plan’s brokerage account and must comply with the fiduciary requirements of the Advisers Act in the account as an advisory account.
Additionally, the adviser may have to comply with ERISA with respect to recommendations he makes. If the participant has an advisory account and the adviser provides what the Advisers Act deems investment advice to that individual, the adviser likely acts as an investment advice fiduciary for purposes of ERISA. Therefore, the adviser should make such recommendations in accordance with ERISA’s fiduciary duty and prohibited transaction (PT) provisions.
On the other hand, if the adviser provides brokerage services, he may or may not provide investment advice for purposes of ERISA. That will depend on the facts and circumstances. But he should not automatically assume he does not act as a fiduciary in respect of a brokerage account. The Department of Labor (DOL), last year, adopted prohibited transaction exemption (PTE) 2020-02. In the preamble to the PTE, the DOL changed its interpretation of its longstanding regulation defining the term “investment advice” for purposes of ERISA. As a result, an adviser is more likely to be a fiduciary when providing recommendations in connection with brokerage services. In that case, he would have to comply with ERISA’s fiduciary provisions and certain prohibited transaction exemptions such as PTE 2020-02.
Advisers should consider how they may be of assistance with regard to such accounts and what their compliance responsibilities are under applicable law, including ERISA.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C.