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Are Brokerage Windows an Effective Way of Limiting Fiduciary Risk After Hughes v. Northwestern?

by | May 4, 2022 |

In Hughes v. Northwestern University, 142 S.Ct. 737 (January 24, 2022), the Supreme Court held that fiduciaries to self-directed defined contribution retirement savings plans are responsible for determining the prudence of all investment alternatives offered on a plan’s investment menu. While the holding is facially consistent with the core fiduciary principles in the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. §1101 et. seq., the devil is often in the details; the plans at issue had over 400 available options during the relevant time period, and the Court rejected the notion that fiduciary duties were met if there were enough prudent low-fee options available for participants to design diversified investment portfolios.[1] The Court directed the Seventh Circuit to consider whether plaintiffs had plausibly alleged that fiduciaries had failed to properly evaluate the fees and appropriateness of the offered investment alternatives.[2]

Going forward, the high standard of fiduciary responsibility embraced by the Court in Hughes may discourage fiduciaries from designating numerous investment alternatives on participant investment menus. Fiduciaries considering less robust plan investment menus, however, may also be concerned that reduced investment options could discourage participation or could trigger challenges from participants that investment options are too restrictive.

Could adding brokerage window options expand investment options while reducing fiduciary responsibility for reviewing investment menus? Brokerage window arrangements allow plan participants to direct investment of their plan accounts outside of offered alternatives. Brokerage windows are excluded from the definition of designated investment alternatives in investment menus for self-directed individual account plans,[3] and participants select and evaluate their own investments through the window, typically without investments being vetted or monitored by plan fiduciaries. While there is limited regulatory guidance on the use of brokerage windows, the ERISA Advisory Council recently examined the state of the law and concluded that no further regulation is needed. Advisory Council Report to the Secretary of Labor, December 2021, at p. 53 (summarizing findings and recommending no further regulatory action but suggesting that the DOL conduct additional fact finding on participant needs in brokerage window only plans). Brokerage windows could provide an opportunity to offer unfettered investment options coupled with a limited curated investment menu that fiduciaries could readily evaluate and monitor.

Brokerage windows could also serve as a path to allow participants to consider environmental, social and corporate governance factors (“ESG factors”) in making investment choices without fiduciaries needing to designate specific ESG-focused investment alternatives. The debate over the role of ESG factors in selecting and evaluating ERISA plan investments has stalled efforts by the U.S. Department of Labor (“DOL”) to revise its longstanding Investment Duties regulation; final rules promulgated in November 2020 have been criticized for improperly discouraging consideration of ESG factors, while the revised version proposed in October 2021 has been criticized for instead improperly encouraging such consideration. Brokerage windows could allow participants to use ESG factors to direct their investments without plan fiduciaries having to take a position on the proper role of ESG considerations or embarking on the difficult task of understanding how ESG factors are used to develop and implement investment strategy.

Can brokerage windows offer a simple fiduciary fix? Not so fast, cautioned the DOL, in commentary discouraging ERISA plan fiduciaries from allowing cryptocurrency investments. In Compliance Assistance Release 2022-01 (March 10, 2022), the DOL expressed serious concerns about the uncertainties and volatility inherent in cryptocurrency investments, citing Hughes for the proposition that fiduciaries cannot allow any imprudent investment options, and strongly suggesting that a cryptocurrency option would not be appropriate. Recognizing that brokerage windows could be used to circumvent designated investment options, the DOL further cautioned that a plan fiduciary who permitted investments in cryptocurrency through a brokerage window should be ready to explain how such a decision was consistent with duties of prudence and loyalty under ERISA. Id. at p.3.

The DOL’s statement that plan fiduciaries could be responsible for the prudence of investment choices made through a brokerage window suggests that fiduciaries retain an undefined level of fiduciary responsibility for the investment of all plan assets, regardless of how participants make their investment directions. While the guidance was in the context of cryptocurrency investments, the underlying policy is not necessarily limited.

The principles supporting the Supreme Court’s decision in Hughes lend credence to the DOL’s suggestion; if fiduciaries are responsible for the prudence of all available investment options—whether there are 10, 50, or 500—it stands to reason that there may be some level of fiduciary responsibility with respect to offered brokerage windows.

The question now is when, whether, and how will the DOL or the federal courts develop standards for plan fiduciaries to apply when designing and monitoring individual account plans with brokerage windows. What types of design functions will fall under the fiduciary umbrella? Will including a brokerage window option in a plan document be considered a settlor or a fiduciary act?

Fiduciaries seeking to use brokerage windows to both limit fiduciary responsibility for vetting investment alternatives and expand available investment opportunities should consider approaching brokerage window design as a fiduciary act, and carefully design rules and safeguards mindful of legal requirements and considering participant demographics, interests, and needs.

Plan sponsors must also be mindful of Code qualification requirements. For example, if a plan sponsor could find some objective way to determine who had a sufficient degree of sophistication and financial understanding to understand cryptocurrency as an investment, there would be a distinct possibility that such a group would be discriminatory under Internal Revenue Code standards for tax-qualified plan benefits, rights, and features provisions.

Approaching brokerage window design as a fiduciary act does not concede that fiduciary duties apply. However, given that ERISA jurisprudence has not yet defined the parameters of responsibility, fiduciaries who exercise their duties of prudence and loyalty in designing brokerage window rules should be ahead of the game and poised to demonstrate compliance as fiduciary standards unfold in light of Hughes and developing DOL policy.

Given that brokerage windows are largely unregulated, fiduciaries might also step back and consider different options, such as whether brokerage windows can be designed within ERISA Section 404(c) rules to capture fiduciary protection from losses, whether 404(c) is the best, or only, way to create a fiduciary shield, or whether Code rules could allow for participant investments outside of plan menu choices through rollovers to IRAs.

The attorneys at The Wagner Law Group are available to assist plan fiduciaries as they consider how to respond to the Hughes decision and recent DOL guidance. Please feel free to contact any of the authors of this Alert, Barry Salkin and Mark Greenstein.


[1] The defined contribution plans at issue in Hughes were Section 403(b) plans that were historically designed as individual contracts, which might have contributed to the high number of offerings. 401(k) plans, however, are not prohibited from having numerous investment options, and plaintiffs have asserted breach of fiduciary duty claims based on the number of offered investment alternatives.

[2] The Hughes court sidestepped application of the Iqbal/Twombly pleading standard to allegations of breach of fiduciary duty regarding defined contribution plan investment offerings, disappointing many practitioners. District and appellate courts have employed different approaches, resulting in inconsistent decisions across the federal bench.

[3] 29 C.F.R. § 2550.404a-5(h)(4).