During the climax of the movie A Few Good Men, Jack Nicholson's character confronts Tom Cruise's with the memorable line “You can't handle the truth!”

We could have something similar brewing in 401(k) and 403(b) plans—and plan sponsors might not like it.

Instead of the word “truth,” substitute the word “freedom” and you'll see what I mean. The beauty of 401(k) plans has always been the 404(c) diversity requirement. As long as plan sponsors offer three “materially different” investment options (that, of course, pass a minimal due diligence regime), the plan sponsor is not liable for the investment decisions of individual employees. In a sense, employees have a degree of freedom, although not unlimited.

This all changed with the concept of the “self-directed brokerage option.” In this option, an employee can buy any stock, bond or mutual fund available through the particular broker platform picked by the plan sponsor. Sounds like the ultimate freedom, right? The trouble is, of course, it is the ultimate freedom, which unfortunately includes the freedom to pick investments that would normally not pass a minimal due diligence regime.

This is where things get tricky—and untested. Who's responsible for buying an investment that doesn't pass due diligence—the employee who has the ultimate freedom or the plan sponsor who gave the employee the ultimate freedom?

Some believe the plan sponsor will be held responsible. After all, an ERISA retirement plan isn't designed to be a “free-for-all” when it comes to investing. For better or worse, ERISA assumes the plan sponsor has the patriarchal role, with plan participants being treated as “minors” regarding their investment sophistication. As a result, the buck for improper investments stops on the shoulders of the plan sponsor.

Still, the existence of this liability hasn't been tested in any consistently reliable way. However, the DOL did provide a hint on how it might interpret matters when, in regard to 401(k) fee disclosure, it required the plan sponsor to treat every investment made through a self-directed brokerage option as a separate option. This elevates the plan sponsor's responsibility for unapproved investments to the same level as approved investments.

According to DOL provided data, the growth in the number of plans offering self-directed brokerage options has been dramatic. The data is only available through 2011, however, so the impact of the 2012 fee disclosure rule has yet to be measured. While we've seen double-digit growth, the number of actual users remains small. Given the liability potential, that may generate a sigh of relief—a sigh of relief which soon withers when one realizes the potential size of the liability remains the same whether one participant uses a self-directed brokerage option or one hundred participants do.

And that's a freedom some just prefer not to handle.

Instant Insights /

The ticking time bomb plan sponsors can&rsquo;t ignore

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The ticking time bomb plan sponsors can’t ignore