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Private Equity Guidance from the DOL 2.0

ERISA exemption for State PlansPrivate equity guidance is here.  Or is it?  Use of private equity within qualified plans has been an outstanding question for quite some time.  Should private equity investments be allowed in the plan’s investment lineup?  It is a puzzling question with no easy answer.

Carol Buckmann, founding partner and ERISA attorney at Manhattan-based law firm Cohen & Buckmann, recently penned an article for InvestmentNews on the topic.  Initially, Ms. Buckmann noted, the Department of Labor (DOL) had issued an information letter addressing the use of private equity investments in 401(k) plans as part of a target date, balanced, or similar funds that were options on the plan’s menu.  The letter brought private equity investments to the fore-front.  There are regulators, investment managers, and fiduciaries on either side of this issue.  Ms. Buckman indicated, “Questions surround the appropriateness due to the lack of transparency, liquidity, high fees, and hard-to-value assets.”

The DOL has clarified its earlier guidance specifically around fiduciaries’ responsibilities with regard to private equity investments in 401(k) plans.  It also noted that prior guidance wasn’t in support of or recommending private equity investments for participants.  Earlier this year, a California court also dismissed a case against Intel for including alternative investments, including private equity, in its investment lineup.

Ms. Buckmann examined the fiduciaries’ role in considering private equity investments for 401(k) plans.  She wrote, “The bottom line is that private equity investments may still be appropriate for certain plans and participant groups if there is a cap on the fund’s private equity investments and fiduciaries do their homework in selecting and monitoring the funds.”  Citing the recent landmark Supreme Court decision in Hughes v. Northwestern University, Ms. Buckmann observed, “fiduciaries must evaluate each fund in their menus individually for prudence and may not rely on a defense that participants have a menu of funds to choose from that includes some prudent investments.  This rule applies to menu selection even if the fiduciaries rely on the safe harbor protecting them from liability for losses when participants control the investment of their accounts.”

The DOL emphasized that its original information letter addressed defined benefit plan fiduciaries who’d already included private equity investments in those plans and were considering implementing them in their 401(k) plans.  Ms. Buckmann noted that in its latest guidance, the DOL cautions against plan-level fiduciaries using private equity investments in small individual retirement savings accounts.

The DOL provided the guidance below for plan fiduciaries who must engage in an “‘objective, thorough and analytical process,’” either on their own or with help from a qualified professional, when considering including private equity investments in their 401(k) plans:

  • The fiduciaries should evaluate whether the investment arrangement being considered complies with securities, banking, and other relevant laws.
  • The fiduciaries should evaluate three compliance areas highlighted by the SEC: conflicts of interest, fees, and policies and procedures regarding material non-public information.
  • The fund must provide sufficient liquidity to provide benefit distributions and direct exchanges to other investment funds as required by the plan.  (Note that the Section 404 (c) safe harbor requires the right to change investments in core options to be available at least quarterly.)
  • Fiduciaries should consider the plan’s participant profile as it relates to the longer-term investment horizon and liquidity restrictions of private equity investments, including participants’ ages, the plan’s normal retirement date, turnover rates, and contribution and withdrawal patterns.

Ms. Buckmann pointed out that despite the DOL guidance and the precedent of the Intel decision, plan fiduciaries increase their liability risk and their potential to be sued should they include private equity investments in their plans.  This does not rule out the usage of private equity investments, however, it does require an extra layer of precaution for plan fiduciaries.  Ms. Buckmann emphasized that fiduciaries should protect themselves by making sure “the investment disclosures given to participants accurately disclose the risk profile, fees, and other material aspects of these investments.”

Guidance and clarifications from the Department of Labor does not occur frequently.  This is a good opportunity to learn more.

Steff Chalk

Steff Chalk

Managing Editor at 401kTV
Steff C. Chalk is Executive Director of The Retirement Advisor University, a collaboration with UCLA Anderson School of Management Executive Education. Steff also serves as Executive Director of The Plan Sponsor University and is current faculty of The Retirement Adviser University.
Steff Chalk
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