DOL Information Letter Allows Private Equity Investments in Defined Contribution Plans
June 11, 2020

On June 3, 2020, through the issuance of an information letter (the “Letter”), the Department of Labor (the “DoL”) effectively expanded the realm of investment alternatives for 401(k) plans and other defined contribution plans to include private equity.  The guidance is clearly a boon to the private equity industry, which can now count 401(k) plan participants as a significant new class of investors.  Plan participants will now also have access to private equity allocations typically reserved to wealthy individuals and institutional investors.   With respect to plan fiduciaries of defined contribution plans, the Letter provides them a framework to include private equity as an asset class with the comfort that they would not be breaching their duties to plan participants by offering such an investment option.

Unlike direct investments in private equity that may be made by defined benefit plans, the DoL notes that the private equity investment option for a defined contribution plan might be a custom target date fund, target risk fund, or a balanced fund that would provide participants with exposure to a range of asset classes.  The Letter contemplates that the private equity investment would be offered as component of an asset class allocation, for example, through a custom target date fund structured by a plan investment committee as a separately managed investment alternative or one managed by a delegated investment manager.  In other cases, the asset allocation fund with a private equity component would be in the form of a prepackaged investment option offered by a financial institution to individual account plans as a “fund of funds” (structured as, e.g., a collective trust fund or other pooled vehicle) that invests in other funds, with one of the underlying funds being a fund that invests primarily in private equity. Importantly, the Letter clarifies that in no case would the private equity component of the asset allocation fund be available as a vehicle for direct investment by plan participants and beneficiaries on a stand-alone basis.

The Letter further notes that there are important differences between a fiduciary’s decision to include private equity investments in the portfolio of a professionally managed defined benefit plan and the decision to include an asset allocation fund with a private equity component as part of the investment lineup for a participant-directed individual account plan.  As such, the Letter identifies the following factors a fiduciary should consider in evaluating whether to include a particular investment vehicle with an allocation of private equity as a designated investment alternative:

  • Whether adding the particular asset allocation fund with a private equity component would offer plan participants the opportunity to invest their accounts among more diversified investment options within an appropriate range of expected returns net of fees (including management fees, performance compensation, or other fees or costs that would impact the returns received) and diversification of risks over a multi-year period;
  • Whether the asset allocation fund is overseen by plan fiduciaries (using third-party investment experts as necessary) or managed by investment professionals that have the capabilities, experience, and stability to manage an asset allocation fund that includes private equity investments effectively given the nature, size, and complexity of the private equity activity; and
  • Whether the asset allocation fund has limited the allocation of investments to private equity in a way that is designed to address the unique characteristics associated with such an investment, including cost, complexity, disclosures, and liquidity, and has adopted features related to liquidity and valuation designed to permit the asset allocation fund to provide liquidity for participants to take benefits and direct exchanges among the plan’s investment line-up consistent with the plan’s terms. With respect to liquidity and valuation, the Letter indicated that a fiduciary could ensure that private equity investments in the investment fund not be higher than a specific percentage of the investment fund’s overall assets (citing in a footnote that the fiduciary could consider whether to follow the 15% limitation on illiquid investments applicable to registered open-end investment companies).

In concluding, the Letter notes that a plan fiduciary would not, in the DoL’s view, violate the fiduciary’s duties under section 403 and 404 of ERISA solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component as a designated investment alternative for an ERISA covered individual account plan in the manner described in the Letter. Importantly, a footnote makes clear that the Letter does not address any potential prohibited transaction issues under section 406 of ERISA or the application of any statutory or administrative prohibited transaction exemptions that may need to be considered in connection with the structure, investments, or fees of any individual designated investment alternative or private equity investments nor does the Letter address any issue with respect to the structure or operations of any particular investment arrangement that may arise under the federal securities or banking laws, the Internal Revenue Code, or any other applicable federal or state law.

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