On June 3, 2020, the Department of Labor (the “DOL”) published an Information Letter confirming that investment options under a defined contribution plan (e.g., a 401(k) or 403(b) plan) may include a limited allocation to private equity. Notably, the Letter does not discuss direct investment in private equity funds (for example, by adding a PE fund to the plan’s investment lineup). Rather, the Letter discusses including private equity as a small allocation within a diversified designated investment option such as a balanced fund or a target date fund (a footnote in the Letter suggests no more than 15%); and the Letter notes that direct investment in private equity would “present distinct legal and operational issues.”
The Letter emphasizes that selection and monitoring of an investment option with private equity is subject to the same fiduciary considerations as other investments (including the duties to be prudent and loyal, and the duty to avoid prohibited transactions). At a high level, this includes evaluating whether the potential upside from the investment justifies the added risk, fees, complexity, and valuation and liquidity issues. The Letter lists the following specific considerations:
- Whether the investment option is sufficiently diversified to mitigate risk over a multi-year period;
- Whether the investment option is overseen by plan fiduciaries (using third-party investment experts as necessary) or managed by investment professionals with the appropriate private equity-related expertise;
- Whether the allocation within the investment option to private equity is sufficiently limited to address cost, complexity, disclosure, liquidity and valuation issues unique to the asset class (again, a footnote suggests no more than 15%);
- Whether the investment option is appropriate for the participant profile (including, for example, participant ages, normal retirement age, anticipated employee turnover, and contribution and withdrawal patterns) and aligns with the plan’s characteristics and needs of plan participants;
- Whether the plan fiduciary has the skills, knowledge and experience to make the required determinations regarding adding and monitoring such allocation, or whether it needs to seek expert guidance; and
- Whether participants will be furnished adequate information regarding the character and risks of such an allocation (in particular, for plan fiduciaries relying on the protection provided under ERISA Section 404(c)).
Although the Letter includes detail that is unique to the private equity asset class, it does not change the law or general fiduciary responsibilities with respect to defined contribution plans. In fact, some defined contribution plans have had private equity and other alternative asset allocations within their investment options for years; and challenges to the prudence of those investments are actively being litigated. Also, the Letter references, and does not resolve, additional issues that might arise under ERISA’s prohibited transaction rules, as well as under securities, banking, tax, and other laws.