The U.S. Department of Labor (the "DOL") this week, on June 4, 2020, issued an Information Letter (the "Letter") regarding the use of private equity ("PE") investments in investment options offered under participant-directed individual-account retirement plans ("Plans"), such as "401(k)" plans, that are subject to the Employee Retirement Income Security Act of 1974 ("ERISA"). The Letter relates to the use of PE investments within professionally managed asset allocation funds (e.g., so-called "target date" funds) that are investment alternatives for Plan participants and beneficiaries.
In the Letter, the DOL confirmed "that a plan fiduciary of an individual account plan may offer an asset allocation fund with a [PE] component . . . in a manner consistent with the requirements of Title I of ERISA." Thus, the DOL expressly confirmed that there is no per se impediment to the use of PE investments as a part of the portfolio in which Plan participants may choose to invest.
The DOL then went on to add several cautionary comments regarding the use of PE investments under a Plan, noting generally, "In evaluating whether to include a particular investment vehicle with an allocation of [PE] as a designated investment alternative, the responsible plan fiduciary must evaluate the risks and benefits associated with the investment alternative."
As a specific example of what a fiduciary should consider, the DOL offered that a "fiduciary should consider . . . 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." Issues like these have presented challenges for Plans’ use of PE investments, even, as the DOL understands that Plan fiduciaries could conclude. Thus, while the DOL acknowledged that an investment option that includes PE exposure could “present the opportunity for enhanced diversification of investment risk and for greater returns on participant investments than could be achieved solely in the public market,” the Letter nevertheless does not provide any rules, guideposts or other solutions for how to implement the use of PE investments in Plans.
As another example of a cautionary note, this time regarding valuation, the DOL stated: "With respect to valuation and liquidity in particular, a plan fiduciary, for example, could require that the [PE] investments in the investment alternative not be higher than a specific percentage, . . . ensure that the [PE] investments be independently valued according to agreed-upon valuation procedures that satisfy [certain accounting rules,] . . . and require additional disclosures needed to meet the plan’s ERISA obligations to report information about the current value of the plan’s investments. [footnotes and citation omitted].” The Letter then suggests that in light of the particular characteristics associated with PE exposure, it would be important for a Plan fiduciary to “make a considered decision about whether the characteristics of the investment alternative align with the plan’s characteristics and needs of plan participants . . . .”
Ultimately, though, the Letter seems not to break any real new analytical ground,* and the DOL summed up by repeating the basic principles that "a plan fiduciary would not, in the view of the [DOL], violate the fiduciary’s duties under . . . ERISA solely because the fiduciary offers a professionally managed asset allocation fund with a [PE] component as a designated investment alternative for [a Plan] in the manner described in this letter" and that "[t]here may be many reasons why a fiduciary may properly select an asset allocation fund with a [PE] component as a designated investment alternative for a Plan.” For anyone that may have been concerned that the use of PE investments under Plans was somehow inherently inconsistent with ERISA, the Letter may be of some comfort.
* By its nature, a DOL information letter "is a written statement . . . that does no more than call attention to a well-established interpretation or principle of [ERISA], without applying it to a specific factual situation." ERISA Proc. 76-1, § 3.01. We note, however, that in the Letter the DOL did state that the Chairman of the Securities and Exchange Commission did urge the DOL "to address uncertainties regarding ERISA that may be impeding plan fiduciaries from considering [PE] investment opportunities as a way to enhance retirement savings and investment security for American workers."