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Department of Labor Releases Guidance for 401(k) Plan Investments in Private Equity

Last month the US Department of Labor (Department) issued an Information Letter stating that it is possible for individual account plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) to offer limited private equity investments in a manner that complies with ERISA, provided certain suitability issues are considered by plan fiduciaries. The Information Letter confirms that a plan fiduciary would not violate ERISA fiduciary duties “solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component.” Similarly, the Information Letter confirms that fiduciaries may offer private equity as a small component of an ERISA plan’s diversified investment option, like a target date fund, a target risk fund, or a balanced fund. 

The Information Letter points out that there may be reasons why a plan fiduciary may properly select an asset allocation fund with a private equity component as a designated investment alternative for a participant-directed individual account plan. The Information Letter did not address any potential issues under the ERISA prohibited transaction rules regarding private equity investments and also did not sanction direct investment in private equity.

The Department provided a number of significant issues that a plan fiduciary must consider when investing plan assets in an asset allocation fund with a private equity component, as follows:

  • The impact of the private equity allocation on diversification and expected returns net of fees (including management fees, performance compensation, or other fees or costs that would impact the returns) on a multi-year basis

  • Whether the plan fiduciary has the skill necessary to manage the private equity investments or whether the fiduciary should hire the help of experts or give investment power to investment professionals who are capable of managing the private equity investments

  • Whether the investment option will include liquidity features that allow participants to take benefit distributions and exchange into other plan investment options

  • The percentage of the investment option to be invested in private equity; the Department notes that the Securities and Exchange Commission (SEC) implemented a 15% limitation on illiquid investments applicable to registered open-end investment companies (i.e., mutual funds and exchange traded funds)

  • Whether the long-term nature of private equity investments align with the plan’s features and participant profile (including, e.g., participant ages, normal retirement age, anticipated employee turnover, and contribution and withdrawal patterns)

  • Whether the plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment as to whether to invest in the investment option, particularly if the plan is designed to shield plan fiduciaries from investment losses that result from participants’ investment directions, in accordance with ERISA 404(c)

The Department noted that the guidance does not address any fiduciary or other ERISA issues that may arise if a defined contribution plan were to allow participants to invest their accounts directly in private equity investments. Such investments present distinct legal and operations issues for fiduciaries of ERISA-covered individual account plans, and the Department is not likely to “bless” such a design anytime soon, although the SEC is exploring ways to increase access for retail investors to private companies.

Remember that legal principles may change and vary widely in their application to specific factual circumstances. You should consult with counsel about your individual plan, any plan amendments, and participant notices. 

© 2020 Jones Walker LLPNational Law Review, Volume X, Number 204

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About this Author

Tim Brechtel Employee Benefits Attorney Jones Walker
Partner

Tim Brechtel began his career with the national accounting firm PricewaterhouseCoopers. His current practice focuses on assisting employers with establishing, administering, merging, and terminating qualified retirement plans, such as 401(k) plans and employee stock ownership plans (ESOPs), as well as nonqualified deferred compensation arrangements under Code Section 409A, health plans, cafeteria plans, severance plans, separation agreements, health savings accounts, flexible spending accounts, transportation, and other fringe benefit plans. His retirement plan...

504-582-8236
Shawn J. Daray Associate New Orleans Tax Practice Group
Associate

Prior to joining Jones Walker, Shawn served as an extern for the Litigation Division of the Louisiana Department of Revenue, where he published articles on effects of the Amazon Tax for online retailers and state retroactive tax laws.

Shawn was previously a summer associate where he researched contract, corporate, and tax law on transactional issues for a tax and maritime firm. Shawn also drafted memorandum on maritime lien priority and limitation of liability.

504-582-8488