Ernie Guerriero, CLU®,ChFC®,CEBS,CPCU®,CPC®,CMS,AIF®,RICP®,CPFA
Plan sponsors, usually the employer, in many cases has the risk tolerance to seek alternative investments in their retirement plan. Generally speaking entrepreneurs are risk takers, they’ve invested in their business, they understand leverage and they are willing to wait for a return on their money. Private Equity (PE) investing is such an investment and the DOL has outlined how PE can be used in a self-directed 401(k) arrangement. However, is this investment appropriate for a Plan and should there be an offsetting investment, life insurance? As a refresher a private equity investment is a type of alternative investment. Individuals own a portion of a company that is not publicly owned, quoted or traded on a stock exchange. Private equity investment strategies include executing leveraged buyouts, contributing venture capital and investing growth capital to name of few investment alternatives.
On June 3, 2020, the Employee Benefit Security Administration of the U.S. Department of Labor (DOL) issued an information letter (Information Letters are for informational purposes only and are not binding on the DOL or any other party.) The Letter outlined the fiduciary responsibility provisions of the Employee Retirement Income Security Act of 1974, as amended (ERISA) do not prohibit fiduciaries of 401(k) and other individual account plans from including diversified investment options with private equity exposure if various requirements are met. However the DOL’s analysis should apply equally to investment funds that invest in other alternative asset classes such as real estate.
ERISA generally provides that plan fiduciaries must discharge their duties prudently and in the exclusive interest of the plan’s participants and beneficiaries. Most 401(k) and other individual account plans have participant-directed investments, and such plans typically are designed to satisfy the requirements of Section 404(c) of ERISA, which provides that individual account plan fiduciaries are not responsible for losses caused by participant investment selections among a menu of designated investment options offered under the plan if the requirements of Section 404(c) are met. As this relates to PE one very important requirement is that fiduciaries must prudently select and monitor any designated investment options offered under the plan.
The DOL indicated that an individual account plan fiduciary may prudently select and monitor an investment fund consisting of an asset allocation fund with a private equity component as described in the letter in a manner consistent with ERISA’s fiduciary responsibility provisions. Given that private equity investments are more complex, have less liquidity, and typically do not have readily ascertainable market values, the DOL indicated plan fiduciaries should consider the following:
1. whether adding such an investment fund would allow participants to invest in more diversified investment options with an appropriate range of expected returns, net of fees, and diversification of risks over a multi-year period.
2. whether the investment fund is overseen by plan fiduciaries (using third-party investment experts as necessary) or managed by professionals who have the capabilities, experience, and stability to manage an investment fund effectively that includes private equity investments given the nature, size, and complexity of the private equity activity.
3. whether the investment fund has limited the allocation of assets to private equity exposure in a manner that is designed to address the unique characteristics associated with such exposure and has adopted features related to liquidity and valuation designed to allow plan benefit distributions and direct exchanges among the plan’s investment line-up.
Considering liquidly, valuation, fees, and other Regulatory issues (SEC), is this a prudent investment for the plan participants and their beneficiaries or is life insurance more appropriate for the plan participants and their beneficiaries?