Private-equity funds allowed in ERISA-covered individual account plans

By Evan Cook, CPA, SingerLewak LLP, Denver

Editor: Mark G. Cook, CPA, CGMA

In Information Letter 06-03-2020, the U.S. Department of Labor (DOL) addressed the issue of using a private-equity fund option in defined contribution plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). The DOL concluded that an asset allocation fund with a private-equity component may be offered to participants in an ERISA-covered individual account plan.

An individual account plan that the DOL is referring to is a defined contribution plan. An example of a defined contribution plan is a Sec. 401(k) retirement plan. In this plan an employee and potentially the employer contribute to the employee's individual account. The employee can choose from a set list of investments. The list is determined by the plan fiduciary.

This letter is dealing with a private-equity investment as part of an asset allocation fund, not a direct investment in private equity. The DOL information letter says, "direct investments in private equity investments present distinct legal and operational issues for fiduciaries of ERISA-covered individual account plans" (fn. 5). A basic example of an asset allocation fund is one whose portfolio consists of 55% stocks and 45% bonds.

The main question is whether the plan fiduciary would breach its fiduciary duty by offering a private-equity investment option as part of an asset allocation fund. Fiduciary duty is covered in ERISA Sections 403 and 404. The information letter refers to ERISA Section 404(a)(1), which states, "A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries," and ERISA Section 404(a)(1)(B), which continues, "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."

The plan fiduciary must act in the best interests of the plan participants and beneficiaries. To do this, fiduciaries need to have the knowledge to evaluate and manage private-equity investments or have third-party advisers who do. Fiduciaries also need to give participants enough information so they can evaluate whether the investment makes sense for them.

The DOL raises a few concerns with having a private-equity fund as an investment choice in an individual account plan, including liquidity and valuation. An investment in private equity tends to be illiquid and hard to value because private equity is not traded on a public market. This could present a problem when participants need to take distributions or want to change investments. As the DOL outlines, one way to address this issue is to make sure the private-equity portion does not exceed a set percentage of the overall investments of asset allocation funds. The remainder is invested in more liquid investments such as publicly traded stock. This allows for participants to enter and exit the fund as needed.

With this guidance from the DOL, individuals may see a fund with a private-equity component become available in their 401(k) plan. This gives average people access to investments that they may not have had the opportunity to invest in previously.

EditorNotes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.

All contributors are members of SingerLewak LLP.

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