WASHINGTON - The Securities and Exchange Commission agreed to reconsider a recent ruling that would have barred hedge funds and other private investment pools from tapping defined contribution plans unless they register as mutual funds.
In a case involving PanAgora Asset Management Inc., Boston, the SEC ruled in April that private investment pools would have to register as mutual funds if their investors consisted of participant-directed defined contribution plans.
Hedge funds and other private investment companies that cloak their trading practices in secrecy are eager to avoid registering as mutual funds, a process that is not only onerous and expensive, but also would require them to open up to public scrutiny investments in their portfolios.
Lawyers representing hedge funds and other private investment pools say such vehicles are an ideal way for plan sponsors to broaden their offering of investment choices to defined contribution plan participants in keeping with the Labor Department's 404(c) regulations.
But it could be a long time before plan sponsors are ready to add hedge funds - aggressive private pools of money designed to profit from swings in interest rates and other market movements - to the stable of funds in which employees invest their retirement dollars.
"It is hard enough to educate participants to put their money in stocks," said Wayne A. Wicker, investments manager at Dayton Hudson Corp., Minneapolis, who oversees the company's $850 million defined contribution plan. "(Hedge funds are) not an asset category I have seen in any defined contribution plan," he noted.
Employees put more than half of their retirement dollars into low-risk guaranteed investment contracts, even though this means giving up higher returns, according to a survey of 280 plan sponsors by The Wyatt Co., Washington, earlier this year.
Mark Kenyon, managing director of The Blackstone Group, New York, wanted to tap defined contribution plans, but was advised by the firm's lawyers that Blackstone would have to register with the SEC if it wanted to do that.
Mr. Kenyon's firm has $700 million invested in hedge funds as a fund of funds.
Only one defined contribution plan, that for Goldman Sachs & Co.'s senior executives, is believed to offer participants the choice of investing in a registered hedge fund - Omega Advisors Inc., run by Leon Cooperman, former chief investment officer of Goldman Sachs Asset Management.
Fred Skolnick, benefits analyst at Goldman Sachs, declined to confirm the information. Mr. Cooperman, and Steven Fredman, partner at Schulte Roth & Zabel, the New York law firm that represents Omega, also declined to discuss it.
What's more, even if the SEC reverses course on the PanAgora ruling, hedge funds that engage in heavy short-selling might lose tax advantages as registered mutual funds. And plan sponsors still might be reluctant to offer hedge funds to participants because they could end up being hit with income taxes on hedge fund investments.
The SEC staff's decision to rethink its position follows the intercession of former SEC Commissioner Edward H. Fleischman, now partner at Rosenman & Colin, a New York law firm that counts hedge funds among its clients. Following a request from Mr. Fleischman, the SEC has postponed the effective date of the ruling in the PanAgora case until Jan. 1.
Now, Jack W. Murphy, chief counsel of the SEC's division of investment management, says the agency is "certainly willing to listen" to persuasive arguments by hedge funds and other private investment pools that the agency's response to PanAgora would deprive defined contribution plans of the ability to invest in these vehicles.
Mr. Murphy said it is not common for the SEC to change its position, "but it's not unheard of."
Lee Robinson, partner at Rosenman & Colin and head of the firm's employee benefits group, has drafted another letter to the SEC outlining arguments against the SEC's ruling in the PanAgora decision.
Mr. Robinson plans to ask the SEC to apply the Labor Department's reasoning - in determining whether investment companies are regulated by the Employee Retirement Income Security Act - to see if investment companies need register as mutual fund companies.
Private unregistered investment companies are not subject to regulation by ERISA if pension plans own less than 25% of the assets of the fund.
An SEC official declined to comment on Mr. Robinson's letter until the agency receives it.
At the heart of the issue is whether bank commingled trusts managed by outside advisers, hedge funds and other private investment pools that have 401(k) plans and other defined contribution plans as investors must register as mutual funds.
A provision in securities laws allows such private investment companies to avoid registering as mutual funds if they have 100 or fewer investors or "beneficial owners." Until the SEC's refusal to exempt PanAgora from registration earlier this year, private investment pools counted as investors only the number of plan sponsors, not plan participants.
PanAgora, in conjunction with Boston Safe Deposit and Trust Co. as trustee, had planned to offer a commingled pool to 401(k) plans and other tax-favored defined contribution plans. The pool would consist of 42 different funds with varying investment objectives. However, then-SEC Special Counsel Richard F. Jackson denied PanAgora's request for exemption from registration, explaining that because plan participants could pick where to put their money, it had to count all of them as "beneficial owners," too (Pensions & Investments, May 30).
John Tavss, partner in charge of the hedge fund group at Seward & Kissel, a New York law firm that represents more than 100 hedge funds, said the SEC might exempt from registration funds whose investors consist of defined contribution plans that allow participants to pick asset classes, but not funds.
The SEC's ruling does not apply to private investment companies that count defined benefit plans as investors, or to those defined contribution plans that do not let participants pick investment options.