WASHINGTON - Hedge funds and private investment pools are expected to step up marketing efforts to defined contribution plan sponsors, thanks to the Securities and Exchange Commission.
In response to an inquiry by money manager Standish, Ayer & Wood, the SEC issued a no-action letter that offers hedge funds and private investment partnerships a way to promote themselves to 401(k) plan investors without having to register as mutual funds.
"It removes a cloud that had been hanging over their marketing efforts, so it could mean more" promotions to draw investments by 401(k) plans, said Thomas S. Harman, partner in the Washington law firm of Fried, Frank, Harris, Shriver & Jacobson. Mr. Harman also is former chief counsel in the SEC's investment management division.
The ruling comes more than a year after the agency curtailed the ability of the funds to court defined contribution investors. At that time, the SEC had turned down a request from PanAgora Asset Management Inc., Boston, to market new investment pools to defined contribution plan investors without registering as mutual funds.
Securities laws let private investment pools avoid registering as mutual funds as long as they have fewer than 100 investors. In turning down the request from PanAgora, the SEC said private investment pools must count as investors all defined contribution plan participants, not just plan sponsors.
The SEC's pronouncement in the no-action letter to Standish Ayer would let private investment pools keep 401(k) plan investors without registering - under certain conditions:
Employers identify to participants these pools only as generic investment options, such as an underlying fund in a core domestic equity multimanager fund or as part of the underlying assets in a synthetic GIC. The funds can't be identified by name.
Plan fiduciaries, not plan participants, must control where to invest the money flowing into the generic options.
Hedge funds and other private investment pools cannot hold more than half the money flowing into any generic investment choices offered by a defined contribution plan.
Employers will not guarantee employees their money will flow into the same funds, or in any fixed manner.
What happens next is up to the plan sponsor.
"The control is with the plan sponsor. How it chooses to configure its investment options will determine" if hedge funds can market themselves to the plans, said Thomas Z. Reicher, partner in the Hartford, Conn., office of the law firm of Day, Berry & Howard.
Defined contribution plan sponsors are most likely to use such hedge funds or private investments as one of the underlying funds in an investment choice made up of several different funds.
Employers also might use private investment pools as one of the underlying funds in "synthetic" GIC funds aimed at offering investors a steady return with low volatility, imitating guaranteed investment contracts.
In fact, the new fund described by Standish Ayer to the SEC is such a "synthetic" GIC fund.
Alternatively, employers might employ hedge funds or private investment funds, along with brand-name mutual funds, in asset allocation funds, Mr. Reicher said.
One such fund offered by Norwalk, Conn.-based EAI Capital Markets Inc., an affiliate of Evaluation Associates Inc., shifted its numerous 401(k) plan investors into a newly created mutual fund this year to overcome the problem created by the SEC's 1994 dictate, said Robert B. Mayerick, senior vice president.
Evaluation Associates, however, maintained its private investment pool for its other institutional investors.
The new EAI Select Managers Equity Fund, made up of multiple funds investing in U.S. stocks, is a clone of the private investment pool. It had seven 401(k) plans as investors with roughly $73 million in assets before registering as a mutual fund; it since has attracted more DC plan investors and grown to $80 million.
The SEC's no-action letter "solved the PanAgora problem for investors that had been invested in the group trust. We essentially created a mutual fund version of the group trust," Mr. Mayerick said.
