DOL letter, Intel ruling pave way for private equity in DC plans

Proponents of incorporating alternative assets in defined contribution plan lineups are optimistic that interest and adoption will grow in 2022, after two recent reassuring developments.

The Biden administration in December kept in place Trump-era Department of Labor guidance that confirmed plan fiduciaries can offer certain private equity strategies without running afoul of ERISA.

Then on Jan. 8, a U.S. District Court judge dismissed the most high-profile lawsuit against a DC plan sponsor — Intel Inc. — in a case that alleged fiduciaries violated ERISA by offering expensive, poor-performing alternative investments.

"The retirement space doesn't move quickly in anything, but both DOL's letter and the Intel case continue to provide an opportunity for some green shoots here in terms of giving participants the opportunity to invest in the types of products that, as DOL noted, defined benefit plans have been using forever," said Kevin L. Walsh, a Washington-based principal at Groom Law Group.

However, the Labor Department in a Dec. 21 supplemental statement did strike a more cautious tone than the June 2020 information letter on which it was based. The statement aimed to clarify the department's views on the use of private equity investments in DC plans and cautioned plan fiduciaries against the perception that private equity is generally appropriate as a component of a designated investment alternative in 401(k) plans. It comes after stakeholders criticized the original information letter as something that could be marketed as endorsing private equity investments in 401(k) plans.

The statement also expressed the department's view that plan-level fiduciaries of small plans typically will not have the expertise needed to evaluate the prudence of private equity investments in their plans.

"After considering reactions to the information letter by stakeholders, the department concluded it was important to release a statement cautioning fiduciaries, especially in small plans, against marketing efforts that may misrepresent the information letter as a U.S. Department of Labor endorsement or recommendation of these investments for 401(k) plans," said Ali Khawar, acting assistant secretary for the department's Employee Benefits Security Administration, in a news release.

The Labor Department issued the 2020 information letter in response to a Groom Law Group request on behalf of its clients Pantheon Ventures (U.S.) LP and Partners Group AG, which have developed private equity strategies that can accommodate DC plans. The letter made clear that DC sponsors can implement certain private equity strategies into diversified investment options, such as target-date, target-risk or balanced funds, while complying with ERISA.

It also outlined the steps a fiduciary must take when evaluating the risks and benefits associated with the investment alternative. In order to comply with ERISA, the Labor Department said a fiduciary should consider whether the allocation would offer plan participants the opportunity to invest their accounts among more diversified investment options within an appropriate range of expected returns net of fees; how the allocation fund is managed; and whether the allocation fund has limited the allocation of investments to private equity in a way that addresses potential cost, complexity, disclosures and liquidity issues.

A proponent of incorporating illiquids into DC plan lineups, Jonathan Epstein, Port Orange, Fla.-based president of the Defined Contribution Alternatives Association, said the Labor Department informational letter and statement align with his group's thinking. "Alts should be part of a diversified, long-term portfolio and professionally managed," he said. "We're not advocating for stand-alone private equity on DC fund menus, but rather as an allocation within a target-date fund or something similar."

Josh Cohen, Chicago-based head of DC client solutions at PGIM Inc., the investment management business of Prudential Financial Inc., said a DC plan is a "perfect place" for DC plan participants to access alternative investments. "You have fiduciary oversight, you have a long-term time horizon, (and) you have professionally managed solutions like TDFs and managed accounts that can help participants allocate to these," he said. "So we just think there's a strong case for a more institutional approach to help participants better meet their retirement income liabilities."

While private equity has long been a part of defined benefit plan investment portfolios, DC plan sponsors have historically steered clear of incorporating alternative assets in their plans due to litigation concerns and structural issues such as liquidity and valuation needs.

But Pantheon and Partners Group, the firms to which the Labor Department directed its information letter, say they solved for the structural issues with private equity investment products containing a liquidity component to be included as an allocation option within professionally managed defined contribution plans.

Pantheon established a collective investment trust in 2013 that's intended to be incorporated within a target-date fund. It currently has pension fund assets within it, but no DC plan clients, said Susan Long McAndrews, a San Francisco-based partner who leads Pantheon's global business development, though she declined to provide specifics.

Partners Group started its own CIT in 2015, which currently has no DC assets but does have two defined benefit plans — one public, one corporate — using the product, according to Robert Collins, partner, head of private wealth U.S. and head of Partners Group (USA) Inc.'s New York office, though he declined to provide specifics.

Inquiries around their respective CITs have picked up since the 2020 information letter, Ms. McAndrews and Mr. Collins said. And with the recent Intel decision, which Mr. Collins described as even more important than the Labor Department letter, those conversations could pick up.

The 2015 lawsuit against Intel alleged that plan managers violated their ERISA fiduciary obligations by offering too many alternative investments and inadequate disclosures of investments. The complaint focused on Intel's use of hedge funds and private equity funds, which, the plaintiffs said, subjected participants' retirement accounts to considerable risk for comparatively high fees and poor results.

Mr. Collins said the case has had a "chilling effect" on incorporating alternatives in DC plans.

But on Jan. 8, a U.S. District Court in San Jose, Calif., dismissed amended claims by participants in two Intel Inc. defined contribution plans. The dismissal came nearly a year after the judge's original dismissal of the lawsuit on Jan. 21, 2021, which allowed for an amended complaint. Among the arguments added in the amended complaint was that it was sufficient to compare the Intel plans' performance to similarly sized DC plans, but U.S. District Judge Lucy H. Koh in her Jan. 8 opinion wrote that "the argument that all plans with similarly sized contributions are meaningful benchmarks is again too conclusory to survive motion to dismiss."

Groom Law's Mr. Walsh said the decision shows that including alternatives in a DC plan doesn't necessarily mean a fiduciary process is imprudent. "Some plan sponsors are afraid that dabbling into new asset classes, whether it be private equity or others, that just being on the cutting edge of investment makes you imprudent because others aren't there," he said. "There's a sense that being a fiduciary means you're in the middle of the herd. And the District Court here is saying, 'If you've got a good process, you can lead the herd, while satisfying your obligations.'"

However, Will Hansen, Arlington, Va.-based executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association, isn't expecting DC plan sponsors to quickly add alternative options to their plans. "While yes, the outcome of that case was positive, I still think that the maybe thousands of lawsuits that have been brought over the last decade-plus still give plan sponsors hesitancy in doing anything that's seen as 'risky' to their investment lineup," he said.

Ms. McAndrews is more bullish and said incorporating alternatives in DC plans is the "right thing to do. And I think the DOL letter spells out how to do it properly and prudently. Millions of workers, savers and retirees could benefit from access to the potential benefits of the higher returns private equity can provide in their retirement plan."

With the Intel decision, Labor Department guidance and the maturation of pooled employer plans, which make it easier for employers in unrelated businesses to join a collective or pooled retirement plan for their workforces while offloading the bulk of their fiduciary responsibilities, Mr. Collins said 2022 will likely be a big year for alternatives in DC plans.

"This year we have a great deal of confidence in saying that you will see significant DC assets to come into private equity funds built for DC," he said. "We think this is going to be the year."