Defined contribution plan sponsors can include certain private equity strategies into diversified investment options, such as target date, target risk or balanced funds, while complying with ERISA, the Department of Labor said Wednesday.
The guidance comes by way of an information letter in response to a Groom Law Group request on behalf of its clients Pantheon Ventures and Partners Group, who have developed private equity strategies that can accommodate DC plans.
While private equity investments have long been incorporated in defined benefit plans, defined contribution plan sponsors have mainly steered clear of incorporating alternative assets in their plans due to litigation concerns.
In recent years, plan sponsors have been hit with class-action lawsuits centering on excessive fees. Notably, a lawsuit against Intel Corp. reached the Supreme Court, whose ruling in February gave DC plan participants more time to file ERISA claims unless they have “actual knowledge” of the sponsor’s investment decisions and actions. The 2015 lawsuit alleged that plan managers violated their ERISA fiduciary obligations by offering too many alternative investments and inadequate disclosures of investments.
In its letter Wednesday, the Labor Department said when evaluating whether to include a particular investment vehicle with an allocation of private equity as a designated investment alternative, a plan must evaluate the risks and benefits associated with the investment alternative.
To do so, the 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.
The guidance will help quell some sponsors’ litigation fears, said David Levine, principal at Groom Law Group. “It highlights that with a good, prudent process you can add these investments,” he said. “Too often ... people are afraid to innovate and this helps support innovation.”
The Labor Department letter did not authorize making private equity investments available for direct investment on a standalone basis. Kevin Walsh, a fellow principal at Groom Law Group, said standalone investments are a different question and may be tackled in the future. “I don’t view this as them saying, ‘No way, no how,’” he said. “I read it more as, ‘That’s a different kettle of fish.’”
Robert Collins, managing director and head of Partners Group’s New York office, said in a statement that the Labor Department has taken “a major step toward modernizing defined contribution plans and providing participants with a more secure retirement. At a time when working families are struggling to save, this guidance gives fiduciaries the certainty they need to finally provide main street Americans access to the same types of high-performing, diversifying investments as wealthy and large institutional investors, all within the safety of their 401(k) plans.”
The information letter will help Americans saving for retirement gain access to alternative investments that often provide strong returns, Labor Secretary Eugene Scalia said in a news release. “The letter helps level the playing field for ordinary investors and is another step by the department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”
A group from the Defined Contribution Alternatives Association met with Labor Department officials in February to discuss what fiduciaries should consider if they intended to include private markets in their plans. In a proceeding letter to Preston Rutledge, former assistant secretary of labor for the Employee Benefits Security Administration, who took part in the meeting, in early March, DCALTA outlined issues such as fees, valuation and liquidity as things for fiduciaries to examine.
On Wednesday, Jonathan Epstein, president of the DCALTA, said in an email that retirement savers should be excited about the Labor Department guidance. “The DOL is helping plan fiduciaries give participants access to investment products that had previously been limited to institutional investors,” he said. “DCALTA was created five years ago to help drive this initiative and we are proud to have Pantheon as a founding member of DCALTA.”
Pantheon, in a statement, said it believes that private equity strategies have the potential to address the performance delta between defined benefit and defined contribution plans and merit consideration as a viable investment.
“In our view, retirees really can’t afford to leave 40 basis points annually on the table over a 35-year investment horizon,” said Susan Long McAndrews, partner and member of Pantheon’s partnership board, in a statement. “We believe the department’s action today is an important step to address this and we look forward to working with plan sponsors to offer millions of ordinary working Americans the potential for a more secure retirement.”
