Department of Labor Opens Door to Private Equity Investment in 401(K) Plans

This week the US Department of Labor released an information letter that opens the door for employee defined-contribution retirement plans to include private equity investments.

The letter said fiduciaries of 401(K) or other similar retirement plans would not violate their duties under federal retirement laws solely by offering a managed asset fund with a private equity component as a designated alternative for individual retirement account plans.

But the letter cautioned that private equity investments do present additional considerations for participant-directed individual account plans. In making such a private equity selection for an individual account plan, the information letter said that the fiduciary must engage in “an objective, thorough, and analytical process that compares the asset allocation fund with appropriate alternative funds that do not include a private equity component, anticipated opportunities for investment diversification and enhanced investment returns, as well as the complexities associated with the private equity component.”

The letter, signed by Louis J. Campagna, chief of the Division of Fiduciary Interpretations of the DOL’s Office of Regulations and Interpretations, also cautioned, “as compared to typical public market investments available in individual account plans, private equity investments tend to involve more complex organizational structures and investment strategies, longer time horizons, and more complex, and typically, higher fees.”

Compared to public market investments, private equity investments are subject to different regulatory disclosure requirements, oversight, and controls, the letter also said. “In addition, valuation of private equity investments is more complex because private equity investments often have no easily observed market value, and there is often an element of judgment involved in valuing each of the portfolio companies prior to their sale by the investment fund or other liquidity event” such as a public offering.

The letter also said that a plan fiduciary must consider whether he or she has the skills, knowledge, and experience to make the required determinations or whether the plan fiduciary needs to seek assistance from a qualified investment adviser or other investment professional. The fiduciary also must periodically review whether the investment vehicle continues to be prudent and in the best interests of plan participants, taking into account the considerations outlined above and any other factors that the plan fiduciary deems appropriate in light of its fiduciary duties under ERISA.”

A fiduciary “must also determine whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment regarding making or continuing an investment in the fund. This factor would be especially important in the case of a plan or responsible plan fiduciary claiming limited fiduciary liability, the letter also read.

The DOL issued the letter in response to requests from Pantheon Ventures (US) L.P. and Partners Group, which have developed private equity investments designed to be used as a component of a managed asset allocation fund in an individual account plan.

The Partners Group, a global private markets investment manager, said the guidance clears “an important hurdle” and clarifies that pension plan fiduciaries can incorporate private equity components into diversified investment options.