Avoiding Or Embracing Benefit Plan Investors - That Is The Question.


For decades, private funds have had to decide whether to accept "significant" investment by benefit plan investors (i.e., ERISA plans and IRAs) under the so-called plan asset regulation under ERISA. The new ERISA and Internal Revenue Code fiduciary definition scheduled to go into effect later this year may cause fund managers to ponder whether to permit any benefit plan investment at all, even if insignificant enough to avoid fiduciary responsibility in managing the fund's assets.

Plan Asset Regulation

If an ERISA pension plan or IRA invests in a fund or other entity, it will be deemed to own not just the equity interest itself but a proportionate share of any assets owned by the entity, unless an exception to the ERISA "look-through" rule applies. The exceptions most utilized by private funds are the "25% test" or operation as either a venture capital operating company ("VCOC") or a real estate operating company ("REOC"). Other exceptions for investment in operating companies, debt instruments with no substantial equity features, publicly offered securities and registered mutual funds - are not typically available to private funds.

If a fund does not qualify as a VCOC or a REOC, it will be a plan asset entity unless benefit plan investors own less than 25% of each class of its equity, measured at each redemption, sale or purchase of any equity interest and disregarding the equity owned by any person (or its affiliate) with discretionary authority over the fund's assets or that provides investment advice to the fund for a fee. However, class is not defined by the plan assets regulation, and experts differ as to whether local law (where the fund is domiciled) or definitions under U.S. securities law should apply to determine when variations in legal or economic rights attached to investors' interests create separate classes.

ERISA Fiduciary Standards

If the look-through rule applies to a fund, the assets of the fund have to be managed in accordance with ERISA. The manager not only must act for the exclusive benefit of the participants of the plan investors, avoiding any form of self-dealing that is not covered by a specific statutory, class or individual exemption, but also must perform to the standard of a "prudent expert." While simple disclosure of potential and actual conflicts may be cleansing under other laws, disclosure is generally insufficient to prevent an ERISA violation by a fiduciary who acts in his own self-interest in managing plan assets....

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