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Dept. of Labor throws its 2020 self under the bus and walks back Trump-era guidance that appeared to open the door to private equity investments in 401(k) plans

A Trump administration 'information letter' affirmed that PE investments could be an 'enhanced' investment option for participants in defined contribution plans under ERISA.

Thursday, December 23, 2021 – 3:25 AM by Brooke Southall
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Ali Khawar: The department concluded it was important to release a statement cautioning fiduciaries.

The U.S. Department of Labor (DOL) 'clarified' a 2020 Trump DOL "information letter" that had the fingerprints of private equity lobbyists all over it in a bid to capture a larger share of defined-contribution retirement plan assets. 

The move followed complaints that the initial letter, request by Pantheon Ventures (US) L.P. and Partners Group (USA), Inc., green lighted a private equity component in individual account plans, such as 401(k) plans, under certain circumstances.  

“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,” wrote Acting Assistant Secretary for Employee Benefits Security Ali Khawar in the statement.

The DOL's reference to "marketing efforts” likely refers to Groom Law, which successfully advocated for private equity investments on behalf of Pantheon Ventures, according to an ERISA lawyer who asked not to be named. 

ERISA is an acronym for Employee Retirement Income Security Act of 1974, which sets minimum standards for most voluntarily established, private-industry retirement and health plans and provides consumer protections. 

Untapped market

The 2020 letter was a significant coup by the PE industry. It opened a wide swath of 401(k) plans with an estimated $7.3 trillion in assets (as of June 2021) to private equity investments. 

About 600,000 401(k) plans have about 60 million active participants and millions of former employees and retirees, according to the Investment Company Institute (ICI), which represents regulated funds globally, including mutual funds, exchange-traded funds and others.  

Most of those plans are small to medium size, which traditionally have been off limits to the private equity industry. 

Participants in their 40s with more than two- to five-years of tenure have an average 401(k) plan account balance of $36,000, compared with an average 401(k) plan account balance of more than $306,000 among participants in their 60s with more than 30 years of tenure, according to the latest ICI data.  

Participants on average had 63% of their 401(k) plan balances invested directly or indirectly in equity securities.  Bond funds accounted for 8% of plan investments, money market funds 2% and other fixed income investments made up the rest.  

The upshot of the Trump era letter affirmed that PE investments as a component of a professionally managed multi-asset class vehicle structured as a target date, target risk or balanced fund can be offered as an investment option for participants in defined contribution plans under ERISA, according to the American Society of Pension Professionals & Actuaries. 

 But the new DOL "supplemental statement" contritely lays out how the department's 2020 letter parroted private equity lobbyists without balancing it with cautionary arguments about how such illiquid, high-risk investments might be unsuitable for average investors. 

The department’s Employee Benefits Security Administration, which released the new missive yesterday (Dec. 21),  did not engage in the uncharacteristic contrition without external pressures by "stakeholders," it acknowledged.

One sided

The DOL's make-good is written in bureaucratic terms yet it is mostly unequivocal in admitting its earlier communication lacked even-handedness. 

"The Department agrees with some stakeholders that the recitation in the Information Letter of representations by the requester regarding the claimed benefits of PE investments reflected the perspective of the PE industry," it reads.

"The representations were not balanced with counter-arguments and research data from independent sources," it continued. 

"For example, some stakeholders expressed concern about representations that designated investment alternatives with a PE component 'offer plan participants who have longer investment horizons an equities-based investment choice that may enhance retirement outcomes when compared to investment choices containing only publicly traded securities.'

"The stakeholders challenged this assertion and warned that performance calculations must be carefully analyzed because they are not standardized or regulated like disclosures from registered investment companies (mutual funds)."

Those "stakeholders" may well include fiduciary groups, yet mutual fund and ETF makers, likely the louder voices, may also have been discomfited by private equity getting a freer pass on scrutiny, a source says.

An SEC “Risk Alert” that followed Information Letter's release in June 2020 highlighted compliance issues in examinations of RIAs that manage PE funds or hedge funds, the agency noted.  

Caveats added

The stakeholders also apparently believed that DOL was not explicit enough in noting that potential downsides of private equity make it a more fraught  investment in the hands of a neophyte consumer. according to yesterday's letter.

"For example, the Information Letter [of 2020] pointed out that the responsible fiduciary should be able to determine, either alone or with the assistance of a qualified adviser, whether the particular investment arrangement complies with applicable requirements under securities, banking, or other relevant laws and regulations," it writes.

"Stakeholder concerns about the ability of the sponsoring employer and other plan-level fiduciaries in a typical 401(k)-type plan to fulfill these obligations led the department to conclude that it should emphasize those parts of the letter."

The DOL added caveats about the importance of financial advisor involvement at the plan level -- namely overseeing PE investments en masse on behalf of participants.

"A plan-level fiduciary that has experience evaluating PE investments in a defined-benefit pension plan to diversify investment risk may be suited to analyze these investments for a participant-directed individual account plan, particularly with the assistance of a qualified fiduciary investment adviser," it states. 

"The Department cautions against application of the Information Letter outside of that context.

"Except in this minority of situations, plan-level fiduciaries of small, individual account plans are not likely suited to evaluate the use of PE investments in designated investment alternatives in individual account plans," it states. 

The advocacy for "plan-level" philosophy of pension oversight by DOL is a reversion to the bureaucracy's bedrock principles -- erring on the side of vanilla returns over the more volatile possibilities of applying rugged individualism to managing nest eggs, says the ERISA attorney.

"It's an example of the pendulum swinging back to the paternalistic DOL." See: Bottom line after DOL bakes change into ERISA is it relented enough that plan sponsors can likely make ESG funds part of default option


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