United States: Pension Reform Bill Amends ERISA’s Plan Assets Regulation - Reform Will Make It Easier for Funds to Avoid Holding "Plan Assets"

Congress approved a major pension reform bill (the Pension Protection Act of 2006 - H.R. 4), which the President is expected to sign in the near future. Once signed by the President, the pension reform bill will amend many provisions of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), including the socalled "plan assets regulation" issued by the Department of Labor.

• Current Rule. Currently under one of the exceptions contained in the plan assets regulation, an entity is not deemed to hold the "plan assets" of a plan subject to ERISA if less than 25% of each class of equity interests in the entity (excluding for this purpose holdings of any manager or adviser to the entity and of any of their affiliates) is held by "benefit plan investors." For this purpose, "benefit plan investor" is defined to include not only ERISA plans and plans subject to Section 4975 of the Internal Revenue Code of 1986, as amended ("Code") – e.g., IRAs and Keogh plans – but also governmental, foreign, church and other employee benefit plans that are not subject to ERISA.
• Amended Definition of Benefit Plan Investor. The pension reform bill will retain the 25% test, but will revise the definition of "benefit plan investor" to include only plans that are subject to Title I of ERISA and/or subject to Section 4975 of the Code, as well as entities that are deemed to hold "plan assets" of any such plans. This will have the effect of excluding, for example, foreign plans, government plans and most church plans from the definition of benefit plan investor.

• New Look-Through Rule. The pension reform bill also provides a proportionate look-through rule for applying the 25% test to the investment by a plan assets entity in another entity. For example, if 40% of the interests in a fund of funds is held by ERISA investors, then when such fund of funds invests in another fund, 40% of the fund of funds’ investment in such other fund will count toward such other fund’s application of the 25% test. (By contrast, under current rules, the entire investment would have been counted towards the other fund’s application of the 25% test.) Alternatively, if only 20% of the interests in the fund of funds is held by ERISA investors (and, consequently, the fund of funds is not considered to hold plan assets), then 0% of its investment in the other fund will count toward such other fund’s application of the 25% test.

• Impact on Existing Funds. Since this provision will be effective immediately upon enactment, some investment funds that previously were required to comply with ERISA will no longer be subject to ERISA’s requirements, and other funds, (e.g., certain hedge funds or fund of funds), will now be able to admit more ERISA plans and more governmental and foreign plans without becoming subject to ERISA’s fiduciary duty and prohibited transaction rules. In addition, certain funds that currently intend to qualify as "venture capital operating companies" ("VCOCs") or "real estate operating companies" ("REOCs") may now choose to rely on the revised 25% test. Funds that intend to rely on the revised 25% "plan assets" test should carefully review their investor disclosures and their contractual obligations with investors to determine if amendments to either are required. Such funds should especially consider the potential impact on their government plan investors since many such investors are subject to ERISA-like laws and may have imposed contractual undertakings to comply with ERISA as if such investors were ERISA plans. Since the 25% test is an ongoing test, open-end funds or funds that may have subsequent admissions or redemptions should carefully consider whether they will be able to continuously satisfy the 25% threshold before relying on the revised 25% test.

• Additional Relief for Plan Assets Funds. In addition to amending the plan assets regulation, the pension reform bill makes certain other amendments to ERISA that may benefit funds that are subject to ERISA. For example, there is a new statutory exemption for transactions with service providers. This new statutory exemption will in most situations eliminate the need for use of the so-called QPAM Exemption (PTE 84-14) for many transactions, such as swaps and other derivatives, financings and many other types of transactions. In addition, the bill adds a new statutory exemption that will permit cross-trades between a manager’s accounts if certain conditions are satisfied.

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