United States: 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. Even generally accepted compensation arrangements that could potentially affect the manager's judgment to the detriment of the interests of the plan investors may have to be identified and adjusted.

Prohibited Transactions and QPAM Exemption

As a fiduciary, a fund manager would also have to avoid otherwise benign transactions between the fund and any party-in-interest to a plan investor, which would include the plan sponsor, fiduciaries to the plan, other service providers to the plan and various affiliates of each. Such "prohibited transactions" carry not only significant excise tax penalties for the party-in-interest, but also potential personal liability for the fiduciary for any losses that result from the original transaction or its unwinding (that may be required to prevent the excise tax from growing from an initial 15% to 100%). If the fund manager is a qualified professional asset manager ("QPAM"), however, transactions between the fund and a party-in-interest to a plan investor would generally be exempt provided neither the party-in-interest nor one of its affiliates had the power to appoint the manager. Although not a perfect solution, the QPAM exemption can solve a multitude of potential problems for the manager of a plan asset fund.

Fee Disclosure

A manager of a plan asset fund, as a party-in-interest to the fund, would be prohibited from receiving any compensation from the fund for its services absent an available exemption. Regulations under Section 408(b)(2) of ERISA (which provides a statutory exemption for reasonable arrangements between a plan and a service provider to the plan) require disclosure of all direct and indirect compensation received in connection with such services and additional information relating to transaction charges and operating and other expenses in the case of fiduciary services to a plan asset entity.

Impact of the New Fiduciary Definition

Although the new fiduciary definition was primarily aimed at brokers and investment advisers in the retail market, it will affect how private funds are marketed to benefit plan investors. Unless the Trump administration rescinds or materially modifies the regulation, the revised definition will expand fiduciary advice to include recommendations regarding the purchase and sale of investments, in addition to the actual management of investments. Accordingly, marketing fund interests to potential benefit plan investors could put the fund manager or its sales personnel in the position of giving fiduciary advice under ERISA, even if managing the assets of the fund had no fiduciary implications under ERISA because the fund is not a plan asset vehicle (either by virtue of keeping benefit plan investors under the 25% limit or by operating as a VCOC or a REOC).

Hire-Me Exception

Although the Department of Labor has indicated that it did not intend an investment manager to become a fiduciary merely by engaging in the normal activity of marketing itself or an affiliate as a potential fiduciary, the application of the so-called hire-me exception is unclear. Many ERISA lawyers who work extensively in the private fund space believe investing in a private fund is tantamount to hiring an investment manager and are comfortable that the hire-me exception should apply; others look at the differences in the legal rights and restrictions on a fund subscriber as compared with simply hiring an investment adviser to manage a separate account and are not so sure.

Independent Fiduciary Exception

Investment recommendations made to an independent fiduciary of an ERISA plan or IRA investor in an arm's-length transaction are not fiduciary advice under the new definition, provided the independent fiduciary is financially sophisticated. To satisfy this exception, the investment manager (i) must know or reasonably believe that the independent fiduciary (a) is a U.S. bank or insurance company, a U.S. registered investment adviser or broker-dealer, or a fiduciary that holds, manages, or controls at least $50 million of assets, (b) is capable of independently evaluating investment risks and (c) is the ERISA or Internal Revenue Code fiduciary responsible for exercising independent judgment with respect to the transaction; (ii) must inform the independent fiduciary that it is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity with respect to, and discloses to the independent fiduciary the existence and nature of its financial interests in, the transaction; and (iii) must not receive a fee or other compensation directly from the benefit plan investor or independent fiduciary for the provision of investment advice (as opposed to a fee for other services) in connection with the transaction. These requirements can be satisfied by representations and covenants in the investment management agreement, subscription agreement, side letter or comparable documentation executed by the benefit plan investor in connection with the transaction.

It is important to note that this exception does not cover advice to fiduciaries of small plans, individual plan participants or IRA owners, however much money they have to invest. Consequently, high-wealth individuals with ERISA or IRA assets cannot be independent fiduciaries under this exception, and fund marketing efforts would have to fit within the more uncertain hire-me exception, or be limited to general communications that a reasonable person would not consider an investment recommendation, to avoid fiduciary responsibility for their becoming fund investors. "Friends and family" may be a category of potential investors particularly difficult to fit within an exception under the new definition.

Future of the New Fiduciary Definition

The Trump administration has already moved to place a moratorium on finalizing new regulations it has not had the opportunity to approve. The memorandum released Jan. 20 contemplates a 60-day delay from that date, which would not affect the timing of the new fiduciary definition, which isn't scheduled to go into effect until April 10, 2017. The Jan. 20 memorandum also encourages department heads to propose further delays for notice and comment, as appropriate. A permanent repeal or major rewrite would require a new round of proposed regulations with an extended comment period, unless Congress intervenes with a statutory fix. Given the long list of promised actions President Donald Trump and House Republicans have on their respective plates, both the near- and long-term future of the new fiduciary definition is unclear. The plan asset regulation, however, does not appear to be on anyone's agenda for a major overhaul, so repeal of the new fiduciary definition would still leave the dilemma of becoming, or not becoming, an ERISA fiduciary to a fund with substantial benefit plan investors.

Funds Talk: February 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions