Should You Include Private Equity in Your 401(k) Plan?

Seyfarth Synopsis: On June 3, 2020, the DOL issued an Information Letter regarding whether a 401(k) plan fiduciary could offer an investment option that included a private equity component in the investment menu of an individual account plan such as a 401(k) plan. 

The Information Letter responds to an inquiry submitted on behalf of professional asset managers.  Their inquiry focused on the use of private equity investments within professionally-managed asset allocation funds (e.g., target date, target risk or balanced funds).  The submission stated that plan participants and beneficiaries may benefit from such an investment option by “diversifying investment risk and enhancing investment returns.”  The DOL is clear that the Information Letter is not addressing a stand-alone private equity investment fund.

The Information Letter focuses on how a plan fiduciary might evaluate such an investment option and emphasizes that whether an investment option is prudent is a factual question that turns on “objective, thorough and analytical processes.”  This should come as no surprise because ERISA fiduciary obligations are process-based. 

The DOL noted some challenges that fiduciaries could face in determining whether such an investment option is appropriate, including that private equity investments generally are complex, illiquid, have higher fees and are not easily valued.  The Information Letter observed that “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 (e.g., initial public offering).”  Note that difficulties in valuation could affect an individual account plan in a number of different ways, including Form 5500 reporting, participant account statements and valuation when a participant withdraws from the investment.

The Information Letter provides a road map for plan fiduciaries when considering these options.  Specifically, items plan fiduciaries should consider include whether such an investment option:  (i) would offer an opportunity for more diversification with appropriate net returns, (ii) is managed by professionals with the appropriate expertise, (iii) is structured to respond to the normal demands of defined contribution plans (e.g., does it provide enough liquidity and how is it valued?), and (iv) makes sense for the specific plan participant population.  The letter also notes that the plan fiduciaries must consider whether they are capable of performing the necessary analysis of the proposed investment option or whether they need assistance.  Another concern for fiduciaries noted in the Information Letter is whether participants will be provided with adequate information about the investment alternative so they can make an informed decision.

Although an information letter merely calls attention to established ERISA principles and does not bind the DOL with respect to specific factual situations, this Information Letter provides welcome guidance for fiduciaries of an individual account plan concerning an investment option with a private equity component.  The guidance, however, does not insulate plan fiduciaries who include such an option in their plan’s investment menu.  Fiduciaries still may have liability under ERISA and could face claims for breach of fiduciary duty.  See Intel Corp. Inv. Policy Comm. v. Sulyva, 140 S. Ct. 768 (2020) (plaintiff alleges plan fiduciaries breached their duties by offering investment options that over-invested in alternative assets such as private equity).  If you are interested in an investment option that includes private equity investments, be sure to contact your Seyfarth Shaw employee benefits attorney.