Considerations are prompted by DOL guidance
Workplace retirement funds represent about $7.9 trillion in potential capital. With fewer companies being traded on public stock exchanges, private equity (PE) funds offer new opportunities for returns and diversification.
A historical reluctance
Fiduciaries of defined contribution (DC) plans (e.g., 401(k) plans) that are subject to the U.S. Employee Retirement Income Security Act of 1974 (ERISA) have traditionally been wary of including PE and other alternative asset classes in plan lineups. Over the years, 401(k) plan sponsors and others have been subject to an endless parade of fee and other class-action litigation. The lawsuits’ intense focus on fees and expenses has been a key driver of these plans’ shift away from actively managed investment funds and toward index funds. It is little wonder, then, that PE’s perceived high cost, opacity and illiquid nature have been obstacles to greater adoption by DC plans.
The new guidance
Recently, the Department of Labor (DOL) provided guidance to fiduciaries on how they can consider PE for DC plans in a manner consistent with ERISA’s strict fiduciary duties. Though this guidance is not a safe harbor from legal liability, fiduciaries responsible for selecting DC plan investment options will likely view this new guidance as a useful framework.
The new DOL guidance is quite limited: It addresses only broadly diversified investment options, such as target date funds, which have relatively small allocations to PE. The diversified fund could itself make PE investments or it could gain PE exposure through a fund-of-funds structure. Regardless of whether the diversified fund invests in PE directly or indirectly, it must in fact consist of mostly liquid asset classes. The DOL suggests that the diversified fund could have up to 15% exposure to alternatives, such as PE.
Standalone PE funds on plan lineups, in which participants directly invest, are not covered by this guidance and continue to remain largely out of reach, not least because the vast majority of plan participants are not accredited investors.
Law firm Stradley Ronon Stevens & Young, LLP, offers some additional insights on the new DOL guidance. Specifically:
Private equity fund sponsors may wish to consider whether they would want to manage all or part of the diversified fund. This vehicle will likely hold “plan assets,” and, therefore, operate in accordance with ERISA (including the fiduciary duties and prohibited transaction rules), though this depends on how the fund is structured. Fund sponsors who have no interest in being subject to ERISA, and who have historically relied upon the venture capital operating company exception from “plan assets,” may instead opt to offer their products to a third-party manager, who would manage the diversified investment vehicle.
The guidance presents a potential opportunity for the asset management industry. However, the creation of PE offerings suitable for inclusion in 401(k) plans raises a number of issues that must be carefully considered.
Additional issues
In addition to the structural considerations and disclosure obligations noted above, there are numerous tax issues involved in designing a potential product tailored to the DOL guidance.
Outside of tax concerns, what’s the best approach to diversification? How do you discern the suitability of alternative investments? Determine the risk profile?
In addition, plan sponsors should assess key attributes of asset managers themselves, such as degree of monitoring, underlying business or industry of assets, experience and competence of the fund manager, compliance infrastructure and any outsourced functions.
The unique reporting procedures for PE funds have technology implications. Can the sponsor deliver and report all the required information in a timely manner?
While PE in 401(k)s offers possibilities for both investors and funds, careful thought must be given to the way offerings are developed.
Contacts:



Michael C. Patanella
National Managing Partner, Asset Management
Michael has been with Grant Thornton for over 14 years. He has been an audit partner for 9 years, and has served as the National Asset Management sector leader for approximately 4 years.
New York, New York
Industries
- Asset management
- Private equity
Service Experience
- Audit



Steven Winter
Partner, National Tax Sector Leader for Asset Management and Banking & Capital Markets
Steve Winter is a partner in the Tax Services practice. Based in our Manhattan office, he has more than fourteen years of public accounting experience, the majority of which has been devoted to serving the financial services industry.
New York, New York
Industries
- Asset management
- Private equity
Service Experience
- Tax
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