Compliance December 22, 2021

DOL Cautions Small Plan Fiduciaries Against Diving Into Private Equity Investments

The agency issued a supplemental statement in response to stakeholder concerns that private equity investments could be inappropriate for small DC plans.

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The Department of Labor (DOL) has issued a statement cautioning plan fiduciaries against the perception that private equity (PE) is generally appropriate as a component of a designated investment alternative in a typical defined contribution (DC) plan, in response to stakeholder concerns.

The DOL said plan-level fiduciaries of small plans will typically not have the expertise necessary for the complex evaluation needed to determine the prudence of private equity investments in designated investment options in participant-directed plans.  

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The DOL’s Employee Benefits Security Administration (EBSA) issued its most recent statement as a response to stakeholders’ concerns that its 2020 information letter could be misapplied as broadly endorsing the benefits of private equity investments and downplaying the risks. Additionally, EBSA officials stressed provisions in the letter regarding the fiduciary expertise needed to evaluate and monitor private equity investment options included in DC plans.

The DOL concluded that the regulator should supplement the information letter to “ensure that plan fiduciaries do not expose plan participants and beneficiaries to unwarranted risks by misreading the letter.” The regulator clarified that private equity investments, outside of limited use cases, are not generally appropriate for a typical 401(k) plan.   

“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,” says Ali Khawar, acting assistant secretary for EBSA. “The supplemental statement emphasizes the limited focus of the information letter as a response to large plan sponsors who offer both defined benefit [DB] plans and participant-directed retirement savings plans, and who invest in private equity for their defined benefit plans but do not do so for the participant-directed plans.”

Many DB plans have unwound plan investment exposures to public equities and diverted some risk investments into private equity, real estate and hedge funds for alternative assets exposure. Alternative investments can offer diversification away from volatile equities and may offer superior risk-adjusted returns to public market counterparts.

“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,” the DOL says in its supplemental statement. “The department further notes that ERISA [Employee Retirement Income Security Act] Section 404(c) does not relieve a plan fiduciary of the prudence duties that apply to the selection and monitoring of designated investment alternatives, investment managers and investment advice service providers.”

A study published last year by Neuberger Berman research partner the Defined Contribution Alternatives Association (DCALTA), completed with the Institute for Private Capital (IPC), suggests that adding private equity funds in DC plan portfolios improves performance and has diversification benefits that reduce overall portfolio risk.  

The June 2020 information letter addressed concerns with offering private equity investments in DC plans, and detailed considerations for plan fiduciaries in evaluating and monitoring the investments.

The DOL’s new statement can be read in full here.
Compliance December 22, 2021

Plaintiffs Refile ERISA Complaint Against Prudential

The original lawsuit was dismissed in September, but the plaintiffs were given time to file an amended complaint, which they have now done.

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The plaintiffs in an Employee Retirement Income Security Act (ERISA) lawsuit filed against Prudential—which was subsequently dismissed—have submitted a second amended complaint to the U.S. District Court for the District of New Jersey.

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The original lawsuit was dismissed in September, with the court’s dismissal order responding to an amended complaint filed by the plaintiffs. The September ruling was filed “without prejudice,” meaning the plaintiffs were given time to file yet another amended complaint.

In response to the second amended complaint, the Prudential defendants have already filed a motion to dismiss, arguing that the deficiencies in the previously rejected version of the complaint have not been corrected. They argue the court should once again find that the plaintiffs fail to allege sufficient facts or provide the substantial circumstantial evidence necessary for the court to reasonably infer that the Prudential defendants breached their duty of prudence. For context, the court’s prior dismissal states that fund fee and performance comparisons are insufficient to plausibly allege that the Prudential defendants’ selection and retention of certain challenged funds was imprudent.

The new amended complaint seeks to provide more detail about 14 different investment options allegedly offered in the plan and which the plaintiffs say should have been removed for excessive fees or poor performance. The plaintiffs point to meeting minutes supplied by Prudential in an attempt to demonstrate the offering of these funds was the result of an imprudent process.

“In addition to the fact that the funds provided a substantial additional revenue stream for Prudential, many of the Prudential-affiliated funds were unnecessarily expensive, consistently and considerably underperformed compared to their respective benchmarks, or both,” the complaint states. “By choosing the financial interests of Prudential over plan participants, the defendants caused participants to incur unnecessary costs and lose the opportunity to invest in more appropriate available funds.”

The plaintiffs argue prudent fiduciaries would have investigated alternative available investments in order to maximize the plan’s retirement assets in the interest of the participants. Instead, they claim the defendants “simply offered Prudential products because they were familiar options that provided additional benefits to Prudential and its affiliates.”

“This type of self-dealing and objective imprudence violates ERISA,” the complaint states.

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