Fiduciary Considerations Following Proposed Regulations Allowing Private Equity in 401(k)s

by Alex Smith

The Department of Labor (DOL) recently issued proposed regulations intended to facilitate 401(k) participants’ access to alternative investments and provide a fiduciary safe harbor applicable to any type of investment option. The proposed regulations were issued in response to the President’s executive order last summer that directed the DOL and Securities and Exchange Commission (SEC) to facilitate 401(k) participants’ access to alternative investments, including private equity, cryptocurrency, real estate, commodities, and infrastructure financing.

The proposed regulations purport to provide plan fiduciaries with a safe harbor that presumes prudent action with respect to the selection of an investment alternative if they evaluate six non-exhaustive factors with respect to a potential designated investment alternative: (i) performance, (ii) fees, (iii) liquidity, (iv) valuation, (v) performance benchmarks, and (vi) complexity. However, the proposed regulations’ safe harbor may be illusory because it does not overrule relevant Supreme Court precedent. The Supreme Court has previously ruled that ERISA does not provide for a presumption of prudence in Fifth Third Bancorp v. Dudenhoeffer.

In addition, it is important for plan fiduciaries to be mindful that ERISA’s statutory fiduciary duties of loyalty and prudence associated with the selection and monitoring of 401(k) investment options still apply to the evaluation of whether private equity, cryptocurrency, real estate, or another alternative investment is an appropriate addition to a 401(k) plan’s investment menu the same way they apply to any investment option or potential investment option. The proposed regulations’ safe harbor does not address the obligation to monitor investment options following the initial selection. The Supreme Court, in Tibble v. Edison International, confirmed that plan fiduciaries have a continuing duty to monitor plan investments and remove imprudent ones.

Even if the DOL’s proposed regulation is finalized in its current form, and the SEC issues guidance resolving additional regulatory concerns with offering alternative investments as part of a 401(k) plans investment menu, plan fiduciaries and their investment advisors may still conclude that alternative investments are not an appropriate addition to the 401(k) plan’s investment menu given some of the inherent characteristics of alternative investments. The proposed regulations do not resolve some of the key ERISA fiduciary issues associated with alternative investments:

• The inherent lack of liquidity still presents an operational issue for 401(k) plans with respect to processing distributions even if legal concerns are addressed.
• The inherent valuation challenges still present an operational issue for 401(k) plans with respect to processing distributions, even if legal concerns are addressed.
• The inherent lack of transparency and complexity can make it challenging for plan fiduciaries to properly evaluate potential alternative investments.
• Even though plan fiduciaries have typically considered each of the factors listed in the proposed regulations’ safe harbor, additional documentation regarding the consideration of each of the factors will likely be necessary if the proposed regulations are finalized in their current form.
• Plaintiffs’ attorneys have already indicated they intend to hold plan fiduciaries accountable if plans offer alternative investments.
• Plaintiffs’ attorneys can argue that courts are free to disregard a regulatory safe harbor related to plan investments based on the Supreme Court’s decision in Loper Bright Enterprises Raimondo overruling the prior judicial deference to agency interpretations of ambiguous statutes.