PLANSPONSOR - October-November 2022 - 38

FIDUCIARY FORUM
DB Plan Investments
Fiduciaries may look to alternative financial assets vs. mutual funds
M
ost of our columns focus on plan committees and
their responsibilities with respect to defined contribution
plans. We have also spent time reminding
our readers that Employee Retirement Income Security Act
fiduciary responsibilities additionally apply to welfare plans.
Now it's our time to talk about defined benefit pension plans.
(Yes, there are still DB plans out there!) Because of the plan
sponsor's funding obligations for a DB plan, people often don't
focus on the ERISA fiduciary obligations. But those are still relevant
and something to keep in mind.
The goals and timelines when selecting investments for a
DB plan differ from those involved when the committee selects
the options for a DC plan. For example, DB plan fiduciaries
may be able to trade some liquidity for the possibility of higher
returns. Given such differences, in addition to or in lieu of
typical mutual fund investments, investment fiduciaries for a
pension plan may look to alternative vehicles, such as investment
partnerships-e.g., private equity funds, hedge funds
and real estate investment trusts. We will refer to them simply
as investment funds. Pension plan investing in investment
funds is common but does bring into play issues that differ
from those found with the typical 401(k) mutual fund offering.
As a starting point, it's key to understand how the investment
fund is structured and whether it holds plan assets. As
a general rule, when any ERISA plan invests in an investment
fund, the underlying assets of the fund are considered plan
assets subject to ERISA fiduciary and prohibited transaction
rules. Because this can create complications and may limit how
the fund may invest, many investment funds are designed to
take advantage of an exception to the general rule. An investment
fund may be excepted from holding plan assets if benefit
plan investor participation is not significant or if the fund is
structured as an operating company-i.e., a venture capital
operating company or a real estate operating company.
While a full discussion of these exceptions is beyond
the scope of this article, it's for plan fiduciaries to determine
whether an investment fund being considered will be able to
avoid holding plan assets. It may often be appropriate to require
an opinion letter confirming that such an exception will apply.
If an investment fund does not hold plan assets, then the decision
to invest in it is a fiduciary decision that should be made in
accordance with the prudent fiduciary rules, but the underlying
38 PLANSPONSOR.COM October - November 2022 Art by Joseph Ciardiello
investments and actions of the investment fund are not subject
to ERISA.
When considering investing in an investment fund, sponsors
need to review the fund documents that spell out the relevant
terms-e.g.,
distribution waterfall, management
fees,
confidentiality obligations and representations, etc. Depending
on how much the plan is investing and the size of the investment
fund, there may be opportunities to negotiate changes to
the fund documents and/or to enter into side letters addressing
specific terms that will benefit the plan.
In connection with Department of Labor investigations, we
have seen that entity ask a laundry list of questions relating to
alternative investments-a recent investigation involved over 25
questions focused on materials specific to investment funds.
Committees deciding to make such an investment should
consider as applicable-and, when possible, retain-documents
regarding the following:
* Meeting minutes concerning the investment decision
(see prior columns we've written about the importance of
committee minutes);
* Investment fund formation materials-e.g., any limited
partnership agreement, limited liability agreement, private
placement memorandum, subscription agreement, etc.;
* Fund valuation information;
* Opinions regarding the investment;
* Descriptions of the investment fund distributions; and
* 408(b)(2) disclosures, if applicable.
Keep in mind that investment funds are often for a defined
term, meaning once the plan invests in the fund, it is generally
" stuck " in it until the term expires and the fund is liquidated.
Therefore, plan fiduciaries need to balance holding liquid assets,
which can be used to pay ongoing benefits, with longer-term
investments designed to provide a greater return.
Investment funds may be an appropriate investment type for
pension plans, but it is important that plan fiduciaries consider,
understand and document their decision.
Summer Conley is a partner in the Los Angeles office of
Faegre Drinker Biddle & Reath LLP. Michael Rosenbaum is
a partner in the firm's Chicago office.
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