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Regulatory update – June 2020 – guidance on private equity in participant directed DC plans and remote notarization

In this update we review the recent DOL information letter on private equity investments in participant-directed DC plans and temporary IRS relief from the “physical presence” requirement for spousal consent to distributions and loans.

DOL issues letter OK-ing private equity in DC plans, in certain circumstances

On June 3, 2020, the Department of Labor issued an information letter with respect to the inclusion of private equity investments in a “designated investment alternative” in a participant directed defined contribution plan (e.g., a 401(k) plan). Under DOL procedures, an “information letter” is “informational only and is not binding on the department with respect to any particular factual situation.” And a “designated investment alternative” is defined in the applicable regulations as “a specific investment identified by a plan fiduciary as an available investment alternative under the plan.”

Summary: DOL concluded that, as a general matter, “a plan fiduciary would not … violate [ERISA fiduciary rules] solely because the fiduciary offers a professionally managed asset allocation fund with a private equity component as a designated investment alternative for an ERISA covered individual account plan in the manner described in [the] letter.” 

DOL noted, however, that private equity investments “present additional considerations to participant-directed individual account plans that are different than those involved in defined benefit plans,” and there are special fiduciary considerations in the participant-directed DC plan context.

Proposed structure: The private equity investment considered by DOL would be a limited part (e.g., a specified percentage) of “a multi-asset class vehicle structured as a custom target date, target risk, or balanced fund.” The fund’s non-private equity investments would be publicly traded securities (or other liquid investments with readily ascertainable market values) and would be sufficient to provide adequate diversification of risk and liquidity for distributions and fund transfers. This sort of fund could be offered as a custom target date fund managed (1) by a plan investment committee advised by an independent ERISA section 3(21) investment adviser or (2) by an ERISA section 3(38) investment manager (as the committee’s delegate). Or it could be a prepackaged fund offered by a financial institution. A private equity investment would not be offered as a standalone investment under the plan.

Issues presented by private equity investments: DOL noted that “there are important differences between a fiduciary’s decision to include private equity investments in the portfolio of a professionally managed defined benefit plan, and the decision to include an asset allocation fund with a private equity component as part of the investment lineup for a participant-directed individual account plan.” Specifically, private equity investments “involve more complex organizational structures and investment strategies, longer time horizons, and more complex, and typically, higher fees.” They generally have “different regulatory disclosure requirements, oversight, and controls” and “often have no easily observed market value.”

Fiduciary judgment required: Fiduciaries of DC plans should generally consider these issues when deciding whether to offer this sort of fund. In that regard, DOL stated that the fiduciary should consider whether:

The fund would offer plan participants an opportunity to diversify investments “within an appropriate range of expected returns net of fees … and diversification of risks over a multi-year period.”

The fund is overseen/managed by fiduciaries or investment professionals with “the capabilities, experience, and stability” to manage this sort of investment.

The limitation on the fund’s private equity allocation is appropriate given the issues private equity investments present.

The fund’s characteristics “align with the plan’s characteristics and needs of plan participants.”

Finally, the prudence standards generally applicable to DC plan fiduciaries would continue to apply. The fiduciary must determine whether it has the skill/competence to evaluate the investment or should seek help from an outside expert. It should periodically review the continued prudence of the investment. And it “must also determine whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment regarding making or continuing an investment in the fund.”

DOL noted that the latter point – that the fund provide adequate information – is especially important (1) for participant directed/ERISA section 404(c) plans and (2) where the fund is to be used as the plan’s default fund (“qualified default investment alternative” (QDIA)). In both those cases, special disclosure rules apply.

Takeaway for plan sponsors: DOL’s guidance provides a useful summary of, and some useful guidance with respect to, the issues presented by the use of private equity in participant directed DC plans. We note that private equity investments are one of the targets in the Intel litigation. Sponsors considering such an option will want to review these issues with counsel.

IRS provides temporary relief from spousal consent “physical presence” requirement

Under applicable IRS regulations, participants may make elections electronically if certain conditions are met. Generally, those conditions are that (1) the individual has effective access to the relevant electronic system, (2) the system is designed to prevent a person other than the appropriate individual from making the election, (3) the system provides opportunity to review, confirm, modify, or rescind the election before it’s effective, and (4) the electing individual receives confirmation within a reasonable time.

Where a participant election, such as a spousal consent to a plan distribution or loan, must be witnessed by a plan representative or a notary public, “the signature of the individual making the participant election must be witnessed in the physical presence of a plan representative or a notary public.” (Emphasis added.)

A number of persons, including sponsors and providers, have asked for relief from this “physical presence” requirement in the context of the Coronavirus crisis, and Notice 2020-42 provides temporary relief, for 2020, both for “remote electronic notarizations” and for consents witnessed by plan representatives.

Remote electronic notarization: Notice 2020-42 provides that the physical presence requirement can be satisfied if the remote notarization is “executed via live audio-video technology that otherwise satisfies the requirements of participant elections under [applicable regulations] and is consistent with state law requirements that apply to the notary public.”

Witnessed by a plan representative: Notice 2020-42 provides that the physical presence requirement can be satisfied if the plan uses an electronic system using live audio-video technology and:

The signing individual presents a valid photo ID during the live audio-video conference. 

The live audio-video conference allows for direct interaction between the individual and the plan representative.

The individual transmits by fax or electronically “a legible copy of the signed document directly to the plan representative on the same date it was signed.” 

The plan representative acknowledges witnessing the signature and sends the signed document/acknowledgement back to the individual in accordance with applicable IRS electronic communications regulations.

These rules will be especially useful in states that do not permit remote notarization.

Application and duration of relief: This relief applies to all plan distributions and loans otherwise subject to the IRS physical presence witness requirement, for the period from January 1, 2020, through December 31, 2020.

Takeaway for plan sponsors: In the context of Coronavirus-related “social distancing,” this relief is welcome. If it is widely used, and effective, it may provide a basis for permanent relief from the physical presence requirement.

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We will continue to follow these issues.

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