proskauer benefits brief podcast

In this episode of The Proskauer Benefits Brief, partner Ira Bogner and senior counsel Adam Scoll discuss the key considerations for ERISA investors in private investment funds, as well as a plan fiduciary’s overarching fiduciary duties and responsibilities that are related thereto. One of the first key considerations is to determine the plan asset status of the private investment fund. Tune in and listen as we break down the material ERISA issues for ERISA investors to consider when investing in private investment funds.


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Adam Scoll: Hello, and welcome to the Proskauer Benefits Brief, Legal Insights on Employee Benefits and Executive Compensation.  I’m Adam Scoll, senior counsel in the firm’s Boston office, and I’m here with Ira Bogner, partner in our New York office, and today we will be discussing key considerations for ERISA investors in private investment funds.

Ira, why don’t we start from the top? If you are an ERISA fiduciary acting on behalf of an ERISA covered pension plan, and considering investing assets of the plan in a private investment fund, what are some of your general overarching duties and responsibilities under ERISA?

Ira Bogner: Of course, Adam. In considering an investment in a private investment fund, really like any other investment, plan fiduciaries should consider their basic fiduciary duties under Section 404 of ERISA, which require them to discharge their investment duties prudently, solely in the interest of the plan participants and beneficiaries, and for the exclusive purpose of providing benefits to the plan participants and beneficiaries, and also defraying reasonable administrative expenses of the relevant plan.

ERISA also generally requires a plan fiduciary to diversify the investments of the plan so as to minimize the risk of large losses; the plan’s investments must comply with the plan’s governing documents, to the extent those documents are consistent with ERISA; and lastly, the plan fiduciary is required to invest the plan’s assets in a manner that does not result in the plan or the plan fiduciary engaging in a non-exempt prohibited transaction.

Adam Scoll: In regards to that exclusive purpose requirement you noted, this should be met if the fiduciary avoids basing its investment decisions on criteria other than obtaining the best investment return to the plan. And the prudence requirement you noted should be satisfied if investment decisions are made by experienced investment professionals, and if such professionals make prudent investment decisions pursuant to pre-established procedures, taking into account the general risk level of the investments they are making.

Okay. So that leads us into what we view as the key considerations for ERISA investors in private investment funds.  Because to a degree reviewing the terms of the fund documents is a critical aspect to a fiduciary’s satisfaction of its fiduciary duties with respect to such investment.  It has to do its homework.

And the terms of the fund documents may dictate whether an investment in the fund is an appropriate one for a particular ERISA investor, or whether it is flat out prohibited, or maybe just likely to result in a potential issue, such as a non-exempt prohibited transaction.

Similarly, if the ERISA related terms of the fund documents are completely off market in a negative way, then that might make it more difficult for a plan fiduciary to make the case that investing in such a fund is prudent. Ira, why don’t you start us off as to the key considerations under ERISA? 

Ira Bogner: Sure.  First and foremost, in my view, is to determine the plan asset status of the private investment fund.  A fund that is considered to hold plan assets basically needs to be run and operated as if it itself was a retirement plan.  So we’re looking at whether the fund documents provide that the fund is going to be operated so as to avoid holding plan assets, or will it be operated as a plan asset fund subject to ERISA.

The answer to that question is critical as there are a totally different set of considerations for an ERISA investor if the fund is going to be operated as a plan asset fund subject to ERISA.  The likelihood of an ERISA related issue or prohibited transaction arising is significantly increased with respect to an investment in a plan asset fund subject to ERISA.

That doesn’t mean it should be avoided or it wouldn’t be prudent to invest in a plan asset fund, it just means that the homework that needs to be done may be more involved in a different and more significant way. 

Adam Scoll: Totally agree. For today’s podcast let’s assume the fund is structured in a manner that is intended to avoid being subject to ERISA.  Key considerations for investing in a plan asset fund can be the topic of our next podcast.

Ira Bogner: Okay. Then the question becomes how do the fund documents state such intention to avoid plan asset status?  ERISA investors typically like to see a covenant from the fund manager to use some level of efforts, like reasonable best efforts, to prevent the fund from holding plan assets. 

Adam Scoll: Agreed. And this is all an issue because of a Department of Labor regulation referred to as the Plan Assets Regulation.  The general rule under the Plan Assets Regulation is as follows:

If an ERISA plan invests in an entity, such as a private investment fund, the plan’s assets include its investment, but do not include any of the underlying assets of the entity. However, there is a look-through rule which provides that if the plan’s investment is in an equity interest, and the equity interest is not a publicly offered security, and the entity is not a registered investment company, then the plan’s assets include both its equity interest and an undivided interest in each of the entity’s underlying assets, unless an exception to this look-through rule applies.

If an exception does not apply, we sometimes refer to the fund as holding ERISA plan assets.  If an exception does apply, then the fund will not be considered to be holding ERISA plan assets.

Ira Bogner: The most common exceptions that private investment funds rely on to avoid holding plan assets are the insignificant benefit plan investor participation exception, sometimes referred to as the ERISA 25% limit exception; the venture capital operating company exception; and the real estate operating company exception.

Each exception has its own set of rules with their own respective traps for the unwary.  Without getting into details on these exceptions, the most important take-away is that ERISA investors will typically want to know which exception the fund intends to rely on. 

Adam Scoll: Furthermore, ERISA investors often want to receive some kind of formal or informal assurances from the fund manager as to the fund’s compliance with one or more of the plan asset exceptions.

For example, it is quite common for ERISA investors to receive opinions and/or certifications as to the fund’s compliance with a plan asset exception, either at the outset of the fund or on an ongoing basis.

Ira Bogner:  Similarly, ERISA investors typically will want to receive prompt notice from the fund manager if the fund ever fails to qualify for a plan assets exception and is holding plan assets. Delivery of these notices, either alone or sometimes together with a written opinion from the ERISA investor’s counsel, often triggers an ERISA investor’s right to withdraw from the fund and/or to be excused from making further capital contributions to a private investment fund.

Adam Scoll: And going back to the ERISA fiduciary’s duty of prudence we discussed earlier, it will always help an argument that an investment in a fund is prudent if there is some ability for the ERISA investor to get out of the fund or to stop contributing more capital into the fund in the event an ERISA related or other regulatory problem arises during the term of the investment. And the terms and conditions of any such excuse and withdrawal related rights will be important issues for an ERISA investor to consider.

Ira Bogner:  ERISA investors will often focus on whether alternative investment vehicles set up by the fund to make certain investments outside of the main fund are required to include substantially similar ERISA related rights and protections as the main fund document includes.

Separately, ERISA investors typically want to know that they will be able to receive and disclose fund related information that is necessary for them to satisfy the ERISA related reporting and disclosure obligations.

Also, ERISA investors may be interested in whether distributions may be made in kind as opposed to in cash, and whether or not those in kind distributions could create some regulatory issues. 

Adam Scoll: ERISA investors will also want to ensure that the fund documents do not allow amendments that would take away their ERISA-related rights and protections without some form of ERISA investor consent.

Lastly for today, ERISA investors also often focus on the borrowing related provisions of the fund documents, just so as to ensure they would not be forced to somehow engage in a non-exempt prohibited transaction in connection with any such fund borrowing.

Ira Bogner:  Of course there are many other items that may come up, depending on the investment strategy or structure of a particular fund, but those are what we would view as the key considerations for ERISA investors investing in private investment funds that are intended not to hold plan assets.

Adam Scoll: Thanks, Ira. And thank you all for joining us on the Proskauer Benefits Brief.  Stay tuned for more legal insights on employee benefits and executive compensation, and be sure to follow us on iTunes.

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Photo of Ira G. Bogner Ira G. Bogner

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of…

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of clients, including financial service companies, entertainment industry clients, and tax-exempt organizations, and also actively represents individual executives in executive compensation matters.

Ira counsels clients with respect to the tax, securities law disclosure, corporate governance, stock exchange and other requirements relevant to executive compensation arrangements. Ira also provides advice regarding equity arrangements, employment agreements, change in control agreements and all other types of executive compensation arrangements, including guidance regarding “409A,” “162m,” “457A,” and “280G.”

Ira frequently is called on to structure and analyze alternative investments for pension trusts and other exempt organizations. He also works with the Firm’s corporate and real estate lawyers in structuring and maintaining investment funds that include participation by pension plans. Through his work in the investment fund area Ira has obtained substantial experience in applying the rules provided under the “plan asset” regulations, including the operation of venture capital operating companies and real estate operating companies. He has assisted in the formation of private equity, real estate, infrastructure and hedge funds, including “fund of funds.” Ira also has advised clients on both avoiding ERISA “plan asset” status and operating an investment fund in accordance with ERISA.

Areas of Concentration

Ira has provided guidance to clients on a wide variety of matters in the areas of employee benefits and executive compensation, including:

  • investment of plan assets
  • implementation of employee benefit plans

  • employee benefit issues in mergers and acquisitions

  • awarding of equity-based compensation

  • negotiation and drafting of employment agreements and severance arrangements

  • structuring, analyzing and maintaining investment funds that are suitable for plan investors

Thought Leadership

Ira has published a number of articles in publications such as The New York Law Journal, The New Jersey Law Journal, The Daily Deal, The Journal of Pension Planning and Compliance, Mergers and Acquisitions (The Monthly Tax Journal), The Journal of Taxation and Regulation of Financial Institutions, The Metropolitan Corporate Counsel, European Private Equity & Venture Capital Associations, The LPA Anatomised and Private Equity International and has been named to the Board of Advisors of the Journal of Taxation and Regulation of Financial Institutions. He also has lectured on topics such as the classification of workers, drafting employment agreements, equity alternatives for senior executives, investing IRA assets, the plan asset regulations, shareholder approval of equity plans, Code Section 409A, and key provisions for ERISA investors investing in a private equity fund.

Recognition

Ira has been recognized and ranked by various directories. US Legal 500 has carried the following comments: “Ira Bogner is ‘available, responsive and knowledgeable;” “Ira Bogner ‘provides a level of comfort with respect to business issues that is rare in the world of ERISA;” “Ira Bogner is the ‘go-to guy for fund sponsors needing help with ERISA.’”

Photo of Adam Scoll Adam Scoll

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard…

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard to compliance with ERISA’s complex fiduciary duty and prohibited transaction rules.

Adam regularly advises private investment fund sponsors regarding the structuring of their funds in order to accept investments from ERISA-covered pension trusts, including compliance with the ERISA “plan asset” regulations and the operation of venture capital operating companies (VCOCs) and real estate operating companies (REOCs).

Adam also represents both employers and senior executives in the negotiation and drafting of employment and separation agreements, deferred compensation plans, and equity and “phantom equity” arrangements, including compliance with the nonqualified deferred compensation rules under Sections 409A and 457A of the Internal Revenue Code.