DOL Warns Retirement Plans to Be Cautious About PE Investments

The Department of Labor (DOL) released a statement yesterday warning defined contribution (DC) plan fiduciaries to be careful with their private equity investments. The statement comes more than a year after the DOL released a letter in which the department wrote that private equity investments were not in violation of Sections 403 and 404 of the Employee Retirement Income Security Act (ERISA).

The original letter had responded to a question from attorney Jon Breyfogle of Groom Law Group, Chartered, asking on behalf of Pantheon Ventures whether the use of private equity (PE) investments was permissible for 401(k) plans.

“You state that certain private equity investments may present the opportunity for enhanced diversification of investment risk and for greater returns,” said the June 2020 statement, referring to Breyfogle’s letter.

The statement, while still warning about the potential risks of private equity, ultimately drew skepticism from some stakeholders. Many wrote to the Department of Labor expressing concern that it overly highlighted the benefits of private equity, while not focusing enough on the potential risks.

This prompted the DOL send out the second statement yesterday.

“The department concluded that it should supplement the information letter to ensure that plan fiduciaries do not expose plan participants and beneficiaries to unwarranted risks by misreading the letter as saying that PE—as a component of a designated investment alternative—is generally appropriate for a typical 401(k) plan,” said the second statement.

The letter went on to caution about liquidity risks involved in private equity investments, which are often difficult to evaluate in real time.

This year has been an excellent year for pension plans invested in private equity. For the California Public Employees’ Retirement System (CalPERS), the largest pension in the United States, private equity outpaced public equity investments by 43.8% to 36.3%. The California State Teachers’ Retirement System (CalSTRS), the second largest pension in the country, saw its private equity investments return 51.9%. Other funds, like the Maryland State Retirement System and the Public Employees’ Retirement System of Mississippi (PERS), also reported returns of more than 50% from private equity.