In its 12 August podcast, “SEC aims to level playing field for retail investors”, Private Funds CFO highlighted the need for asset managers to comment on the SEC’s Concept Release on the Harmonization of Securities Offering Exemptions. Two key takeaways from the podcast were:
- Yes, asset managers would benefit if a deeper pool of money had access to their products.
- Yes, defined contribution plans could be significant future investors for private market asset managers.
However, what remains to be amplified and reinforced with the SEC is that:
- Yes, retirement savers could significantly benefit from access to private funds.
- Yes, the SEC can facilitate this access through modernising its relevant guidance in no-action letters.
On the podcast, Keith Higgins highlighted that defined contribution plans (401(k) plans) generally do not qualify as “accredited investors” unless each participant in the plan is an “accredited investor”. This “accredited investor” requirement generally restricts the types of investments that defined contribution retirement savers have and leaves them reliant on other asset classes as their tools for managing risk and generating the returns needed to secure retirement.
This outcome is in stark contrast with other long-term investors like defined benefit plans, foundations and endowments, which all generally have access to private funds. As a result, studies show the average participant in a defined contribution plan can expect a lower long-term investment return.
Even absent formal regulatory change, the asset manager community can help encourage the SEC to provide defined contribution retirement savers with meaningful access to private funds. The SEC rules limiting defined contribution plan access are contained in no-action letters.
In the late 1990s and early 2000s, the SEC issued three letters stating that a 401(k) plan could invest in a private fund even if each participant were not herself an accredited investor if certain conditions were met. These conditions were:
- A plan fiduciary adds the investment option containing the private fund to the plan’s investment menu and only provides a generic description of the private fund (ie, the option is white labelled);
- The investment option invests less than 50 percent of its assets in the private fund;
- The investment option does not guarantee plan participants that the investment option will invest any specific amount in the private fund; and
- Participant decision making is limited to allocating money to or making redemptions from that investment option or other investment options that the plan makes available.
However, these conditions have proven challenging for a number of reasons:
- First, because of the complexity of 401(k) plan operations, implementing the restrictions and requirements in the no-action letters can be challenging for all but that largest 401(k) plans.
- Second, because plans cannot provide an assurance that any portion of plan assets will be invested in a specific fund, there is little incentive for fund managers themselves to design standardised investment vehicles. Instead, plan fiduciaries who want to design these vehicles have typically had to use custom vehicles – which has increased cost.
- Third, the concentration and no guarantee rules have led to more opaque investment structures. Because plans cannot provide assurances, they have typically provided generic information.
- Fourth, some progressive plan fiduciaries who have moved ahead and designed the options have recently faced a new deterrent – litigation from plaintiffs’ class action firms. Here, plaintiffs have alleged that the products are more expensive and more opaque than other investment options and also that the lack of uptake by defined contribution plans is itself a sign that these products are unsuitable to retirement savers. This litigation has further chilled access.
So how do asset managers and 401(k) stakeholders address these challenges? A core foundation is working with and encouraging the SEC to support and facilitate these investments. At a minimum, the SEC should update its no-action letters to signal that target date funds that allocate to private funds do not need to look past whether a defined contribution plan itself is an accredited investor. Second, chairman Jay Clayton could build on his prior statements that Jane and Joe 401(k) need access to risk-mitigating and performance enhancing products and issue some formal statement reminding investors with access to private funds that they should consider private funds as part of their investment portfolio.
Asset managers can significantly help move this ball.
Kevin Walsh and David Levine are principals at Groom Law Group.