A Trump Administration Executive Order on investments in private equity, real estate, and digital assets in defined contribution plans
President Trump has issued an Executive Order ("Order") to enable defined contribution plans (e.g. 401(k) and 403(b) plans) to invest in "alternative assets," such as private equity, real estate and digital assets. The Order also directed the U.S. Department of Labor ("DOL") to curb the risk of litigation under the Employee Retirement Income Security Act ("ERISA"). Plan sponsors should understand the impact of the Order on the investment menus for their defined contribution plans.
What was the tussle behind the Executive Order?
In June 2020, the DOL under the Trump Administration issued a favorable information letter on the inclusion of private equity investments as a component of a target date fund in a participant-directed defined contribution plan. On December 21, 2021, the DOL under the Biden Administration issued a supplemental letter limiting the scope of the Trump Administration's letter. President Trump has now issued an Order broadly authorizing investment in alternative assets and asking the Secretary of Labor to rescind the Biden Administration's letter. Below we review the Order and whether fiduciaries are protected if they offer alternative assets.
What are alternative assets?
They could be any of the following:
- Private market investments, including direct and indirect interests in equity, debt, or other financial instruments not traded on public exchanges, including those where investment-managers take an active role in company management;
- Direct and indirect interests in real estate, including debt instruments secured by direct or indirect interests in real estate;
- Holdings in actively managed investment vehicles that are investing in digital assets;
- Direct and indirect investments in commodities;
- Direct and indirect interests in projects financing infrastructure development; and
- Lifetime income investment strategies including longevity risk-sharing pools.
Why?
Per the Order, the vast majority of defined contribution plan participants are missing out on the "potential growth and diversification opportunities associated with alternative asset investments" The Order purports to be "democratizing" access to these important assets.
Has this been available before?
To some extent, yes, but available alternative assets were not widely used except by defined benefit plans for two reasons. First, many of these investment types are not necessarily structured in a way that is suitable for defined contribution plans (e.g. securities laws have long prevented defined contribution plans from investing in certain private equity funds), and commentators have consistently noted the increased litigation risk because of their high cost, illiquidity and risk of loss. The Order notes that "burdensome lawsuits seeking to challenge decisions by loyal, regulated fiduciaries" have meant that plan sponsors are not generally willing to allow or consider investments in alternative assets. Second, the Order notes that "stifling Department of Labor guidance," issued by the Biden Administration, has also hindered alternative assets. The Order is an attempt to address both of these items.
Will we be required to offer alternative assets?
No. Per the Order, it is US policy that participants should have access to alternative assets "when the relevant plan fiduciary determines that such access provides an appropriate opportunity for plan participants and beneficiaries to enhance the net risk-adjusted returns on their retirement assets." In other words, there is no change to plan fiduciaries' duty to create and monitor a plan's investment menu prudently and in accordance with ERISA's fiduciary duties so that it is in the best interests of participants and beneficiaries. The difference is that the Order is trying to pave the way for alternative assets to break onto the defined contribution plan platform.
Will the lawsuits against defined contribution plans stop?
That is the million-dollar question, but it is very doubtful. The Order states the Trump Administration will relieve the litigation risk and regulatory burden, so we await further guidance on how they will achieve this, especially given the Supreme Court decision in Cunningham v. Cornell University that makes it so much easier for a lawsuit to reach discovery and harder to win on a motion to dismiss. Moreover, plan fiduciaries would welcome the Trump Administration first addressing litigation risk related to non-alternative assets before worrying about risks associated with alternative assets. See our previous advisory, Excessive Fees or Incessant Litigation – Time for Legislative and Employer Action on Retirement Plans.
What is next?
Within 180 days the DOL must: (1) review its guidance regarding fiduciary duties under ERISA for investing in alternative assets; (2) clarify its position on alternative assets, including guidance for fiduciaries to prudently balance potentially higher expenses against the objectives of seeking greater long-term net returns and broader diversification of investments; and (3) propose rules to clarify a fiduciary's duties to plan participants when deciding whether to include alternative assets, which might include safe harbors, while prioritizing actions to curb ERISA litigation.
What should plan sponsors do?
No immediate action is required. However, defined contribution plan fiduciaries should discuss the Order with their investment consultant and ERISA attorney so they understand alternative assets and whether offering them would be in the best interests of plan participants and beneficiaries. Without a strong safe harbor and protection from litigation, we anticipate many defined contribution plan fiduciaries will act with extreme caution.
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