ERISA – Plan Asset Rule

If an employee benefit plan invests in a fund, does the plan’s assets include the investment in the fund (e.g., a limited partnership interest) or does it include the underlying investments of the fund? The answer to the question has broad implications to the management of the fund, including: (i) who is the fiduciary managing the assets, (ii) whether any of the underlying transactions of the fund are prohibited transactions, (iii) how the manager may be compensated (i.e., the use of incentive compensation), (iv) whether the persons managing investments of the funds must be bonded, and (v) whether, in the case of investment of foreign securities, special arrangements must be made.

Should the plan be deemed to have an interest in the underlying assets of the fund, the fund will be deemed to have ERISA.

An important consequence of a fund’s assets being considered Plan Assets is that such status imposes new obligations, responsibilities, and restrictions on the “fiduciaries” of the fund (i.e., the investment manager or general partner, as the case may be). In general, a “fiduciary” of a fund under ERISA includes any person who either exercises discretionary authority or discretionary control over the fund’s assets or renders, for a fee or other compensation, investment advice to the fund. Accordingly, the investment manager or general partner is considered a fiduciary under ERISA.

As a fiduciary under ERISA, the investment manager is required to (j) act solely in the interest of the participants and beneficiaries of each plan investor, (ii) act prudently, (iii) diversify the investments of the fund to minimize the risk of large losses, (iv) act in accordance with the documents and instruments governing each plan investor to the extent such documents and instruments are consistent with ERISA, and (v) maintain the indicia of ownership of the fund’s assets within the jurisdiction of the U.S. District Courts.

To protect employee benefit plans against loss as a result of fiduciary misconduct, ERISA requires that certain plan fiduciaries be bonded in an amount equal to the lesser of 10 percent of the funds handled by such fiduciaries or $500,000. Typically, such bonds cover losses resulting from fraud or other types of misappropriations. In addition, if an investment manager is handling plan assets it is recommended that such investment manager also obtain fiduciary liability insurance to cover potential claims against the investment manager relating to other possible breaches of ERISA’s fiduciary requirements.