The Pension Protection Act Modifies ERISA "Plan Asset Rules"

Client Advisory

August 17, 2006
Today, August 17, 2006, President Bush signed the Pension Protection Act of 2006 (the “Act”). The changes made by the Act that are described in this Client Advisory apply to transactions occurring on or after August 18, 2006.

The Act contains two important developments of interest to private investment funds that will affect the way these funds deal with employee benefit plans and other retirement arrangements, including investors that are subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). As described below, the new law (a) narrows the definition of “benefit plan investor”, and (b) limits the effects of equity ownership by benefit plan investors in fund-of-fund structures by clarifying the portion of an investment fund considered owned by benefit plan investors for purposes of its investment in another fund.

Existing regulations issued by the U.S. Department of Labor (“DOL”) define “plan assets” that are subject to the fiduciary principles of ERISA and the prohibited transaction restrictions under ERISA and the U.S. Internal Revenue Code of 1986, as amended (the “Code”). The regulations generally provide, under the so-called “look through rule,” that when an employee benefit plan subject to ERISA and/or a retirement arrangement subject to Section 4975 of the Code (e.g., an individual retirement account) invests in an equity interest of an entity primarily engaged in the investment of capital that is neither a publicly offered security nor a security issued by an investment company registered under the Investment Company Act of 1940, the plan’s investment includes the equity interest and an undivided interest in the underlying assets of the entity. One exception provided by the regulations applies if the equity participation by “benefit plan investors” in the entity is not “significant,” that is, benefit plan investors do not hold 25% or more of any class of equity of the entity. Many private equity funds rely on this exception to avoid the fund managers becoming fiduciaries with respect to the assets of the ERISA and/or IRA investors in the fund.

For purposes of this “25% benefit plan investor” exception, the new law overrides the definition of "benefit plan investors" in the DOL regulations to exclude non-U.S. plans, U.S. state and local government plans and certain church plans. Only U.S. employee benefit plans that are subject to ERISA, individual retirement accounts and annuities, medical and education savings accounts and investment funds that are deemed to hold "plan assets" by reason of equity investment in such funds by the foregoing types of plans will be "benefit plan investors." In terms of what is likely to be most significant to many private investment funds, the change means that non-U.S. pension plan investors no longer need to be counted with ERISA plan investors in the 25% test.

The new law also limits the effects of exceeding the 25% limit in a fund-of-funds structure. A private investment fund that exceeds the 25% limit will be considered to hold "plan assets" only to the extent of the percentage of equity held by "benefit plan investors." For example, if "benefit plan investors" hold 25% of an investment fund and that fund invests $20 million in a second fund, only $5 million of this investment will count as an investment by a "benefit plan investor" for purposes of applying the 25% limit to the second fund. The new law resolves the prior uncertainty of how the 25% test should be calculated in fund-of-fund structures; uncertainty that often necessitated a conservative interpretation of the DOL regulations in the past.

All private investment funds should review their offering documents and subscription agreements to determine the supplements or revisions needed to conform to the new definition of benefit plan investor. Investment funds currently relying on any of the “25% benefit plan investor”, “venture capital operating company” or “real estate operating company” exceptions may wish to review subscription agreements of investors previously identified as benefit plan investors or request confirmation of benefit plan investor status to determine whether any changes to fund structures could be made to benefit from the new law.

Questions regarding this Client Advisory should be directed to Patricia Matzye at (212-238-8730,

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2018 Carter Ledyard & Milburn LLP.
© Copyright 2006

© Copyright 2018 Carter Ledyard & Milburn LLP