Section 404(a)(1) of ERISA generally requires a fiduciary to act in the interest of participants and beneficiaries and to act prudently. ERISA also requires, under Section 103(b)(3)(A), an annual report which includes a financial statement containing, among other things, a statement of assets and liabilities "valued at their current value." Current value is to be determined in good faith by a trustee or named fiduciary.
A July 1, 2008 letter from James Benages of the DOL's Boston office has made its way around the market. There, he considers a plan which was invested in a number of alternative investments ("AIs"), and which apparently took a fairly common approach to the Form 5500 reporting thereof. For example, one particular AI was valued at cost by the applicable committee "based on the general partner's unaudited Capital Account Balance Statement" for the period in question "and the accompanying audited financial statements." Another AI was valued according to the general partner's unaudited determination of fair market value.
The July 1 letter, which could be indicative of an approach generally being taken by the DOL office issuing the letter, states that (i) not only has the committee "failed to establish a process to determine the most accurate fair market value," but cost and fair market value have been "equate[d]," (ii) such failure violates ERISA's "solely in the interest" requirement, and (iii) as a result, in the DOL's view, the committee "is in violation of ERISA and will remain so until it takes corrective action." Before discussing Section 502(l) and the possibility of action by other governmental agencies and third parties, the July 1 letter kindly comforts that, if corrective action is taken, no lawsuit will be brought by the DOL.
The issues implicated by the July 1 letter are significant. Many private equity and other investment funds provide valuations on the bases noted in the letter, and plan fiduciaries would not ordinarily be expected to have the information required to second-guess the available valuations or the expertise to do so even if they had the information. The DOL's approach seems to raise the specter that making an investment not practically susceptible to ready valuation is somehow a per se violation of Section 404(a)(1) of ERISA.
AIs can form a critical part of a plan's investment strategy, and in some cases, probably account in part for superior overall performance. The point here is not to address whether AIs are or are not wise investments; rather, the concern being expressed is that certain investments may effectively become unavailable to investment professionals as a result of the application of the reporting rules. See also our comments regarding the July 1 letter on the BNA Pension and Benefits Blog captioned, "A Report on Yet Another Reporting Issue for Private Equity and Other Investment Funds," (Aug. 15, 2008).
If the approach in the July 1 letter out of the DOL's Boston office begins to proliferate, there could be an effect on private equity and other funds, and investing plans. White & Case would be happy to discuss this development with plan managers and other fiduciaries, and with those funds that are marketed to plans.