Limitation on Erisa Assets Investment in a Hedge Fund. Erisa Plan

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What is meant by the 25% limitation on ERISA assets investment in a Hedge Fund?

The Departments of Labor Regulation defines the use of ERISA assets. ERISA Assets include self-employed persons, and individual retirement accounts in pooled investment vehicles. Section 403 (a) requires that generally all assets of an employee benefit plan shall be held in Trust by one or more Trustees. Section 3(21) defines a fiduciary to include any person who exercises discretionary authority or control over the management of Plan Assets. Section 404 provides that a fiduciary must discharge responsibilities in accordance with fiduciary standards of care as set forth in Section 404 (a) (1); that is, (a) solely in the interest of the participants and beneficiaries of the plan (b) with the care skill prudence and diligence under circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and would like aims; and (c) with respect to an investment of a Plan Asset, by diversifying the investments of the plan so as to minimize the risk of large losses.

Section 406 also prohibits a fiduciary from causing a plan knowingly or negligently, to engage in prohibited transactions with "parties-in-interest." A party-in-interest includes the plan sponsor a person providing services to the plan, a person in control of the plan sponsor, a person controlled by any of the forgoing or an employee, affiliate or relative of any of the forgoing. Section 4975 of the Internal Revenue Code imposes excise taxes on "prohibited transaction" the definition of which is similar to the definition of prohibited transactions under 406 of ERISA. Taxes range from 15% of the amount involved each year up to 100% of the amount involved if corrective action is not undertaken within a certain time period. Section 502 (1) of ERISA imposes upon a fiduciary a civil penalty equal to 20% of the amount received from such fiduciary as a result of a settlement agreement or judicial preceding involving a breech of fiduciary duty. Section 406 also prohibits a fiduciary from dealing with plan assets for his own interests or account, acting in any transaction in which his interest are adverse to those of the plan or receiving consideration for his personal account in connection with any transaction involving plan assets. Section 409 imposes personal liability upon a fiduciary who breeches his duties and responsibilities. Section 405 provides that a plan fiduciary may under certain circumstances be liable for a breech of fiduciary responsibility by a co-fiduciary or for improper delegation of investment authority. Section 412 requires that with certain exceptions a plan fiduciary shall be bonded. Section 403 (a) provides that the trustee shall have the exclusive authority and discretion to manage and control the assets of the plan unless the plan provides that the trustee is subject to the discretion of a named fiduciary or the authority is delegated to an investment manager who is either a bank, an insurance company, or registered as an investment advisor under the Investment Advisor Act 1940.

If the assets of the fund are considered plan assets the trustee may have improperly delegated its investment authority unless the managers and general partners of the fund are either named fiduciaries of the ERISA Plan limited partners or properly appointed as an investment manager within the meaning of Section 3 (38) of ERISA. Moreover, unless the fund manager is a bank or insurance company, it must be registered as an investment advisor under the Investment Advisors Act of 1940 to serve as an ERISA Investment manager. Under the regulations, if a retirement plan purchases an equity interest in an entity, underlying assets will be considered plan assets unless (a) the equity interest is a publicly offered security; (b) the equity interest is a security of a registered investment company; (c) The entity is an operating company; or (d) Benefit plan ownership of equity securities is not significant. The underlying assets are not significant where such assets represent less than 25% of the value of the class of equity security of the entity. Thus, for a hedge fund, a significant benefit plan participation would be an investment of 25% or more by a benefit plan investor in the hedge fund.

It is to be noted however, that only an equity investment in an entity can cause an underlying assets of that entity to be plan assets. The acquisition of debt instruments will generally not result in plan asset treatment

ERISA plan

Not under Rule 501(a)(1). Rule 501(a)(1) accredits as ERISA plan that has a fiduciary which is a bank, insurance company or registered investment advisor, or that has total assets in excess of $5 million. The plan, however, may be an accredited investor under a different provision of Rule 501(a).

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