Private Equity Fund Valuation by ERISA Plans
September 8, 2008
How should a fiduciary for a retirement plan governed by the Employee Retirement Income Security Act of 1974 (“ERISA”) evaluate the value of the plan’s alternative investments (
e.g., private equity and hedge funds)? Typically, administrators rely upon the valuation provided by the general partners of such funds. However, a recent letter from the Boston office of the Department of Labor (the “DOL”) has indicated that such an approach may constitute a breach of fiduciary duty under ERISA.
After completing its investigation of a plan, the Boston office found that the fiduciaries of the plan (the “Committee”) invested a portion of the plan’s assets in several private equity funds. The Committee, along with the plan’s investment advisor and monitor, regularly reviewed the plan’s financial statements and met periodically to discuss the plan’s financial results. These financial statements included the values of these funds, in each case based on valuation data prepared by the general partners of the funds. In at least some instances, the plan’s fund investments were valued at cost. The Committee did not review whether the valuations provided to the plan accurately reflected the value of the fund’s assets and hence the value of the plan’s interest in the fund.
According to the DOL’s Boston office, relying solely upon the general partners’ unaudited valuations is inappropriate. Rather, the Committee breached its fiduciary duties by failing “to have an established process by which the fair market value of alternative investments” could be determined. The Boston office asserted that the fiduciaries should have “a complete understanding of the underlying investments and the fund’s investment strategy,” as well as “a thorough knowledge of the general partner’s valuation methodology to assure it comports with the fund’s written valuation provisions and reflects fair market value.”
The office further questioned whether it was appropriate to treat cost as fair market value. Ultimately, the Boston office concluded that the Committee “is in violation of ERISA and will remain so until it takes corrective action” to implement a process for establishing the fair market value of alternative investments and listing the fair market value of such investments separately from cost on asset statements.
So far, only the DOL’s Boston office seems to have staked out such a position regarding an ERISA fiduciary’s obligations in connection with valuing alternative investments. Because this issue will likely have a significant impact on ERISA plans investing in alternative investments, we expect the DOL will give further consideration to the standards set out in the Boston office’s letter.
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