Fiduciary Proposal Would Bar Certain Retirement Plans from Investing in Private Equity Funds

By Robert J. Raymond, Cleary Gottlieb Steen & Hamilton LLP

The Department of Labor’s (“DOL”) proposed rules expanding the circumstances where a person is considered a “fiduciary” for…

By Robert J. Raymond, Cleary Gottlieb Steen & Hamilton LLP

The Department of Labor’s (“DOL”) proposed rules expanding the circumstances where a person is considered a “fiduciary” for purposes of the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”) have met significant criticism from lawmakers, service providers and investors. One concern is that the rules, if adopted as proposed, would prohibit small pension plans and individual retirement account (“IRA”) investors from investing in private investment funds.

Unless a carve-out applies, a person is considered a fiduciary by providing investment advice to a plan or IRA for a fee or other compensation. Under the proposal, investment advice includes recommending an investor acquire an interest in a fund under circumstances where “such advice is specifically directed to, the recipient for consideration in making investment or management decisions” for the plan or IRA[1] (emphasis added). A person will be deemed to receive a “fee or other compensation” if he receives a fee or compensation from any source incident to the transaction in which the investment advice is or will be rendered, which presumably would include management and incentive fees and other similar compensation.

The proposed rules include several carve-outs where a person would not be considered a fiduciary for the provision of investment advice. The “Seller’s Carve-Out” would apply if the fund sponsor has neither represented nor acknowledged he is acting as a fiduciary under ERISA and one of two tests is satisfied. Unfortunately, the tests are not applicable to plans with under 100 participants or that have managers with under $100 million in assets under management. IRAs (no matter the size) also cannot satisfy these tests. According to the DOL, “[m]ost retail investors lack financial expertise…and are unable effectively to assess the quality of the advice they receive.”[2] Consequently, a private investment fund could not market to small plans or IRAs without becoming a fiduciary and potentially rendering the acquisition of a fund interest a prohibited transaction under ERISA and the Code.

The proposal also includes an exemption intended to allow certain fiduciaries to receive compensation (that might otherwise be prohibited) for the provision of investment advice to plan participants, IRA owners, and non-participant-directed ERISA plans with fewer than 100 participants. However, this Best Interest Contract (“BIC”) exemption covers only compensation for services provided in connection with the purchase, sale or holding of specified liquid assets, which do not include interests in private investment funds. Even if the BIC exemption were expanded to cover private investment funds, the conditions would render it impractical for fund sponsors.

The DOL has received over 3,000 comments, reflecting the impact the new rules will have on the financial industry.[3] In October, the House passed a bill that would prohibit the DOL from finalizing its proposal until the Securities and Exchange Commission adopts its own rules.[4] While the debate appears to break down along party lines, some Democrats have warned the DOL about adopting a rule that would increase costs for small plan participants and IRA investors and restrict access to investment options. They have also encouraged the DOL to consider a principles-based approach to the BIC exemption. One Democrat lawmaker has called for a new comment period once the DOL’s revised proposed rules are published to ensure the final rules are properly vetted.[5] Notwithstanding these efforts, it seems clear the Obama Administration intends to finalize its proposal in 2016, although how the rules may be modified remains unclear.

The DOL’s apparent view that small plans and IRA investors are unsophisticated and cannot understand the risks of investing in private investment funds seems overstated. The DOL could appropriately limit the rules’ scope by adopting a “qualified purchaser” standard similar to the one in the Investment Company Act of 1940. By allowing small plans and IRA investors who are qualified purchasers to invest in private investment funds under the Seller’s Carve-Out, the DOL would be embracing a more principles-based approach while still protecting less sophisticated investors.


Cleary Gottlieb Steen & Hamilton LLP is a Tier 1 Associate Member of the PEGCC.


[1] Definition of the Term ‘‘Fiduciary’’; Conflict of Interest Rule—Retirement Investment Advice, 80 FR 21928, 21957 (April 20, 2015).

[2] Proposed Best Interest Contract Exemption, 80 FR 21960, 21968 (April 20, 2015).

[3] Comments available at

[4] H.R.109: Retail Investor Protection Act.

[5] Nick Thornton, “Dem lawmaker urges new comment period on DOL fiduciary rule,” BenefitsPro, October 30, 2015, available at