Executive Order Encourages Inclusion of Private Markets Investments in US Retirement Plans
President Trump today signed “Democratizing Access to Alternative Assets for 401(k) Investors,” an Executive Order (EO) aimed at reducing legal uncertainty around the inclusion of alternative assets, including investments in private markets, cryptocurrency, and real estate, in US defined contribution (DC) retirement plans.
Pension and social security funds around the world, acting as institutional investors on behalf of their stakeholders, have been allocating to private markets for decades and benefiting from their potential for improved diversification and investment performance. Now, defined contribution sponsors and their participants have a clearer path toward achieving the same benefits of private markets investing through their own plans.
With public markets shrinking, private markets exposure is necessary to rebalance core holdings. By providing this EO, we believe the Trump administration has made it clear that addressing the regulatory ambiguity in this area is a priority. Here are some key questions and answers for private market investors interested in following the process:
What is the current policy around private investments in DC plans?
While US defined benefit (DB) plans have long included private investments due to their potential for higher long-term returns and diversification benefits, DC plans have historically only allowed plan participants access to public market investments. However, in June 2020, under the first Trump administration, the DOL released an “Information Letter” to confirm that “investment options under a defined contribution plan…may include a limited allocation to private equity.”1
A follow-up statement from the DOL emphasized several key fiduciary considerations and established that the original guidance was intended for large plan fiduciaries with experience in private investments because they also manage DB plans.2 This guidance was later affirmed by the DOL under President Biden. However, important questions remain outstanding on the specifics of what is permitted under the guidance, including:
- What constitutes “appropriate due diligence” for private investments?
- Will the DOL consider providing a safe harbor for fiduciaries, which could significantly reduce perceived litigation risk?
- How should fiduciaries handle disclosure and participant communications?
- What level of liquidity must be maintained for daily trading?
- What types of structures are acceptable under ERISA?
- How can private investments meet ERISA’s “reasonable fee” requirement and transparency expectations?
- Is there a set asset or participant level that distinguishes a smaller plan from a large plan?
As the idea of explicitly allowing DC plan administrators to participate in the opportunities of private markets has become more and more mainstream, plan administrators have historically been wary of exploring the options due to the lack of legal clarity. Today’s EO should alleviate some of that concern.
Why are policymakers interested in changing this policy?
The opportunity set in public markets continues to shrink, with the number of US publicly traded companies peaking at 7,300 in 1996 and now hovering around 4,300. Meanwhile, the number of private companies backed by PE firms has jumped from 1,900 to 11,000.3 In addition, the growth opportunities available to public market investors has become more limited as firms stay private for longer and arrive on the IPO market larger and more mature. The result is a public market that has become extremely concentrated, with just a handful of stocks driving performance.
Partially in response to these market dynamics, DB plans have already embraced private market assets. Between 2001 and 2016, the share of pension plans invested in alternatives rose from 9% to 29%.4 DC plans, however, have been hampered by the regulatory uncertainty involved with their unique legal obligations, including the fiduciary responsibility to operate in the best interest of plan participants.
While the DOL has put out several pieces of guidance meant to clarify the issue, there has not previously been an explicit push from the White House to look more holistically at the matter and ensure the full regulatory framework is clear for plan administrators.
What happens next in the process?
The EO importantly lays out a deliberative process by which its changes can be implemented. Specifically, it directs the Secretary of Labor to:
- Within 180 days, review the Department of Labor’s (DOL) fiduciary guidance on alternative asset investments in DC plans that are governed by the Employee Retirement Income Security Act of 1974 (ERISA).
- Within 180 days, clarify the DOL’s position on alternative assets and the appropriate fiduciary process associated with offering funds containing alternative asset investments.
- Consult with regulatory counterparts at the Treasury Department, SEC, and others to determine whether rule changes should be made to assist in the effort.
Further, the SEC is directed to facilitate access to alternative assets by revising applicable regulations and guidance.
When the DOL (or SEC) is directed to reevaluate guidance, it generally follows a multi-step administrative process involving internal review, stakeholder engagement, and potential rulemaking. First, key DOL divisions such as the Employee Benefits Security Administration (EBSA) will review existing guidance, relevant statutory and regulatory authority, court precedents, and economic literature.
The DOL will often hold public listening sessions or roundtables at which stakeholders representing a broad spectrum of interests will be invited to share their opinions on the merits of the rule when significant changes such as these are being contemplated. DOL staff will also likely hold private meetings with industry leaders, labor groups, consumer advocates, and academics. For example, the DOL held multiple public hearings and roundtables during the original development of the fiduciary rule. In some cases, the DOL may issue a Request for Information (RFI) to gather data before proposing new rules or guidance.
If the DOL, the SEC, or other regulators determine that reevaluation warrants a change to their regulatory framework, it would initiate the formal rulemaking process governed by the Administrative Procedure Act (APA). The process is as follows:
- Notice of Proposed Rulemaking (NPRM) is published in the Federal Register
- Public comment period
- Review and analysis of comments
- Final Rule is issued, with an effective date and transition guidance
How long might this process take?
The timeline for completing a full re-evaluation can take anywhere from 6 months to several years. Beyond the 180-day time frames stipulated by the EO, it is difficult to put an exact timeline on the rest of the process.
Any major policy change would potentially be in danger of reversal should the next administration have a different perspective on these issues. As such, regulators will typically aim to get these in place during the first half of the administration. Under the Congressional Review Act, Congress has 60 legislative days (not calendar days) to introduce and pass a “joint resolution of disapproval.”
If the resolution passes both houses of Congress (which would likely not happen unless both were under Democratic control) it goes to the President for his signature or veto. Obviously, if President Trump or a similarly aligned individual is in that position at the time, they are likely to veto. Thus, this scenario usually only plays out when there is a full transfer of power (House of Representatives, Senate, and presidency) from one party to another following a Presidential election.
What guardrails might be put into place during this process?
During this process, important guardrails will likely be set in order to insulate everyday retirement savers from some of the risks inherent to private investing. This order does not signal unrestricted access for all retail investors to enter private markets. While all investments carry some level of risk, the administration is seeking to responsibly open up the opportunity in the robust private markets while maintaining a level of security for the everyday 401(k) or 403(b) plan participant.
The SEC Chairman recently said that he would work with the Department of Labor to develop “good guardrails” around this access. The SEC has mentioned requiring investors to work with a fiduciary to put private markets products into their long-term savings and retirement plans. Other guardrails could come in the form of specific requirements for funds that are offered to these plans, such as a threshold level of diversification.
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Key takeaways
This is a critical moment for US retirement plans, comparable to the QDIA regulations enacted nearly 20 years ago that transformed retirement accounts by introducing target date funds and expanded access to diversified, professionally managed portfolios.
Private markets, with their long-term focus, innovation, and historical ability to outperform public market returns are particularly suited for retirement plans. Providing more plan participants access to these benefits could revolutionize the retirement industry and improve outcomes for millions of Americans.
While the details are still to be finalized, HarbourVest aims to contribute to this process by sharing our perspective and leveraging over 40 years of experience in diversified, multi-manager strategies at scale. We look forward to sharing our insights on this and other issues of importance for our clients as they develop.
Footnotes
- https://www.erisapracticecenter.com/2020/06/dol-information-letter-outlines-fiduciary-considerations-for-including-private-equity-allocations-in-defined-contribution-plan-investments/
- https://www.erisapracticecenter.com/2020/06/dol-information-letter-outlines-fiduciary-considerations-for-including-private-equity-allocations-in-defined-contribution-plan-investments/
- Chairman and CEO Letter to Shareholders, JPMorganChase (April, 2024)
- Examining Private Equity in Public Pension Investments, Reason Foundation (January, 2021)
Disclosure
Diversification does not ensure a profit or protect against a loss.
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