(Photo: Shutterstock)

Can Open Multiple-Employer Plans serve as thecatalyst to wider adoption of illiquid alternative asset classes in401(k) plans?

While the connection may not be obvious on its face, JoshuaLichtenstein, an ERISA attorney and partner at Ropes & Gray,says the benefits that alternatives have served in defined benefitportfolios is compelling reason to expand the range of investmentvehicles in 401(k) plans.

The fiduciary structure of MEPs could facilitate wider access toalternatives, thinks Lichtenstein.

"Defined benefit returns are higher and difference seems to bethe use of alternatives," he said.

Illiquid alternatives like private equity, hedge funds, and realestate are staples in pension management. Some alternatives areavailable to investors in 401(k) plans. Data from the Plan SponsorCouncil of America shows that about 11 percent of DC plans includesome form of alternative asset class, typically through mutual fundTDFs.

Registered funds are limited to the amount of underlyingunregistered investments they can include before tripping theSecurities and Exchange Commission's definition of accreditedinvestor.

That limitation, and a decade of fee-based lawsuits againstsponsors of defined contribution plans, has left most employersleery of offering illiquid, opaque, and often expensive assetclasses, even if those assets could enhance returns and retirementoutcomes.

"It's impossible to talk about the DC landscape without talkingabout litigation risk," said Lichtenstein. "In my view, that hasinfluenced the makeup of investment menus. The big movement hasbeen to identify the lowest cost investment options to reducelitigation risk."

That could change with MEPs. Under the Setting Every CommunityUp for Retirement, or SECURE Act, which was attached to the fundingpackage President Trump signed into law last week, large moneymanagers can be the fiduciary sponsors of Open MEPs.

"Part of the challenge individual sponsors face when designing amenu with alternatives is they always don't have theinfrastructure. It's more difficult to benchmark and compareprivate funds compared to public funds. But providers of Open MEPswill be sophisticated financial institutions. They understand howprivate funds work, the questions that need to be asked of fundmanagers, and how to evaluate their claims. And they have a broadview of what's available in the market."

SECURE allows recordkeepers, asset managers and insurancecompanies to sponsor Open MEPs. Still, industry will enter 2020waiting for the Labor Department to issue clarifying regulations onMEP sponsorship.

While SECURE is positioned toward small and midsized employersthat don't offer retirement plans, nothing in it limits the size ofemployers that can join an Open MEP, which allows unaffiliatedemployers to pool workers under one centralized MEP that is run bya fiduciary.

"There is no restriction in the Act as to the size of employerthat can joint a MEP," said Lichtenstein. "We think theconversations on alternatives in DC plans that have been ongoingcould become more real. Financial Institutions will want to do thisbecause it could provide a competitive advantage, and that couldopen larger scale plan design to a broader range of employers. Notjust for big plans, but small plans as well."

If Open MEPs prove to be a catalyst to wider use of alternativeinvestments in 401(k)s, two things will have to happen, saysLichtenstein.

A lawsuit against Intel Corp. in the Ninth Circuit over its useof alternative assets in its 401(k) will have to have a favorableresult for the company. The case was recently argued before theSupreme Court on a statute of limitations question.

If the case is remanded back to the district court, tried, andruled on in favor of Intel, the role of alternatives in 401(k)swill be encouraged, to a degree. If the lower court finds Intel'sfiduciaries mismanaged the plan by including alternatives, theopposite would be the case.

The other factor will be the type of regulations Laborproduces.

"A lot will depend on what Labor puts out and when. If they putout early guidance that provides enough for industry to move on,things will happen more quickly. If the guidance is too vague, itwill take a longer time," said Lichtenstein.

READ MORE:

• Impact and opportunities in the SECUREAct
• With or without SECURE Act, industryon the precipice of new evolution
• What the SECURE Act means for annuities in401(k)s