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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
Congressional leaders are calling for guidance from the Department of Labor (DOL) on the use of alternative investments by pension plans, following a Government Accountability Office (GAO) recommendation that the DOL provide plan fiduciaries with guidance, specifically designed for qualified plans under ERISA, regarding plan investments in hedge funds and private equity.
In recent years, a growing number of defined benefit (DB) pension plans have been investing in alternative investments, such as hedge funds and private equity funds. There is no statutory definition of either term but, the GAO notes, the term “hedge fund” commonly refers to a pooled investment vehicle that is privately organized and administered by professional managers, which often engages in active trading of various types of securities, commodity futures and options contracts. “Private equity funds” generally refer to privately managed investment pools administered by professional managers, who typically make long-term investments in private companies, taking a controlling interest with the aim of increasing the value of these companies through such strategies as improving operations or developing new products. Both investment vehicles are usually managed so as to be exempt from certain aspects of federal securities law and regulations that apply to other investment pools, such as mutual funds.
While hedge funds and private equity funds remain a relatively small portion of DB plans’ assets, concern has been raised about the potential risks in utilizing such unregulated investments in place of more traditional investments. As a result of these concerns, Congress requested that the GAO ascertain the extent to which plans were utilizing alternative investments, examine the potential benefits and pitfalls in such investments, and investigate what mechanisms currently exist to regulate and monitor pension plan investments in alternative investments.
The GAO’s analysis of survey data found that average allocations to hedge funds and private equity in 2007 were about 4 percent and 5 percent of total plan assets, respectively, although some plans had hedge fund allocations as high as 30% and private equity allocations as high as 20%. In 2007, the GAO found, 47% of large DB plans had investments in hedge funds, up from 11% in 2001, and 80% of such plans had private equity investments, up from 71% in 2001. The GAO found that midsize plans had a lower level of alternative investments. Data on plans with less than $200 million in total assets was unknown.
Hedge funds have the potential benefit of offering greater and more stable returns than traditional stock market investments, the GAO found, but also posed risks which stock market investments do not have, such as:
Certain plans surveyed also admitted that their hedge fund investments had not yet been tested under stressful economic conditions, such as a significant stock market decline, the GAO found.
Private equity funds are used by plans to attain returns superior to the stock market, the GAO reported. Plan officials generally had a longer history of investing in private equity than in hedge funds, in some cases up to 20 years, and they claimed that such investments have met expectations for returns. According to the GAO, the challenges unique to private equity include:
Both hedge funds and private equity, the GAO states, require considerably greater effort and expertise to monitor and perform due diligence than do more traditional investments, and such steps may be beyond the capabilities of some pension plans, particularly smaller ones.
Federal law and regulations impose no explicit restrictions on private sector plan investments in hedge funds or private equity, the GAO found, other than the general fiduciary duty to invest plan assets prudently. (Certain states were found to have legislation that restricts or prohibits public plan investments in hedge funds or private equity.) The GAO concluded that, in order to assist plan fiduciaries in assessing their ability to invest in hedge funds and private equity, the DOL should issue guidance on such investments specifically designed for qualified plans under ERISA. The GAO noted that the DOL itself generally concurred with this recommendation.
Senate and House committee leaders have expressed their support for the report’s recommendations.
“The current turmoil in our financial markets reminds us of the need to discourage excessive risk-taking and inappropriate speculation,” said Rep. Paul Kanjorski (D-PA) of the House Financial Services Committee.
“Plan sponsors…are investing more and more pension assets in these risky investments in pursuit of big returns,” stated Senate Finance Committee Ranking Member Chuck Grassley (R-IA). “But these healthy returns could go south overnight. When the bottom falls out, it’s the plan participant, or in the worst case, the taxpayer, who pays the price.”
Rep. Mike Capuano (D-MA) of the House Financial Services Committee concluded that “…it is imperative that the Department of Labor promptly issue their pending guidelines on alternative investments so that investors and pensioners are thoroughly aware of the challenges and risks of these ventures.”
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