George Michael Gerstein

George Michael Gerstein advises financial institutions on the fiduciary and prohibited transaction provisions of ERISA. As co-chair of the fiduciary governance group, he assists clients with tracking, and understanding, the numerous fiduciary developments at the federal and state levels, including the rules and regulations of governmental plans. He also advises clients with respect to the fiduciary duty implications of ESG investing.

ERISA Excerpt: COVID-19 Checklist & Considerations for Private Fund Advisers

ERISA excerpt from yesterday’s blog post, COVID-19 Checklist & Considerations for Private Fund Advisers:

  • Non-ERISA Funds. Private funds that are structured to avoid being subject to the U.S. Employee Retirement Income Security Act of 1974 (ERISA) by reason of the significant participation/25% exception should carefully monitor to ensure that redemptions out of a fund do not result in “benefit plan investors” (i.e., ERISA plans, individual retirement accounts, and “plan assets” fund-of-funds, etc.) holding 25% or more of any equity class of the fund. For a description of the significant participation test, please see our recent client alert here.
    • The fund sponsor/manager may have contractually committed to preventing the fund from holding “plan assets,” in which case it should refer to, and comply, with such commitments. Amendments to these terms will likely require consent of the ERISA plan, and even potentially governmental plan, investors.
    • If redemptions inadvertently cause the fund to hold “plan assets,” the sponsor/manager may face significant obstacles in terms of ERISA compliance. For example, special care should be taken where the investment manager is newly formed, where a performance fee is paid to the investment manager, and/or where the investment manager enters into transactions with affiliates.
  • ERISA Funds. Sponsors and managers of funds that are structured to operate as “plan assets” vehicles, and, therefore, comply with ERISA, will likely be relying upon the QPAM Exemption. The QPAM Exemption contains multiple technical conditions, some of which may be stressed in volatile times. For example, the QPAM Exemption would not cover transactions otherwise consummated by the investment manager on behalf of the fund if one or more investing plans of an employer (or affiliates of the employer) constitute more than 20% of the total client assets (e., inside and outside of the fund) managed by the investment manager at the time of the transaction. Investment managers that lose numerous, or particularly important, clients could potentially run afoul of this condition, which would mean they would have to rely on some alternative exemption, such as Section 408(b)(17) of ERISA, for its trading. Finally, in terms of significant volatility of pricing, investment managers operating ERISA “plan assets” funds should be careful about using their own valuation methodologies of fund holdings so as to avoid potential self-dealing concerns.

How Hedge Funds Can Avoid Becoming Subject to ERISA

The U.S. Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that governs the management and investment of U.S. private sector employee benefit plans. It aims to protect plan participants from conflicts of interest and imprudent decision-making. ERISA imposes stringent standard of care requirements on “fiduciaries” and prohibits a wide range of transactions absent adherence to an exemption. A breach of a fiduciary duty under ERISA or a non-exempt prohibited transaction under ERISA or Section 4975 of the U.S. Internal Revenue Code of 1986 (Code) can result in severe penalties, including civil liability and excise taxes.

Numerous hedge fund sponsors/managers try to avoid becoming subject to ERISA due its technical requirements and potential liability. The most prominent way in which sponsors/managers avoid ERISA is by structuring its fund to fall within a safe harbor, the significant participation test. This client alert focuses on that safe harbor. (Sponsors and managers of other alternative funds, such as private equity, may rely on other safe harbors). We will address in a future client alert the ramifications for a fund sponsor/manager if its hedge fund becomes subject to ERISA.

A hedge fund manager is a fiduciary under ERISA if it has discretionary management over “plan assets.” An ERISA plan’s investment in a hedge fund would generally convert the fund into a “plan assets” ERISA investment vehicle. A hedge fund that holds “plan assets” would subject the investment manager to ERISA, including strict fiduciary duties and prohibited transaction restrictions.

However, Department of Labor (DOL) regulations provide a safe harbor from “plan assets” status on which many hedge funds rely. Simply, a hedge fund avoids becoming subject to ERISA if “benefit plan investors” hold less than 25% of each equity class (excluding any interests held by the general partner or investment manager). This test is conducted on a class-by-class basis. Section 3(42) of ERISA and applicable DOL regulations define “benefit plan investors” (BPIs) as plans subject to the fiduciary responsibility provisions of ERISA, plans subject to Section 4975 of the Code (e.g., IRAs), and fund investors that are themselves plan asset vehicles. Subscriptions from governmental plans and non-U.S. plans are not counted toward the 25% limit. Subscription booklets will often include an ERISA questionnaire to ascertain whether a potential investor is a BPI for purposes of determining whether the fund falls within the safe harbor.

Fund sponsors/managers need to be vigilant and recognize that the test is recalculated at the time of each new subscription, transfer and redemption into and out of the hedge fund. If the 25% threshold is met or exceeded, the fund immediately becomes an ERISA “plan assets” vehicle and the investment manager must comply with ERISA. Hedge fund sponsors/managers that wish to avoid this result will typically have certain rights to ensure the fund stays within the safe harbor. The sponsor/manager will probably have the right to require BPIs to redeem out of the fund if the 25% threshold may be breached. The sponsor/manager should also have the right to approve any prospective transfer of interests. Most BPIs do not object to these types of provisions. Some ERISA plan investors may negotiate certain rights in a side letter, such as a requirement that the mandatory redemption provisions be implemented against all BPIs in an equitable manner. It would be important to evaluate whether granting too many, or certain, rights in a side letter inadvertently creates a new “class,” thereby undermining the strategy of avoiding “plan assets” status.

The significant participation test is tested on an entity-by-entity basis. This means that, in a master-feeder structure, each feeder fund and the master fund are all tested separately. Some fund sponsors attempt to “hardwire” their feeder funds as a way to increase ERISA capacity while still falling within the safe harbor. Under this structure, the offshore feeder fund would hold “plan assets” because 25% or more of its share class will be held by BPIs, whereas both the domestic feeder fund and master fund would avoid holding “plan assets” by satisfying the significant participation test. Both feeders would have to invest all of their investible assets in the master fund. Some take the position that, even though the offshore feeder holds “plan assets,” the investment manager is not an ERISA fiduciary because the manager effectively has no discretion or ability to trade out of the feeder. This allows hedge fund sponsors/managers to increase ERISA capacity while avoiding ERISA compliance. Hardwiring may not be feasible for all funds, so this should be considered early in the structuring process.

The safe harbor/significant participation test does not address the idiosyncratic issues associated with governmental plans. These plans are not subject to ERISA and they have their own set of rules and investment restrictions. Governmental plans may have their own “look through” to the hedge fund’s operations, regardless of whether the fund holds “plan assets” under ERISA. It is important for hedge fund sponsors/managers to independently confirm whether the laws applicable to governmental plan investors could extend to the hedge fund.

The safe harbor also does not cure prohibited transactions that arise from subscribing to the hedge fund. For example, a prohibited transaction exists if the seller of the fund’s interests is a “party in interest” to the BPI. Subscription materials will typically ask for a representation from the BPI that the subscription is either not a prohibited transaction or that such prohibited transaction is covered by an exemption. Another example of a potential prohibited transaction is when principals of the fund sponsor wish to invest their IRAs in the fund. Irrespective of whether the fund holds “plan assets,” such subscription gives rise to prohibited transaction concerns and should be addressed accordingly. The most likely approach to addressing that prohibited transaction is to waive all fees with respect to the IRA’s investment in the fund.

Only ‘Actual’ Knowledge of Disclosure Triggers Three-Year Limitations Period for ERISA Fiduciary Breach Claims

The U.S. Supreme Court’s unanimous decision in Intel Corp. Investment Policy Committee et al. v. Sulyma sharpens the ‘actual’ knowledge standard that triggers the three-year limitations period for breach of fiduciary duty claims arising under the Employee Retirement Income Security Act. Under Sulyma, the statutory phrase ‘actual’ knowledge means what it says: the three-year period is limited to circumstances where a plaintiff/participant actually knows of the disclosure evidencing the alleged breach. Absent proof of such knowledge, ERISA’s longer six-year repose period applies.

Background and Analysis
Plaintiff Sulyma worked at Intel between 2010 and 2012 and participated in two of Intel’s ERISA retirement plans, investing in target date and other funds managed by an Intel investment committee responsible for making the funds’ asset allocations. Over time, the committee increased the funds’ allocations to alternative investments, increasing the funds’ cost and resulting in performance that lagged index funds with greater equity exposure. In October 2015, Sulyma sued the Intel committee and other plan administrators on behalf of a putative class for breach of fiduciary duty under ERISA, complaining of allegedly imprudent investments and inadequate disclosures regarding the same.

Intel had disclosed these investment decisions to all plan participants, including Sulyma, through various notices and plan documents distributed by email and made available through an online benefits website. The documents disclosed the existence of the alternative investments and the basis for allocating some of the funds’ assets to alternatives, including hedge funds, private equity funds and commodities. Sulyma received the emails and accessed some of this information online, but testified that he did not “remember reviewing” the disclosures and was “unaware” while working at Intel that the monies he had invested in the funds had been reinvested in hedge funds and private equity. He recalled viewing account statements sent by mail, which noted that his plans were invested in “short-term/other” assets but did not specify the investments.

Intel moved to dismiss the case because Sulyma filed more than three years, but less than six years, after Intel issued relevant disclosures to plan participants, including Sulyma. The District Court granted summary judgment in favor of the Intel defendants, and the Ninth Circuit reversed, focusing on the plain meaning of ‘actual’ knowledge. In adopting the Ninth Circuit’s reasoning, which echoed most other Circuits, the Supreme Court emphasized that where ERISA utilizes ‘actual’ rather than a constructive or implied knowledge standard, the term “actual” must be given its plain meaning and requires “more than evidence of disclosure alone.” To meet the ‘actual’ knowledge requirement, a plaintiff/participant “must in fact have become aware of” the disclosure underlying the alleged breach of fiduciary duty. The Supreme Court recognized that ‘actual’ knowledge can be proved through “inference from circumstantial evidence,” including electronic records showing a plaintiff/participant viewed the relevant disclosure and evidence suggesting that she understood and took action in response to the information in the disclosure. Importantly, the Intel defendants did not argue that ‘actual’ knowledge was established in these ways. Instead, they argued “only that they need not offer any such proof,” an argument that the Court rejected.


  • To the extent that the Court’s ruling diminishes the protections afforded to plan fiduciaries under ERISA’s limitations framework, the Court deferred such policy considerations to Congress.
  • The opinion leaves room for plan fiduciaries to argue that evidence of a plaintiff/participant’s “willful blindness” to disclosures supports a finding of ‘actual’ knowledge.
  • When crafting disclosures, fiduciaries should take care to use plain language that is accessible and understandable for the average participant.
  • Dissemination of disclosures should be tracked, with acknowledgments sought where appropriate, to confirm plan participants are reading and comprehending such information.
  • When considering challenges to class certification, fiduciaries may find utility in highlighting the individualized nature of probing the ‘actual’ knowledge of plaintiff/participants.