On August 3, 2006, Congress passed the Pension Protection Act of 2006 (the “Act”), which President Bush is expected to sign into law soon. Buried in this legislation is a nugget that will be a real help to private equity funds. Specifically, the Act provides a new “plan asset” definition for purposes of ERISA that will allow funds to avoid ERISA’s burdensome requirements more easily.
Most private equity funds avoid ERISA’s requirements by either qualifying as a venture capital operating company or making sure that participation by benefit plan investors in the fund is not significant. Under current law, participation by benefit plan investors is deemed significant if, immediately after the most recent acquisition of any equity interest in an entity, twenty-five percent or more of the value of any class of equity interests in the fund is held by benefit plan investors. The Act keeps this percentage at twenty-five percent, but helps private equity funds in two ways:
- First, an entity will only be considered to hold plan assets to the extent of the percentage of the equity interests owned by benefit plan investors. For example, suppose a fund-of-funds is subject to ERISA because fifty percent of its equity interests are owned by benefit plan investors and that fund invests $20 million in a second fund. Under pre-Act rules, the entire $20 million would be treated as an investment by a benefit plan investor for purposes of determining whether participation by benefit plan investors in the second fund was significant. Under the Act, it appears that only $10 million would now be treated as an investment by a benefit plan investor (i.e., fifty percent times $20 million).
- Second, under pre-Act law, a benefit plan investor was defined broadly to include not only plans that are subject to ERISA, but also certain other employee benefit plans that are not subject to ERISA, such as government and foreign plans. Under the proposed legislation, only plans subject to ERISA’s fiduciary duty rules or to the prohibited-transaction rules of Section 4975 of the Internal Revenue Code will be considered benefit plan investors. Therefore, investments by foreign and government plans will not count as benefit plans investors when applying the twenty-five-percent test.
Some funds trip over the twenty-five-percent test because of investments made by government and foreign plans. Now that these plans no longer count toward the test, it will allow more funds to stay below twenty-five percent and, thereby, avoid ERISA’s requirements without having to qualify as a venture capital operating company. This statutory change becomes effective with respect to transactions occurring after the date that the president signs the Act into law.
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