Private Placement in 401(k) Plan

[Jim Chad]

90% of the 401(k) Plan is the owner and his wife, other 10% belongs to two employees.

It is trustee directed Plan, presently.

Owner is in the financial industry and a very knowledgeable investor. He wants to invest $200,000 in a private placement. (Broker dealer has approved him.)

He says he will be able to get a proper valuation every year.

Do you see any problems with him buying it for the Plan as a whole?

Should we make this Participant directed and have him buy it for himself only?

[QDROphile]

This is a fiduciary issue. Who is the fiduciary? If the individual is the trustee with investment authority, what are you asking (or perhaps, why are you asking)? Does the individual need educaton about ERISA fiduciary standards to supplement his vast financial and investment knpowledge? The question about change to participant direction could be handled as a corporate function by plan amendment.

[Jim Chad]

I guess I don't know if there is a minefield regarding private placements. I have never dealt with one before. Any thoughts?

[QDROphile]

Custody, liquidity, valuation, liquidation/distribution, possible prohibited transactions, UBTI (especially for an operating company), fiduciary issues because of the ERISA plan asset rules (for an investment vehicle). All of those concerns are manageable if considered and addressed. For example, the valuation concern may have been adequately addressed, at least for the present. Things change with these investments, especially if they are not successful. As a very general matter of prudence, an investment that is illiquid should not represent a very large portion of the plan assets.

[Kevin C]

You will also need to keep an eye on the small plan audit waiver requirements. My experience has been that private placements don't meet the requirements to be "qualifying plan assets" under §2520.104-46 (b)(1)(ii). If they are not careful with their bond amount, they could be in for an unpleasant surprise and find an audit required for their 5500.

Don't be surprised if the "proper valuation" each year he is referring to ends up being a copy of the K-1.

[K2retire]

Don't be surprised if the "proper valuation" each year he is referring to ends up being a copy of the K-1.

And the rules are abundantly clear that the "book value" shown on a K-1 has no relationship to the "fair market value" required to be determined for a plan valuation.