Prohited Transaction through Common Ownership

[austin3515]

A pooled 401k Plan wants to make an investment in a limited partnership. Plan will purchase 50% of the LP from an unrelated party, and the owner of the Plan sponsor will purchase 50% of the LP from an unrelated party.

Is this a prohibited transaction? I wouldn't think that simply being related to the other owners would create a PT. As an example, the Plan could by Microsoft stock and the owner could also by Microsoft stock without engaging in a PT (assuming the shares were acquired from unrelated parties).

[Belgarath]

Does having sole control (in essence) of the LP confer any benefit upon the owner, as opposed to owning only 50%? This is just an off-the-cuff reaction - I haven't done any research on this question. But it smells bad...

[austin3515]

I don't think so, it's just regular old ownership.

[Belgarath]

I can't help thinking that there may be self-dealing by a fiduciary here. But I would refer to ERISA counsel on this one - I'm sure they would look through to the possible benefits to the fiduciary of this transaction. I may be all wet,

[masteff]

I agree about having an ERISA atty vet it, but meanwhile here's some brief reading that might help...

http://www.sdraservices.com/2011/02/15/sit-nofit-and-bernie-madoff-part-1/

http://www.sdraservices.com/2011/02/23/sit-nofit-and-bernie-madoff-part-ii/

http://www.jeffnabers.com/2008/07/24/coinvesting-with-your-plan-partnering-with-disqualified-persons/

http://www.dol.gov/ebsa/programs/ori/advisory2000/2000-10a.htm

The most important sentence (in my opinion) from that DOL opinion for your current scenario is: "Moreover, the fiduciary must not rely upon and cannot be otherwise dependent upon the participation of the IRA in order for the fiduciary (or persons in which the fiduciary has an interest) to undertake or to continue his or her share of the investment."

A few search words you might try in combination with "prohibited transaction" and "dol advisory" are coinvest and simultaneous invest

[QDROphile]

First question: Is the owner of the plan sponsosr a fiduciary? If so, is that fiduciary the fiduciary that made the dscision that the plan would invest in the LP? If both are true, the ice is extremely thin and I would not go there.

[jpod]

Even if the owner is not explicitly a plan fiduciary, there still could be a self-dealing PT because the fiduciary who is nominally making the investment decision here may be under so much pressure to please the owner that either (a) the owner is acting as a fiduciary, and/or (b) the owner is someone in whom the fiduciary has "an interest." Bottom line is that regardless of whether this is a good investment for the plan, the facts as stated are such that I think we all know that there is probably a self-dealing PT going on here.

[KJohnson]

Agree with the above. Also, always be sure to look at the plan asset rules. In certain instances if the LP is not an operating company the underlying assets of the LP would be considered plan assets and you woud not only hae to deal with the initial investment itself, but also PT issues on the underlying assets.

[austin3515]

You've got me convinced on this one:

The most important sentence (in my opinion) from that DOL opinion for your current scenario is: "Moreover, the fiduciary must not rely upon and cannot be otherwise dependent upon the participation of the IRA in order for the fiduciary (or persons in which the fiduciary has an interest) to undertake or to continue his or her share of the investment."

I'm sure the plan got in the mix as a source of capital to make the deal go through. I over simplified, the truth is the plan owns about 15%, and the rest is owned by the owners. But I think it's a reasonable assumption that the plan was involved to "top off" the investment.

[masteff]

Actually, I'm measurably more comfortable at 15% than I was with a 50/50 split.

[Peter Gulia]

austin3515, a further way to think about the hypothetical situation you described is to ask yourself a rhetorical question: Why did these particular LP interests suddenly become the best thing that the retirement plan could invest in? If there isn't a cogent investment-grounded answer to that internal question, it seems likely that at least one transaction is a prohibited transaction (although perhaps one that might be or become exempt).

If you're not sure that everything is perfect, consider suggesting to your client that it engage an independent fiduciary to make the plan's decisions.