Unqualified Asset - Private Equity/Stock in 401k Plan

I know that the #1 best answer to my question will be "hire an ERISA attorney". But I'm hoping someone here has experience, and can relay their thoughts on my PITA situation. And please don't fuss at me too much; only looking for real life experience, not scolding. I hate non-qualified assets in a Plan, but this wasn't my idea.

Background info: 

-- Medical practice with 401k, Trustee is the doctor. 73% of the Plan assets belong to the owner (Dr), his wife, and his daughter, and the other 27% belongs to 9 NHCE participants.

-- 56% of assets are in a pooled account (Schwab) + 44% is in private stock (this valuation is part of my question though, so the 44% may not be accurate). All requirements are being met concerning the 5500/Sch I/audit reqm't.

-- This 401k Plan purchased the private stock for $2/share in 2019. The company prepared IRS Forms 5498(?) in 2022 stating its value as $17.57/share. There is going to be a valuation done this fall (b/c of a capital-raise) and most likely a sale of the company next year. (Thank goodness) So in this plan, the stock asset showed a large gain in 2022, to reflect the value of $17.57/share.

-- The doctor is now very worried the value will drop to $0, and wants to report its value on 12/31/25 as being back at the purchase price of $2/sh.

-- One of the 9 NHCE participants was paid out during 2024, and her vested balance was determined using the Schwab account + private stock at $17.57/share. She was paid out of the Schwab acct to avoid having to transfer shares of the private stock in-kind (would be very impractical). 

Question --

(1) Can we make future plan distributions by paying out their share of the Schwab account, but hold back their portion of the private stock to be paid once it liquidates? They'd get the 2nd payout as soon as that occurs.

(2) Should we reflect the asset's value back down at the $2/share? Or is the more accurate value the $17.57/share as reported by the company to its other share-holders?

There is no way to really know how much it's worth until it does actually sell. I personally believe the $17.57/sh valuation is the more accurate of the two since that is what has been used consistently in this plan since 2022, and in other reportings outside of just this plan since then as well.

My main objective, of course, is to be as fair as possible to the NHCE participants in the plan.

THANK YOU.

I am not even going to try and answer the distribution question.  That is just a classic example why these kinds of assets should never be in these kinds of plans but you know that already.  

Regarding the stock's value.  Since this isn't an ESOP they are technically no legally required to get an appraisal.   However, both the trustee and Plan Administrator as fiduciaries are REQUIRED to ascertain a fair market value of all assets in a plan ANNUALLY.  And simply guessing isn't a valid method.  Since the Dr is most likely the trustee that person needs to be able to document on what basis the stock was been valued every year and it sounds like they have failed at that.  That is the start of the legal mess this plan is in.   

My advice to you is to get something in writing from the trustee directing you on what they want the value has been determined.  I might even ask them to give a brief description of how they came up with that value.  If they aren't willing to do that I think you should seriously ask yourself if you need this in your life. 

Yes, I get landing client is very hard and asking one to go away is very hard to do.  This sounds like a huge mess.  

But picking numbers like $2/shr or $17.57/shr out of thin air is a failure on the part of the trustee to do their fiduciary duty.  That is a pretty serious problem for that person if the DOL or IRS catches it.  

Unequivocally, DO NOT get involved in making any decisions about the plan, and DO ask for written documentation (preferably with the signature of at least one fiduciary) about the pricing of the stock and about the value used for making distributions.  If the client and fiduciaries refuse to do this, resign immediately.  Otherwise, in the near future you may get a call from the DOL or IRS, and you may be making a call to you E&O insurance provider and legal counsel.

Read the plan provisions about what value is used to determine the amount of a participant's vested benefit, and read the provisions about the permissible form of payment, including if it must be in cash or could be in-kind.  It also would be prudent to read those often-unread provisions in the plan document (particularly in the Basic Plan Document if this is a pre-approved plan) dealing with trustee and fiduciary responsibilities.  If the trustee clearly is violating the plan document or trust agreement and is adamant about directing you to violate these documents, resign immediately.

If the plan was audited, the auditors may or may not be aware of the machinations being contemplated by the trustee.  You may suggest to the client that they consult with the auditors and also with the plan's legal counsel.

This is not your circus unless you make it your circus.

Thank you both, ESOP guy and Paul I.

I will be following both of your advice - GET IT IN WRITING from the Trustee/Plan Sponsor.

Thank you so much.

I want to add this comment -- the Dr could take 100% of the private stock as his own segregated investment, however, if it does sell at a huge gain, he wants all the participants to share in that! It's a double-edged sword, I guess. If the stock does go to $0 value, they'll all share in that massive loss.

At least the Dr's intentions are good!

In addition to what everyone else has been saying, before beginning to do any work for them, I would also ask for as much of your anticipated fee for this to be paid up front. If this goes South, the doc will be looking to point the finger at you and developing a convenient memory of what was said and by whom, and use that as a basis for not paying you. In addition, as the sole fiduciary, he may well end up being personally liable for any shortfall resulting from a massive loss, in which case, you would need to get in line with everyone else who wants to get paid. If the doc does not agree, do not do the work, dismiss the client and sit back and watch the fireworks! You will be glad you followed these steps and possibly financially ahead of the game.

Of course this involves a doctor. I have seen doctors do this or similar with profit sharing plan funds (that primarily cover themselves) but using 401(k) deferrals (of others) really shows someone working with clogged stethoscope.  (Lawyers do this too but doctors are in a class of their own) The exit on this can likely be structured to work from an IRS perspective, which might end up having to pay out the illiquid assets with participants entering shareholders' agreements (f permitted under company articles, etc.), delaying payments due to the illiquid nature of the assets or even terminating the plan and distributing funds to a liquidating trust in a nonqualified plan.  That said, no matter how it is structured, one of these participants is going to end up calling the DOL.   I mean if you try to value the stock at $2/share (idiotic) the hit the participants will take when they see their plan statements may cause them to call the DOL immediately.

All this scenario bring up is questions with few answers.  The DOL likely is going to look first at whether there was a prohibited transaction when the stock was initially purchased.  That is, was the stock purchased from a related party/disqualified person/party in interest?  What is the relationship of the doctor with the company and/or the prior owners of the company?  How much of the company is now owned by the "plan"? etc. etc.  Then, they will look at this valuation issue.  Depending on the answer to the prior questions, was the $2/share valuation accurate.   And as noted above, he can't simply say it is now worth $2/share.  He needs a valuation, preferably from an independent third party, to rely on.  Where did the $17 valuation come from?  Was it an independent appraisal or was it determined by the board, or something like that?  What was the purpose of that valuation (if to get a loan... likely high... if for taxes... likely low).  So, it could have been too low even.  Using $2/share at this time is just an arbitrary decision (let's get a second x-ray, I liked what the first one showed and the MRI costs too much... (oh yeah, I own the x-ray machine but not the MRI so someone else will get the MRI fees).   Even upon the sale you have to worry about a PT.  They may have to look into the voluntary fiduciary correction program when the sale comes up.. there are some illiquid asset provisions in there depending on if there is a PT or not.

Yeah, protect yourself, get paid, and warn the doctor that there are serious fiduciary/DOL issues here and that he may end up having to fund these participants' retirements.

On 6/20/2025 at 8:08 PM, Artie M said:

Of course this involves a doctor. I have seen doctors do this or similar with profit sharing plan funds (that primarily cover themselves) but using 401(k) deferrals (of others) really shows someone working with clogged stethoscope.  (Lawyers do this too but doctors are in a class of their own) The exit on this can likely be structured to work from an IRS perspective, which might end up having to pay out the illiquid assets with participants entering shareholders' agreements (f permitted under company articles, etc.), delaying payments due to the illiquid nature of the assets or even terminating the plan and distributing funds to a liquidating trust in a nonqualified plan.  That said, no matter how it is structured, one of these participants is going to end up calling the DOL.   I mean if you try to value the stock at $2/share (idiotic) the hit the participants will take when they see their plan statements may cause them to call the DOL immediately.

All this scenario bring up is questions with few answers.  The DOL likely is going to look first at whether there was a prohibited transaction when the stock was initially purchased.  That is, was the stock purchased from a related party/disqualified person/party in interest?  What is the relationship of the doctor with the company and/or the prior owners of the company?  How much of the company is now owned by the "plan"? etc. etc.  Then, they will look at this valuation issue.  Depending on the answer to the prior questions, was the $2/share valuation accurate.   And as noted above, he can't simply say it is now worth $2/share.  He needs a valuation, preferably from an independent third party, to rely on.  Where did the $17 valuation come from?  Was it an independent appraisal or was it determined by the board, or something like that?  What was the purpose of that valuation (if to get a loan... likely high... if for taxes... likely low).  So, it could have been too low even.  Using $2/share at this time is just an arbitrary decision (let's get a second x-ray, I liked what the first one showed and the MRI costs too much... (oh yeah, I own the x-ray machine but not the MRI so someone else will get the MRI fees).   Even upon the sale you have to worry about a PT.  They may have to look into the voluntary fiduciary correction program when the sale comes up.. there are some illiquid asset provisions in there depending on if there is a PT or not.

Yeah, protect yourself, get paid, and warn the doctor that there are serious fiduciary/DOL issues here and that he may end up having to fund these participants' retirements.

 

Artie M, thank you. "Clogged stethoscope".... love it!

The $2/share was the purchase price. I do NOT think that is a fair value, because the issuing-company (board, I guess) was raising money in 2022 and I'm almost certain the valuation was an independent one (I'll have to double check on that). IF the $17.57/sh was indeed produced independently, that is the best value to use at this time.

Fortunately, there is no related party/PII issue. No relationship at all. The shares of this private stock makes up 42% of the total plan value. The other 58% is in a regular investment account (Schwab, with an outside manager).

THANK YOU!

Even if there might be no breach grounded on a prohibited transaction, the fiduciaries might want its and his lawyer’s advice about whether there might be a diversification or other prudence breach.

ERISA § 404(a)(1)(C): “[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and— . . . by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so[.]” http://uscode.house.gov/view.xhtml?req=(title:29%20section:1104%20edition:prelim)%20OR%20(granuleid:USC-prelim-title29-section1104)&f=treesort&edition=prelim&num=0&jumpTo=true

Also, a fiduciary or a participant might want one’s lawyer’s advice about ERISA’s statute-of-repose- and statute-of-limitations periods.

ERISA § 413: “No action may be commenced under this title with respect to a fiduciary’s breach of any responsibility, duty, or obligation under this part, or with respect to a violation of this part, after the earlier of—

(1)   six years after (A) the date of the last action which constituted a part of the breach or violation, or (B) in the case of an omission the latest date on which the fiduciary could have cured the breach or violation, or

(2)   three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation;

except that in the case of fraud or concealment, such action may be commenced not later than six years after the date of discovery of such breach or violation.”

http://uscode.house.gov/view.xhtml?req=(title:29%20section:1113%20edition:prelim)%20OR%20(granuleid:USC-prelim-title29-section1113)&f=treesort&edition=prelim&num=0&jumpTo=true

Did the 2019-2023 financial statements disclose the investment concentration?

A service provider might want its lawyer’s advice about how to manage the service provider’s work (if any) so no one could plausibly assert that the service provider was involved in a fiduciary’s concealment (including by falsely reporting a value in a Form 5500 report) of a fiduciary’s breach.

An independent qualified public accountant might want its lawyer’s advice about how best to protect the CPAs’ work on the 2019, 2020, 2021, 2022, and 2023 financial-statements reports, and about whether the firm must or should decline an engagement to audit the plan’s 2024 financial statements.

Anyone might consider probabilities about whether a claim might be pursued. Even if the nine participants who are not the fiduciary, the fiduciary’s spouse, and the fiduciary’s child discern a breach and how it harmed them, their stakes might be too small to attract EBSA enforcement.

1 hour ago, Peter Gulia said:

Even if there might be no breach grounded on a prohibited transaction, the fiduciaries might want its and his lawyer’s advice about whether there might be a diversification or other prudence breach.

ERISA § 404(a)(1)(C): “[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and— . . . by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so[.]” http://uscode.house.gov/view.xhtml?req=(title:29%20section:1104%20edition:prelim)%20OR%20(granuleid:USC-prelim-title29-section1104)&f=treesort&edition=prelim&num=0&jumpTo=true

Also, a fiduciary or a participant might want one’s lawyer’s advice about ERISA’s statute-of-repose- and statute-of-limitations periods.

ERISA § 413: “No action may be commenced under this title with respect to a fiduciary’s breach of any responsibility, duty, or obligation under this part, or with respect to a violation of this part, after the earlier of—

(1)   six years after (A) the date of the last action which constituted a part of the breach or violation, or (B) in the case of an omission the latest date on which the fiduciary could have cured the breach or violation, or

(2)   three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation;

except that in the case of fraud or concealment, such action may be commenced not later than six years after the date of discovery of such breach or violation.”

http://uscode.house.gov/view.xhtml?req=(title:29%20section:1113%20edition:prelim)%20OR%20(granuleid:USC-prelim-title29-section1113)&f=treesort&edition=prelim&num=0&jumpTo=true

Did the 2019-2023 financial statements disclose the investment concentration?

A service provider might want its lawyer’s advice about how to manage the service provider’s work (if any) so no one could plausibly assert that the service provider was involved in a fiduciary’s concealment (including by falsely reporting a value in a Form 5500 report) of a fiduciary’s breach.

An independent qualified public accountant might want its lawyer’s advice about how best to protect the CPAs’ work on the 2019, 2020, 2021, 2022, and 2023 financial-statements reports, and about whether the firm must or should decline an engagement to audit the plan’s 2024 financial statements.

Anyone might consider probabilities about whether a claim might be pursued. Even if the nine participants who are not the fiduciary, the fiduciary’s spouse, and the fiduciary’s child discern a breach and how it harmed them, their stakes might be too small to attract EBSA enforcement.

Peter, this is great information - thank you!

I have reported the assets as required each year, so all are aware of the investments & their ratios. BUT, I know that's not enough to save my behind, necessarily.

Regarding the Code Section 404 -- this plan is not intended to be a 404c plan. Does that declare moot the reference you gave? 

I am going to highly encourage the client speaking with an ERISA attorney, and I'm making note of the 2 statutes you mention. I'll research those (and other items you mentioned) myself.

THANK YOU.

Thank you for your kind words.

The plan’s administrator might imagine it or he has reported as required, but that would not be so if one or more of the reported year-end values for the untraded shares is incorrect and not at least a good-faith estimate. As your discussion-opening post puts it: “There is no way to really know how much [an untraded share is] worth until it does actually sell.” If the plan’s administrator reported the untraded shares’ estimated value without support from an independent appraisal or other respectable valuation method, and one that measured the value as at each reporting date, the administrator might not have sufficiently reported. It might not be a prudent, or even good-faith, estimate to assume that an asset’s value is unchanged from a year’s end to the next year’s end. That might be especially so for an early-stage business.

If a year-end value is off, assumptions about the proportions of different kinds of investments might be mistaken. And one or more disclosures about concentration risks might be incorrect.

That the plan’s fiduciary does not expect an ERISA § 404(c) defense heightens the fiduciary’s responsibility regarding § 404(a)(1)(B) prudence and § 404(a)(1)(C) diversification.

2 hours ago, Peter Gulia said:

Thank you for your kind words.

The plan’s administrator might imagine it or he has reported as required, but that would not be so if one or more of the reported year-end values for the untraded shares is incorrect and not at least a good-faith estimate. As your discussion-opening post puts it: “There is no way to really know how much [an untraded share is] worth until it does actually sell.” If the plan’s administrator reported the untraded shares’ estimated value without support from an independent appraisal or other respectable valuation method, and one that measured the value as at each reporting date, the administrator might not have sufficiently reported. It might not be a prudent, or even good-faith, estimate to assume that an asset’s value is unchanged from a year’s end to the next year’s end. That might be especially so for an early-stage business.

If a year-end value is off, assumptions about the proportions of different kinds of investments might be mistaken. And one or more disclosures about concentration risks might be incorrect.

That the plan’s fiduciary does not expect an ERISA § 404(c) defense heightens the fiduciary’s responsibility regarding § 404(a)(1)(B) prudence and § 404(a)(1)(C) diversification.

Excellent points, again. Thank you!

A competent plan document will deal with mid year distributions when there are questions about valuation of pooled assets. One of the provisions that goes with competent terms is the ability to perform a mid-year valuation at the discretion of the fiduciary. Liquidity is definitely one of the issues that should be addressed by plan terms relative to distributions. As suggested by others, you should be instructed concerning what to do pursuant to plan terms as interpreted by the appropriate fiduciary in accordance with that fiduciary’s prudent discretionary determinations.