Compliance December 15, 2023

SEC Suggests Retirement Assets Should Not Count Toward Accredited Investor Threshold

The regulator’s report on the accredited investor definition noted that many only qualify because of their DC plan assets.

Reported by

The Securities and Exchange Commission on Friday released a report on its accredited investor definition, noting concerns that expertise was not being emphasized enough in the definition and that retirement assets should be excluded from the wealth threshold.

An accredited investor is someone eligible to invest in private offerings on their own behalf. There are multiple ways to qualify: having a net worth of at least $1 million; having an income of at least $200,000 in consecutive years; being a partner of the entity making the private offering; or holding certain certificates as a financial professional, such as a FINRA registration as a broker/dealer.

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

The SEC is required to publish a report to Congress every four years evaluating these criteria. In its evaluation, the SEC is charged with considering the sophistication and ability to endure financial losses of those who qualify as accredited investors.

In this year’s report, the SEC noted that the number of accredited investors in both absolute and relative terms has increased significantly since 1982, when this exemption for public registration was created under Regulation D. This is in part due to the fact that the wealth and income caps were never tied to inflation. The SEC report estimated that 3% of households qualified under the wealth and income thresholds in 1989, but in 2022, 18.5% qualified.

Additionally, the report explained that many who qualify do so only due to their holdings in a defined contribution plan. According to the report, 16.44 million households qualify on the basis of their income or wealth, but that number drops to 11.6 million when DC plan assets are discounted.

This has raised concerns that many accredited investors do not have the sophistication to invest in private offerings, since their wealth comes in large part from retirement assets and because they cannot easily endure losses in private markets, since their retirement assets, likely in an individual retirement account, are at stake.

The report explained: “The increase in the size of the accredited investor pool over time as a result of inflation and the expanded role of retirement savings in qualifying as an accredited investor, have led some to question the continuing utility of the financial thresholds as a measure of accredited investors’ ability to sustain the risk of loss of investment with respect to accredited investors who are investing for imminent retirement or to provide income in retirement.”

The report noted that the North American Securities Administrators Association has recommended discounting retirement assets for the purposes of accreditation.

Jay Gould, a special counsel with law firm Baker Botts LLP, says accreditation is not tied to sophistication and he is pleased the report identifies this as an issue. He explains that many accredited investors “are not financially sophisticated at all; they need help.”

He adds that the wealth and income thresholds are not set by statute, and the SEC is actually free to fix the issues identified in the report, though any attempted rulemaking would likely be met with furious industry opposition.

The risk of savers with large IRA accounts losing their retirement savings while investing in private offerings is a “fair concern for the regulators to point out and watch,” Gould says. “If you allow people to blow all their 401(k) money [after rolling it over] on shady private placements, that can be problematic.”

Gould says there are some potential regulatory fixes. The SEC could rule that advisers are in breach of their fiduciary duty if an adviser recommends a client invest more than a certain percentage (say 10%) of their retirement assets in private assets, for example. Similarly, the Department of Labor or IRS could rule that retirement accounts that hold more than 10% in private offerings are no longer tax-exempt. Gould emphasizes that both solutions might shore up retirement security but would not address the issue of sophistication and would be met with intense industry backlash.

Congress is currently considering multiple bills to expand the definition of accredited investor in ways that emphasize expertise. One such bill, the Fair Investment Opportunities for Professional Experts Act, which passed the House of Representatives in June, would permit any adviser or broker registered with the SEC, FINRA or state securities authority to become accredited. It would also permit the SEC to accredit those with expertise in a specific field to invest in private offerings in that field, such as a doctor investing in a medical company.

Similarly, the U.S. House Committee on Financial Services passed the Expanding Access to Capital Act in April, which would allow anyone to become accredited, provided they work with a registered adviser and do not invest more than 10% of their wealth in private holdings. The full House has not yet considered the bill.

Compliance December 15, 2023

Clorox Seeks Dismissal of 401(k) Forfeiture Complaint

The company argues in the filing that its fiduciaries followed IRS guidance on how unused retirement assets can be used.

Reported by

The Clorox Co. filed a motion to dismiss a proposed class action suit alleging it violated federal benefits law by using 401(k) forfeitures to reduce company contribution costs instead of defraying costs for plan participants.

Participant James McManus filed the complaint against the Clorox Co. and the fiduciaries of the Clorox Co. 401(k) Plan in U.S. District Court for the Northern District of California on October 18. The filing alleges that plan fiduciaries consistently used forfeited funds exclusively for the company’s benefit by reducing company contributions to the plan, instead of by reducing administrative expenses that are passed on to participants.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

According to the complaint, from 2017 to 2022, company nonelective contributions to the plan were reduced by a total of $5.7 million as a result of Clorox’s reallocation of forfeited funds. The class action is seeking to recoup any amount the court would find was improperly used, along with litigation fees.

On Wednesday, Clorox filed a motion to dismiss the case on the grounds that the plan committee had laid out the use of forfeitures in the plan documents, as per IRS guidance, and did not violate any fiduciary duties by using the funds as laid out.

“The Complaint should be dismissed because it effectively seeks (i) to bar the long-standing practice, expressly required by a sixty-year-old IRS regulation, of reallocating forfeitures to cover other benefits promised by the Plan and (ii) to require instead that forfeitures be diverted to individual participant accounts to provide additional benefits not promised by the Plan,” the motion states. “The Court should reject Plaintiff’s novel, and strained, construction of ERISA.”

Lawyers for Clorox went on to argue that Congress and the Department of Labor, which has authority over the Employee Retirement Income Security Act, have endorsed this use of forfeitures.

McManus v. Clorox Co. is one of five filed by Pasadena, California-based law firm Hayes Pawlenko LLP this year regarding how plan sponsors managed funds from nonvested portions of terminated participant accounts. In addition to Clorox, those complaints target HP Inc., Intuit Inc., Qualcomm Inc. and Thermo Fisher Scientific Inc.

According to the IRS, participant forfeitures can be used to pay plan expenses, to reduce employer contributions or by allocating them back to plan participants, according to a recent presentation by attorneys from Faegre Drinker Biddle & Reath LLP. How fiduciaries handle forfeitures, however, must be laid out in the plan documents, Faegre Drinker attorneys noted.

In Clorox’s attempt to dismiss the case, its attorneys note the five other complaints being filed in a short period of time, arguing that the law firm is seeking “to undo sixty years of lawful conduct.”

In an additional filing by the Clorox defendants, they requested judicial notice of several plan documents intended to show the fiduciaries followed procedure in documenting how the plan would use participant forfeitures. The documentation included the Clorox Co. 401(k) Plan Amendment and Restatement and summary plan description, both effective January 1, 2017.

“The Court may consider a document that contains the [p]lan’s terms and benefits even though [p]laintiffs do not reference the document in the [complaint],” the court document states.

Clorox has also requested judicial notice of the plan’s Forms 5500 from 2017 to 2023, which were filed with the DOL, as well as excerpts from H.R. No. 99-841, which is a “proper subject of judicial notice because it constitutes excerpts of the legislative history for the Tax Reform Act of 1986.”

Clorox’s 401(k) plan has 6,451 active participants with about $1.87 billion in assets, according to 2022 Form 5500 filings tracked by Brightscope, which, like PLANADVISER, is owned by ISS STOXX.

According to the court documents, eligible Clorox employees begin receiving the plan’s nonelective employer contribution after one year of service. At the end of each calendar year, the company makes a contribution equal to 6% of the participant’s eligible compensation, with vesting of that contribution based on a set schedule according to years of service.

If a participant leaves the plan, any nonvested amount reverts to the plan. The plan document notes that the “[f]orfeited amounts will be used, as determined by the Committee in its sole discretion, to pay Plan expenses, to reduce contributions to the Plan and to restore forfeitures,” according to the court filings.

McManus initially brought six claims of negligence against the plan committee, including breaching fiduciary duties regarding the forfeitures and failing to monitor fiduciary practices. Clorox is seeking dismissal of all six claims. Its request for dismissal was filed ahead of the January 23, 2024 hearing on the case.

«