The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that should be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.
In earlier posts, I covered the first two factors—Performance and Fees, and their examples. In my last post Alternative Assets (15), I skipped to the sixth factor—Complexity.
This article looks at the first example under the Complexity factor. As a refresher, here’s how the proposal describes that factor:
(l) Complexity. The plan fiduciary must appropriately consider the complexity of the designated investment alternative and determine that it has the skills, knowledge, experience, and capacity to comprehend it sufficiently to discharge its obligations under ERISA and the governing plan documents or whether it must seek assistance from a qualified investment advice fiduciary, investment manager, or other individual.
(The bolding in this article is mine…just to emphasize the points that I consider the most important.)
The proposal then gives two examples about the application of the Complexity factor. The first of those two is:
(1) Example.
Complexity; Fees—
(i) A participant-directed individual account plan offers a designated investment alternative that is a pooled investment vehicle with an investment strategy involving target positions in particular types of assets, which includes holdings of private assets. The private assets in the designated investment alternative are varied and use sophisticated and variable fee-based incentive structures to drive performance, including management fees and performance fees which include carried interest rights.
Comment: I am concerned about this example. It seems to me that the “pooled investment vehicle” will—at least for all but the largest plans—be a mutual fund or a collective investment trust (CIT). Where the investment vehicle is a CIT, in my view the fiduciary responsibility is to vet the trustee and the sub-adviser and determine if they are qualified to determine allocations to private assets. A trustee of a CIT is effectively a 3(38) investment manager and, if prudently selected and monitored, fiduciary responsibility for the allocations, investments and fees will be transferred to the trustee (and the agreements should specify that it is). The analysis for a mutual fund is somewhat similar and somewhat different. The adviser to a mutual fund is not an ERISA fiduciary of any kind, much less a 3(38) investment manager. However, plan fiduciaries should be able to satisfy their responsibilities by vetting the adviser to the fund and determining whether the fund adviser has the competency to make decisions about allocations to private assets. In both cases, the plan fiduciaries would need to determine if the overall fee of the CIT or mutual fund is reasonable.
(ii) As described in more detail in paragraph (h), the fiduciary must determine that the fees and expenses of the designated investment alternative are appropriate, taking into account the designated investment alternative’s risk-adjusted expected returns and any other value the designated investment alternative brings to furthering the purposes of the plan. In order to make this determination, the plan fiduciary must comprehend the fees that will be charged to the plan and determine, within its discretion, that such fees are appropriate given the value proposition offered by the designated investment alternative.
Comment: I don’t see a need to make that determination where the allocation vehicle is a mutual fund or CIT. In my view, plan fiduciaries should evaluate the expense ratio of the fund or CIT and determine if it is reasonable. To illustrate my point, it isn’t an industry practice to evaluate the fees of each mutual fund that composes a target date fund. Instead, the practice is to look at the expense ratio of the TDF.
(iii) Conclusion. A plan fiduciary is deemed to have met the comprehension requirements of paragraph (l) of this section, and section 404(a)(1)(B) of ERISA, with respect to the complexity of a designated investment alternative’s fee structure in either of the two following scenarios.
(A) In the first scenario, the plan fiduciary conducts relevant due diligence to understand each fee that the plan may pay, and, in so doing, critically evaluates and determines, including, if appropriate, with the advice of a third-party investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA, the average total expected rate of the designated investment alternative’s fees, when fees will be paid, and how they will be determined. After this evaluation, the plan fiduciary determines (1) that the fee structure will deliver increased value by incentivizing performance which will, in turn, increase expected risk-adjusted return on investment and (2) that this increase outweighs the variability or potential unpredictability of the amount and timing of the fees.
Comment: As explained earlier, I don’t see this as the responsibility of the primary plan fiduciaries when mutual funds or CITs are involved. However, for mega-sized plans (of, say, a billion dollars or more in assets) that use unitized custom target date funds with allocations to private funds, I think this type of analysis would be needed.
(B) In the second scenario, three conditions are met. First, the fiduciary obtains a written representation from the person responsible for managing the designated investment alternative, or otherwise performs adequate due diligence to confirm, that none of the underlying fees will be passed through to the plan, and that, instead, the plan will pay an appropriate, flat, AUM- based fee, to the person responsible for managing the designated investment alternative, who will then internalize the underlying fees. Second, the fiduciary reads, critically reviews, and understands any written representation and consults a qualified professional where appropriate. Third, the fiduciary does not know, or have reason to know, other information which would cause the fiduciary to question any written representation.
Comment: Is this realistic? In my limited involvement with private funds, I haven’t seen this type of arrangement.
The preamble discusses the Complexity factor and this example, but doesn’t really add anything beyond what is in the example.
Concluding Thoughts
If the regulation becomes final “as is” with the Complexity factor, and if fiduciaries understand its impact, I believe that many fiduciaries will decide that they do not have the education, experience and knowledge to do this type of analysis. In that case, the “out” would be to engage discretionary investment advisers (in industry lingo, 3(38) investment managers) to make the decisions for them. If I were the attorney for those fiduciaries, I would recommend that and require that the advisers have explicit language in their agreements that they would be responsible for applying the 6 identified factors, including the Complexity factor.
Note: While I have not discussed managed accounts in this article, the same principles would apply. That is, the advisers managing the accounts would be responsible for determining if the fees are reasonable (and not the plan fiduciaries). However, the plan fiduciaries would be responsible for prudently selecting and monitoring the adviser and its fees.
