Key Points: To obtain the safe harbor for mutual funds for the liquidity factor for plan-level liquidity, fiduciaries may rely on SEC regulation of mutual funds. However, for other investments, such as CITs, there is a three-step process for obtaining the safe harbor.
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 four of the factors—Performance, Fees, Performance Benchmarks and Complexity, and their examples.
In my last four articles, Alternative Assets (22), Alternative Assets (23), Alternative Assets (24), and Alternative Assets (25) I looked at the Liquidity factor and examples of the application of that factor. This article continues the discussion of the third example.
(3) Example. Plan-level liquidity—
(i) Facts. Plan terminations, changes in plan recordkeepers or investment providers, and corporate sponsor mergers and acquisitions are examples of circumstances that may impose relatively short-term liquidity demands on a plan’s designated investment alternatives. This is especially true in the case of a designated investment alternative (such as a pooled investment vehicle) with a strategy involving a target position in certain private assets along with public assets (e.g., publicly traded securities). With such designated investment alternatives, a specific plan’s (or, in a pooled investment product, other plan’s or non-plan investors’) need for relatively short-term liquidity (e.g., when the investor wants to exit the investment) may present significant liquidity risk to the designated investment alternative as a whole such that it cannot maintain its asset allocation targets. Thus, in such circumstances, designated investment alternatives may or must impose temporal restrictions on redemptions (e.g., they might require advance notice and permit only incremental redemptions over a period of time). When fulfilling withdrawals, particularly large withdrawals, diversified designated investment alternatives may temporarily deviate from their target asset allocations. For example, a designated investment alternative that is designed to have a 90 percent allocation to fully liquid instruments may have to temporarily accept a lower allocation to fully liquid instruments to satisfy a large withdrawal.
(The bolding in this article is mine…just to emphasize the points that I consider the most important.)
Comment: This example illustrates a liquidity issue at the plan level. A liquidity restriction may involve timing (e.g., a 12-month put or a queue for quarterly redemptions with a cap on the maximum redemption amount per quarter) or a reduction in value due to the redemption (e.g., a market value adjustment, MVA, or a contingent deferred sales charge, CDSC). For our purposes, a liquidity restriction could be any limitation that could result in an impairment on daily trading…that would include a penalty, a cost or a timing restriction.
(ii) Analysis. Plan fiduciaries must give consideration to, and determine, that the scope and duration of redemption restrictions at the plan level meet the anticipated needs of the plan. This includes whether the designated investment alternative has a sufficient process in place to balance the plan’s potential need for withdrawal against the plan’s desire for the designated investment alternative to maintain smooth and consistent target positions, including following a significant withdrawal of investors other than the plan.
Comment: As explained in my last article, which discussed the first fact scenario under this example, the analysis requires an evaluation of the benefit provided by the restriction as compared to the burden imposed by the restriction.
The DOL’s conclusion below discusses two scenarios. My last post covered the first scenario; this one covers the second.
(iii) Conclusion. A plan fiduciary is deemed to have met the consideration and determination requirements of paragraph (i) of this section, and section 404(a)(1)(B) of ERISA, with respect to the plan-level liquidity needs of a given plan in connection with a given designated investment alternative (including one that holds a percentage of assets that are not securities, non- publicly traded securities, or securities acquired in exempt offerings) in either of the two following scenarios.
(A) In the first scenario….
(B) In the second scenario, the plan fiduciary relies on the fact that the designated investment alternative is a mutual fund registered as an open-end management investment company with the SEC under the Investment Company Act of 1940, which is required by rules under such Act to adopt and implement a written liquidity risk management program that is designed to assess and manage their liquidity risk. If the designated investment alternative is not such a fund, the fiduciary must meet three conditions. First, the fiduciary obtains a written representation from the person responsible for managing the designated investment alternative, or otherwise performs appropriate due diligence, that the designated investment alternative has adopted and implemented a liquidity risk management program that is substantially similar to a program that meets the liquidity risk management requirements under such Act. 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: This scenario focuses on plan level liquidity for (1) mutual funds (i.e., registered investment companies) subject to SEC regulation and (2) other entities that are not subject to SEC regulation. While that would include a potentially wide range of products, my comments will focus on the type most commonly found in 401(k) plans—collective investment trusts, or CITs.
For mutual funds, there isn’t anything that fiduciaries need to do, except correctly determine that the investment alternative is a mutual fund registered as an open-end management investment company with the SEC under the Investment Company Act of 1940. That’s it. The liquidity fiduciary issue is handled and the presumption on prudence is obtained—for plan level liquidity.
The issue is more complex for CITs. In that case, there is a three-step process. First, the fiduciaries would need to obtain a written representation from the CIT trustee that it has adopted a liquidity program that the CIT has a liquidity program similar to the SEC requirement for mutual funds (or the fiduciaries “otherwise preforms appropriate due diligence”—whatever that means). Then a fiduciary must read, critically review and understand the representation. (Hopefully there is a fiduciary adviser who can help with this.) Finally, the fiduciary “fiduciary does not know, or have reason to know, other information which would cause the fiduciary to question any written representation”. This is, in and of itself, a “mini” safe harbor, because it is more of a check-the-box process than a true evaluation (that is, it does not require any real thoughtfulness).
Keep in mind that this “requirement” is to obtain the DOL’s presumption of prudence. It does not establish the only way to satisfy ERISA’s prudence requirement. However, since most rational people will want the safe harbor, it may effectively be seen as a requirement.
The preamble discusses this example as follows:
Paragraph (i)(3) of the proposed regulation contains a positive example of how a plan fiduciary may be deemed to have appropriately considered the plan-level liquidity needs of the plan when selecting a designated investment alternative, including one that holds a portion of illiquid, non-publicly traded securities. Just as plan participants may want or need liquidity, retirement plans themselves may need to convert a designated investment alternative’s assets into cash without a reduction in value. For example, plans may terminate, merge, or the plan fiduciary may simply decide to liquidate the plan’s share in a designated investment alternative if the fiduciary decides to close out the position. Plan-level liquidity considerations also include whether the designated investment alternative manager has the ability to maintain asset allocation targets if other plans (or other investors) demand a redemption.
…..
Under the second path, plan fiduciaries may instead conduct an objective, thorough, and analytical evaluation, on their own or with the help of a third-party investment advice fiduciary, to assess whether a pooled investment is sufficiently liquid to offer as a designated investment alternative. The plan fiduciary should determine the time it would take a designated investment alternative to sell its illiquid investments in the quantity required by the plan’s liquidity needs without reducing their value and the liquidity restrictions the investment manager places on the designated investment alternative. The plan fiduciary must conclude that the designated investment alternative appropriately balances future liquidity needs with the ability of the designated investment alternative to achieve increased risk-adjusted return on investment net of fees and the ability to maintain its asset allocation targets even if the fund faces a significant pull on liquidity from redemption requests.
Comment: The preamble discussion basically affirms the scenario in the proposed rule. To avoid confusion, I should explain that the DOL discussion in the preamble describes the second scenario as the first path. So the following discussion is of the second scenario:
The first path is the same approach discussed in the example in paragraph (i)(1) of the proposed regulation addressing participant-level liquidity needs of the plan. Under this path, a fiduciary may rely on the fact that a mutual fund is required to adopt and implement a written liquidity risk management program that is reasonably designed to assess and manage its liquidity risk under the Act. With respect to designated investment alternatives that are not mutual funds, the plan fiduciary could obtain a written representation that the designated investment alternative has adopted and implemented a liquidity risk management plan substantially similar to a program that meets the requirements of such Act (or otherwise perform appropriate due diligence), provided that the plan fiduciary read, critically reviewed and understood any written representation (independently or with assistance of a qualified investment professional if necessary) and did not know (or have reason to know) other information which would cause the fiduciary to question any written representation.
In essence, the preamble reiterates the discussion of the example in the proposed rule. Nothing new added to the explanation.
Concluding Thoughts
The good news is that, for mutual funds subject to SEC regulation, the job is done before it is started.
The less good news is that for investments such as CITs, the burden on fiduciaries (or their advisers) is increased due to the need to obtain and evaluate representations. Hopefully, trustees of CITs will prepare and deliver representations as a part of their proposal packages. I think that will be the case. I also think that advisers will need to develop processes for reviewing and advising on the representations.
Keep in mind that this isn’t limited to investments that include private funds. This issue exists with every stable value fund.
