Financial Services Insights: To Be (a DFE) or not To Be (a DFE) – That is the Question

As a result of the financial crisis, many managers of alternative investments have experienced a substantial reduction of inflows or even outflows from their funds.  Consequently, many fund managers that did not previously accept investments from ERISA plans (retirement trusts or welfare benefit trusts) are now accepting such investors to help boost assets under management.

Background 

When a fund manager accepts investments from two or more ERISA plans, it triggers a notification requirement to the ERISA plan sponsor and an optional reporting requirement (filed on IRS Form 5500) for the fund as a Direct Filing Entity (“DFE”) with the U.S. Department of Labor (“DOL”).  In the past, ERISA plan sponsors would frequently report on their Form 5500 that the fund manager had filed a Form 5500 as a DFE when, in fact, the fund manager had not filed a Form 5500 as a discussed below.  The DOL now has a program to match the reporting on the ERISA plan sponsor’s Form 5500 with the Form 5500 DFE filing of the fund manager and is issuing notices to ERISA Plan sponsors requesting clarification and, in some cases, additional information.  Thus, it is important for fund managers to decide if they will file Form 5500 for their fund and clearly communicate this decision so that the ERISA plan sponsor can correctly report their investment in the fund on the plan’s annual Form 5500.

DFE Filing 

The DOL created the option for the manager of a pooled separate account, common or collective trust, master trust investment, or 103-12 investment entity (hedge fund, private equity, REIT, etc.) (collectively “fund” or ‘funds”) to provide information regarding the underlying assets of their funds to the DOL by filing a Form 5500 as a DFE.  When the fund manager files as a DFE, each ERISA plan investing in the fund must provide less detail regarding the fund on the balance sheet (Schedule H) of the plan’s Form 5500 (see 1 below).  Because filing as a DFE simplifies the reporting requirements for the ERISA plan investor, many fund managers file Form 5500 as a DFE as a courtesy to their ERISA investors.  The consequences of being a DFE or not being DFE are as follows:

Fund Manager Files as a DFE.  If the fund manager decides to file as a DFE, it files a separate Form 5500 and applicable schedules for the fund.  The fund manager also supplies information about the underlying assets of the fund to DOL by attaching a copy of its audited financial statements (does not apply to pooled separate accounts or common/collective trusts) to the Form 5500.  Each ERISA plan investor must still file its own Form 5500; however, when reporting its investment in the fund, it must only report the fund as a single line item on its balance sheet (Form 5500 Schedule H), rather than separate line items for its proportion of each underlying investment in the fund.

Fund does not File as a DFE.  If the fund manager does not file as a DFE, each large (100 or more participants) ERISA plan investor in the fund must report its proportional interest in the underlying assets of the fund on its balance sheet for Form 5500.  This can result in additional questions being posed to the fund manager from the plan sponsor or from their outside auditor responsible for auditing the ERISA plan’s trust financial statements in order to have sufficient detail for reporting the investment on their Form 5500.

1. Fund Manager Files as a DFE. If the fund manager decides to file as a DFE, it files a separate Form 5500 and applicable schedules for the fund. The fund manager also supplies information about the underlying assets of the fund to DOL by attaching a copy of its audited financial statements (does not apply to pooled separate accounts or common/collective trusts) to the Form 5500. Each ERISA plan investor must still file its own Form 5500; however, when reporting its investment in the fund, it must only report the fund as a single line item on its balance sheet (Form 5500 Schedule H), rather than separate line items for its proportion of each underlying investment in the fund.
2. Fund does not File as a DFE. If the fund manager does not file as a DFE, each large (100 or more participants) ERISA plan investor in the fund must report its proportional interest in the underlying assets of the fund on its balance sheet for Form 5500. This can result in additional questions being posed to the fund manager from the plan sponsor or from their outside auditor responsible for auditing the ERISA plan's trust financial statements in order to have sufficient detail for reporting the investment on their Form 5500.

Notification Requirement 

Whether it files as a DFE or not, the fund manager is required to notify its ERISA plan investors annually regarding whether it intends to file as a DFE.  The fund manager must also give ERISA plan sponsors the information needed to complete the Form 5500 for their plan within 120 days after the ERISA plan’s year end.

Conclusion 

As a result of the DOL’s new matching program for Form DFE filers and ERISA plan Form 5500 filings, it is imperative that fund managers clearly notify their ERISA investors whether they will be filing with the DOL as a DFE in order to avoid notices being issued to their ERISA plan sponsor.