What Is ERISA?
The Employee Retirement Income Security Act of 1974 (ERISA) is the federal law that sets minimum standards for private-sector employee benefit plans, including pension plans, 401(k) plans, and certain health and welfare plans. For fund managers, ERISA is relevant because it governs how pension fund capital flows into private investment vehicles and what obligations attach when it does.
ERISA is administered jointly by the Department of Labor (DOL) and the IRS. Its core purpose is protecting plan participants by imposing fiduciary duties on anyone who manages or controls plan assets, mandating diversification, prohibiting self-dealing, and requiring that investment decisions be made solely in the interest of plan beneficiaries.
The Plan Asset Rules
The most consequential ERISA concept for fund managers is the “plan asset” designation. Under DOL regulations, if benefit plan investors hold 25% or more of any class of equity interests in a fund, the fund’s underlying assets are treated as plan assets. This is commonly called the 25% test.
Once a fund is deemed to hold plan assets, the general partner becomes an ERISA fiduciary. That triggers several obligations:
- Prohibited transaction rules. Broad restrictions on transactions between the fund and “parties in interest” (service providers, affiliates, other funds managed by the same GP). Violations can result in excise taxes and personal liability.
- Fiduciary standards. The GP must act prudently, diversify investments, and follow plan documents. The standard of care is higher than the typical contractual duties in a limited partnership agreement.
- Reporting and disclosure. Additional compliance requirements that increase fund administration costs.
The 25% Threshold in Practice
Most fund managers manage ERISA exposure by monitoring the percentage of benefit plan investors across each class of equity. The calculation includes not just direct pension fund LPs, but also funds of funds and other pooled vehicles that themselves hold plan assets.
This is where it gets operationally complex. An LP that is itself a fund of funds may or may not be a benefit plan investor depending on its own investor composition. Subscription documents typically require LPs to represent whether they are benefit plan investors, but the GP needs to track these representations across closes and secondary transfers.
Exemptions: VCOC and REOC
The plan asset rules include two key exemptions. A fund that qualifies as a venture capital operating company (VCOC) or real estate operating company (REOC) is not subject to the plan asset rules regardless of how much benefit plan capital it holds.
A VCOC must hold at least 50% of its assets (at cost) in operating companies where it has management rights, and must actually exercise those rights in at least one portfolio company per year. A REOC must hold at least 50% of its assets in real estate where it has the right to substantially participate in management.
These exemptions are why you see management rights letters in venture and growth equity deals. They are not just governance tools; they are ERISA compliance mechanisms.
Why This Matters for Capital Raising
Pension funds are among the largest allocators to private capital. Turning away pension money because you do not want ERISA complexity means leaving significant capital calls on the table. The practical path is to work with experienced fund administration counsel to either maintain the 25% cushion or structure for a VCOC/REOC exemption from the outset. Retrofitting ERISA compliance after first close is far more expensive than building it into the fund documents from day one.
Frequently Asked Questions
What is the 25% test under ERISA?
If benefit plan investors (pension funds, 401(k) plans, IRAs) hold 25% or more of any class of equity interests in a fund, the fund's assets are deemed 'plan assets' under ERISA. This triggers fiduciary obligations, prohibited transaction rules, and reporting requirements for the GP. Most fund managers either stay below this threshold or rely on an exemption.
How do fund managers avoid ERISA plan asset status?
The most common approach is to cap benefit plan investor participation below 25% of each class of equity. Alternatively, managers can structure the fund as a venture capital operating company (VCOC) or real estate operating company (REOC), both of which are exempt from the plan asset rules regardless of benefit plan investor concentration.
Why do pension funds invest in private funds despite ERISA complexity?
Pension funds allocate to private equity and venture capital for diversification and return potential. According to data from Preqin, pension funds represent one of the largest LP categories in private capital globally. The ERISA compliance burden falls primarily on the fund manager, not the pension fund itself, which makes the allocation operationally straightforward from the LP's perspective.
