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Invisible pension investments.

A large share of the more than $6.28 trillion in private pension plan assets is held in certain types of indirect investment vehicles. If those vehicles file their own annual return with the Department of Labor they are called "direct filing entities" (or DFEs), and pension plans that invest in them are excused from providing detailed information concerning the assets, liabilities, and investment performance of the DFEs. consequently, the publicly-available summary financial information reported by pension plans investing through one or more DFEs is seriously incomplete: while a plan must identify the categorical nature of its direct investments (for example, as common or preferred stock, corporate or government debt, real estate, etc.), indirect investments through a DEE are reported only as interests in the DFE, without regard to the underlying nature of the DFE's assets and liabilities. Matching the DFE's return with the returns filed by plans that invest through the DEE is theoretically possible, but it is technically difficult and has not been comprehensively achieved.

This study undertakes the task of linking returns filed by large private pension plans and DFEs in 2008. After explaining the types of DFEs, summary statistics on the extent of pension plan investment through DFEs and the composition of DEE portfolios are reported. The process employed to link the holdings of each DFE to its investor-plans is described, followed by description and analysis of the results. Important differences in the asset allocations of pension plans of various types are revealed, and the portfolio compositions of plans that do and do not invest through DFEs are compared Because thirty-five percent of plans that invest in a DFE are found to file internally inconsistent returns that preclude successful linking of DFE financial information to the investor-plan, the plan characteristics associated with such deficient filings are investigated. Although the composition of DEE portfolios is currently invisible to plan participants and the general public, we find little evidence that DFEs have been systematically exploited to obscure the identity of pension plan investments. Finally, the results of this study are reviewed in light of the purposes of pension plan financial disclosure. Even if routine, accurate, and comprehensive matching of DFE financial information with investor-plans were available, ERISA 's text and policies support the regulatory formulation of a far more detailed digital disclosure regime.


Funds accumulated in private pension plans now exceed $6.28 trillion in the aggregate. (1) This vast, store represents a large share of the retirement savings of American workers, both active and retired. (2) How are those pension funds invested? Despite annual financial reporting requirements imposed by the Employee Retirement Income Security Act of 1974 (ERISA), (3) we don't know. Nor is the U.S. Department of Labor, which administers the ERISA's reporting and disclosure regime, able to shed much light on the matter. (4) The problem lies in a failure to connect the dots.

Large private pension plans, meaning plans covering 100 or more participants at the start of the plan year, annually report summary balance sheet (asset and liability) and income statement (earnings and expenses) information on Form 5500, Schedule H. (5) These plans commonly invest a large share of their assets in various collective investment vehicles, including common trust funds managed by banks, trust companies, or similar institutions, pooled separate accounts sponsored by insurance companies, and master trusts, which facilitate joint investment of the assets of more than one plan sponsored either by a single employer or by a group of commonly controlled employers. (6) Some of these collective investment vehicles are permitted or required to file their own annual reports with accompanying financial information (Form 5500 and Schedule H), and are referred to as "direct filing entities" (DFEs). A pension plan that invests through a DFE need only report its interest in the entity; the investor-plan is excused from providing detailed information about the underlying assets, liabilities, and transactions of the DFE. (7) Thus, the annual return of a pension plan that invests some of its funds in a DFE will show its direct investments in stocks, bonds, real estate, and other asset categories, and will report its interest in any DFEs, but will not disclose the underlying holdings of the DFE. The DFE's return will of course report a categorical breakdown of its assets and liabilities, but linking the DFEs investments with its investor-plan's presents the challenge. Without such a link we lack a composite picture of a pension plan's direct and indirect holdings of various categories of assets and liabilities, effectively rendering part of the plan's financial position invisible, in the sense that plan participants, federal regulators, policy analysts, and the public at large cannot "see" the characteristics of indirect investments held in DFEs, nor evaluate the composition of the plan's overall portfolio.

Just how serious is the resulting gap in our knowledge? Flow concerned should we be about the inability to look inside the black box of DFEs? When it comes to readily available public information on the allocation of private pension plan investments, we are astonishingly ignorant. Figure 1 shows that in 2010 large single-employer defined benefit plans had invested 64.3% of their total assets, on average, in four types of DFEs: master trusts (49.4%), bank common trust funds (11.7%), 103-12 investment entities (1.8%), and insurance company pooled separate accounts (1.4%). Thus, a majority of the assets of large single-employer defined benefit plans are reported only as undifferentiated indirect investments made through DFEs.
Figure 1: Large single-employer defined benefit plan
asset allocation. 2010

Assets in masster trusts                   49.4%
Assets in common/collective trusts         11.7%
Common stock                                8.9%
Assets in registered investment companies   7.3%
U.S. Government securities                  3.7%
Corporate debt instruments; All other       3.6%
Partnership/joint venture interests         3.0%
Employer contributions receivable           2.9%
Assets in 103-12 investment entities        1.8%
Other general investments                   1.8%
Assets in pooled separate accounts          1.4%
Corporate debt instruments; Preferred       1.3%
Interest-bearing cash                       1.0%
Other assets                                2.1%

Note: Table made from pie chart.

Figure 2 shows the corresponding breakdown for large single-employer defined contribution plans in 2010. They held 33.8%, or more than one-third of their total assets, on average, in master trusts (20.4%), bank common trust funds (9.9%), and insurance company pooled separate accounts (3.5%). The single largest slice of defined contribution plan assets in 2010 is the 42.1% invested in registered investment companies (mutual funds). These mutual fund holdings have increased substantially since the early 1990s, apparently due to the growth of 401(k) plans that call for participant-directed investments: such plans typically allow participants to select from a menu of mutual fund investment options. (8)
Figure 2: Large single-employer defined benefit plan
asset allocation. 2010

Assets in registered investment companies   42.1%
Assets in masster trusts                    20.4%
Assets in common collective trusts           9.9%
Employer securities                          7.3%
Assets in insurance co. general accounts     4.4%
Assets in pooled separate accounts           3.5%
Other general investments                    2.3%
Common stock                                 2.0%
Participant loans                            1.7%
Interest-bearing cash                        1.6%
Other receivables                            1.3%
Other assets                                 3.3%

Note: Table made from pie chart.

Each DFE's assets and liabilities can in principle be attributed in proper proportion to the pension plans investing through that collective investment vehicle. Form 5500 Schedule D, entitled "DFE/Participating Plan Information," is designed to elicit the information necessary to connect the dots. A plan that invests in one or more DFEs is required to report on Schedule D information about its interest in each such DFE, including the name and identifying information of the DFE, the type of DFE (e.g., master trust investment account., common trust fund, or pooled separate account), and the dollar value of the plan's interest in the DFE as of the end of the year. (9) The DFE, in turn, must disclose the name and identifying information of each plan that invested in the DFE at any time during the year. (10) Linking the two data sets presents certain data quality and programming challenges. This paper describes a project to associate DFE asset holdings with the pension plans investing in the DFE based upon returns filed for reporting years ending in 2008. The paper first reports the size and composition of DFE investments, and then turns to investigate the extent to which the composition of pension plan asset holdings, including those held indirectly through DFEs, vary according to a number of plan characteristics.

The paper is organized as follows. Part H, following this introduction, provides additional background information on pension plan reporting requirements and how they relate to collective investment vehicles. That discussion exposes the limits of existing publicly available information on pension investments. Part III briefly describes the methodology used to link DFE asset and liability data to the balance sheets of investor-plans. Part IV reports the results for 2008 and highlights and discusses interesting correlations between pension plan characteristics and investment allocations. Part V assesses the current state of pension plan financial disclosure from the standpoint of ERISA's policies. A brief conclusion summarizes the study's principal findings and suggests avenues for further investigation.


A. History and Policy

Financial disclosure was the focus of the first federal foray into the regulation of employee benefit plans. In the 1950s a number of state and federal investigations into labor racketeering uncovered notorious examples of embezzlement and abuse of employee benefit funds by union officials. (11) Most instances of misconduct involved multiemployer welfare funds; although jointly managed by representatives of contributing employers and labor organizations under the Taft-Hartley Act, in practice these funds often came to be dominated by union officers. President Eisenhower recommended a congressional study of pension and welfare benefit plans in 1954 and put forward draft legislation in 1956 to require benefit plans to report their terms and finances to the Department of Labor. Fortified by public outrage over corrupt practices revealed by the McClelland committee's investigations in 1957-1959, proponents of federal regulation pushed through the Welfare and Pension Plans Disclosure Act of 1958 (WPPDA). The objective of disclosure was to deter abuses and promote self-policing by employees, assisted by the press. Yet as originally enacted, the core financial information required in the annual report was limited to a "summary statement of assets, liabilities, receipts, and disbursements of the plan." (12) The WPPDA imposed reporting obligations on both multiemployer and single-employer (company-managed) plans, but withheld investigative and enforcement authority from the Department of Labor. In signing the bill President Eisenhower lamented that it accomplished little more than "establish[ing] a precedent of Federal responsibility in this area." (13)

The Kennedy Administration took up the cause, championing legislation to strengthen the disclosure act. (14) The 1962 WPPDA amendments gave the Department of Labor investigative authority and the right to sue to enjoin violations, made false statements and concealment of facts relating to disclosure obligations a federal crime, (15) and in place of the "summary statement of assets" required that the annual report specify "the total amount in each of the following types of assets: cash, government bonds, non-government bonds and debentures, common stocks, preferred stocks, common trust funds, real estate loans and mortgages, operated real estate, other real estate, and other assets." (16) Routine disclosure of broad categories of investments was as far as Congress was prepared to go; the Secretary of Labor was authorized to demand an itemized report of all investments only if he found reasonable cause to believe that investigation would uncover violations of the act. (17)

Even as amended in 1962, the WPPDA imposed no federal standards of investment propriety or fiduciary conduct on employee benefit plan administrators, (18) so the limited disclosure it demanded merely provided access to information that might help workers vindicate their rights under state contract or trust law. Plan participants' state law rights, however, were often severely restricted by the terms of the plan. (19) That ended in 1974, when ERISA imposed unalterable federal fiduciary obligations on employee benefit plan trustees and plan decision-makers, (20) and authorized plan participants, beneficiaries, and the Secretary of Labor to bring civil actions to enforce those fiduciary standards. (21) Recognizing the instrumental value of disclosure, ERISA replaced the WPPDA with a more robust, detailed, and exacting information regime. "Federal fiduciary standards were designed to work in combination with improved disclosure of plan finances and powerful enforcement tools to stem misconduct in plan administration." (22) The House Committee on Education and Labor explained:
  The underlying theory of the Welfare and Pension Plans Disclosure Act
  to date has been that reporting of generalized information concerning
  plan operations to plan participants and beneficiaries and to the
  public in general would, by subjecting the dealings of persons
  controlling employee benefit plans to the light of public scrutiny,
  insure that the plan would be operated according to instructions and
  in the best interests of participants and beneficiaries. The
  Secretary's role in this scheme was minimal. Disclosure has been seen
  as a device to impart to employees sufficient information and data to
  enable them to know whether the plan was financially sound and being
  administered as intended. It was expected that the information
  disclosed would enable employees to police their plans. But
  experience has shown that the limited data available under the
  present Act is insufficient. Changes are therefore required to
  increase the information and data required in the reports both in
  scope and detail. Experience has also demonstrated a need for a more
  particularized form of reporting so that the individual participant
  knows exactly where he stands with respect to the plan--what
  benefits he may be entitled to, what circumstances may preclude him
  from obtaining benefits, what procedures he must follow to obtain
  benefits, and who are the persons to whom the management and
  investment of his plan funds have been entrusted. At the same time,
  the safeguarding effect of the fiduciary responsibility section will
  operate efficiently only if fiduciaries are aware that the details
  of their dealings will be open to inspection, and that individual
  participants and beneficiaries will be armed with enough information
  to enforce their own rights as well as the obligations owed by the
  fiduciary to the plan in general. (23)

Concerning plan finances, the annual report required by ERISA must include "a statement of the assets and liabilities of the plan aggregated by categories and valued at their current value," and in addition a "schedule of all assets held for investment purposes aggregated and identified by issuer, borrower, or lessor, or similar party to the transaction (including a notation as to whether such party is known to be a party in interest), maturity date, rate of interest, collateral, par or maturity value, cost, and current value." (24) The annual report is filed with the Department of Labor and is open to public inspection. (25)

A summary annual report (SAR) must be furnished to plan participants, and to beneficiaries receiving benefits under a pension plan, within 210 days of the close of the plan year (today this distribution is often accomplished by electronic means of communication), but the SAR presents only the most general financial information. (26) With respect to assets, the SAR reports only the total net asset value of the plan as of the beginning and end of the plan year. (27) Upon request, participants are entitled to receive without charge a copy of "a statement of the assets and liabilities of the plan and accompanying notes, or a statement of income and expenses of the plan and accompanying notes, or both." (28) This statement of assets and liabilities refers to the broad categorical overview of the plan's financial position (the generic balance sheet data reported on the plan's Form 5500, Schedule H); it does not include the detailed schedule of all investment holdings. The plan administrator must make copies of the latest annual report available for examination by plan participants and beneficiaries, and they are entitled to be furnished with a copy of the full annual report (or any portion thereof) upon making a written request and paying a reasonable charge to cover the cost of copying. (29) Only by making such a request and payment can a plan participant obtain a copy of the itemized schedule of plan investments, or information concerning indirect investment vehicles in which the plan holds an interest. (30)

B. Data Sources and Limitations

The Department of Labor is authorized to prescribe forms for filing financial information required in the annual report and to use the data for statistical and research purposes, compiling and publishing "such studies, analyses, reports, and surveys based thereon as [the Secretary of Labor] may deem appropriate." (31) Form 5500, the "Annual Return/Report of Employee Benefit Plan," is the vehicle prescribed (in conjunction with the Treasury Department) for satisfying ERISA's annual report obligation. (32) Pension plans and funded welfare plans covering 100 or more participants are obliged to file the financial information called for by Schedule H. (33) Part I of Schedule H contains basic balance sheet information, reporting beginning-of-year and end-of-year values of assets and liabilities aggregated into broad categories, including in the case of assets: noninterest bearing cash, receivables (categorized as employer contributions, employee contributions, and other), interest bearing cash, U.S. government securities, corporate debt instruments (other than employer securities) classified into preferred and other debt, corporate stock (other than employer securities) classified into preferred and common, partnership or joint venture interests, real estate (other than employer real property), loans (other than to participants), participant loans, interests held in various specified indirect investment entities, employer securities, and buildings and other property used in plan operations. Part II reports income and expense information, again aggregated into broad categories, including unrealized appreciation or diminution in value of real estate and "other" assets (including government securities, corporate debt, and stocks), and the net investment gain or loss attributable to interests held in various specified indirect investment entities. The Department of Labor annually compiles the categorical balance sheet and income statement data that large pension plans report on Schedule H, Parts I and H, and publishes the results, subdivided into the amounts attributable to defined benefit and defined contribution plans, in a series entitled, "Private Pension Plan Bulletin: Abstract of Form 5500 Annual Reports." (34) This is the published source of asset allocation data on which Figures 1 and 2 are based.

Figures 1 and 2 demonstrate that various indirect investment vehicles, including master trusts and mutual funds, comprise a very large share of overall pension plan investments. Yet such indirect investment vehicles are like black boxes that hide their contents--the underlying investment holdings of such entities, whether comprised of corporate stocks, bonds, real estate, or other assets, are practically invisible. Consequently, even the broad categorical breakdown of pension plan assets is potentially misleading, because the reported value of direct investments in corporate common stock (for example) could be significantly augmented through indirect ownership of common stocks held by opaque investment intermediaries.

Each master trust investment account, or MTIA (defined below), is required to file its own Form 5500 annual report, including a Schedule H reporting the assets, liabilities, income, gains and losses of the MTIA. Correspondingly, an employee benefit plan that invests in the MTIA is granted a simplified method of reporting: instead of including the plan's proportionate share of each underlying asset (and liability) of the MTIA along with the plan's direct investments in the appropriate categories (e.g., U.S. government securities, corporate debt instruments, common and preferred stock) of the plan's Schedule H balance sheet, the plan reports the beginning and end-of-year values of its interests in all MTIAs as a separate asset category, (35) and files a Schedule D on which the plan identifies each MTIA in which it invests along with the year-end dollar value of its interest in each such MTIA. (36) The Schedule D information is intended to allow the attribution of indirect asset holdings (reported on the MTIA's Schedule H) to the investor-plans that are the ultimate owners.

Certain other indirect investment vehicles are permitted (but unlike MTIAs, are not required) to file their own Form 5500 annual report and accompanying schedules. These include common or collective trusts managed by a bank or trust company, insurance company pooled separate accounts, and investment entities that hold assets of two or more plans that are not members of a related group of employee benefit plans. Such collective investment vehicles that file their own Form 5500 annual reports are, together with MTIAs, referred to as "direct filing entities" (DFEs). An employee benefit plan that invests in one or more DFEs reports on Schedule H the total current value of its interests in all DFEs of each type, and identifies separately on Schedule D each DFE in which it participated at any time during the plan year together with the year-end value of the plan's interest. If an insurance company pooled separate account (for example) does not file its own Form 5500, then it is not classified as a DFE. A plan that invests in such a non-DFE pooled separate account must include the current value of its allocable portion of the underlying assets and liabilities of the pooled separate account in the proper categories of the plan's Schedule H, where those amounts will be combined with any assets (or liabilities) directly owned (or owed) by the plan that fall in those categories.

In principle, the Schedule D information allows proper attribution of indirect asset holdings (reported on the DFE's Schedule H) to the investor-plans that are the ultimate owners of those assets, and that attribution would provide a picture of overall portfolio composition of employee benefit plans that invest through DFEs. In practice, linking the data poses serious challenges, and to date such matching has not been comprehensively accomplished. In 2008, 10,512 large (meaning plans covering 100 or more participants) defined benefit pension plans filed annual reports, as did another 70,029 large defined contribution pension plans. (37) For that same year (2008) there were 7352 Forms 5500 filed by DFEs. (38) Clearly, comprehensive attribution of indirect investments held in DFEs to their pension plan owners requires automated data processing.

Automated data processing, of course, requires data to be available in electronic form. Historically, annual reports under ERISA (and its WPPDA predecessor) were submitted on paper forms. Beginning in 1999, the Department of Labor instituted a system requiring the information contained in Form 5500 and its accompanying schedules to be submitted in a format that could be read by optical character recognition technology. This initiative, called "EFAST" (for ERISA Filing Acceptance System), entailed scanning paper forms, capturing the data, flagging questionable data for manual verification and key-from-image correction as necessary, and routine random independent quality control audits of data validity. (39) In accordance with ERISA's public inspection mandate, the data, once converted to electronic form and stripped of personally identifiable information (such as plan participant social security numbers), was made publicly available. (40) In addition, the data pertaining to private pension plans received 'special attention. Private pension plan filings were scrutinized to identify and correct many statistically important logical and arithmetic data inconsistencies that remained after completion of EFAST processing. A private contractor performed various automated error checking and correction operations to improve the accuracy of the pension plan statistics. Important for purposes of this study, special attention was given to the pension plan features and characteristics codes. (41) The resulting edited pension plan statistics (starting with the year 2000) are posted on the Department of Labor web site under the heading, "Form 5500 PH vote Pension Plan Research Files," together with a "User Guide" for each year that details the editorial operations performed and explains the structure of the Research File data set. (42)

Since January 1, 2010, all Form 5500 returns, required schedules, and attachments must be filed electronically using the new EFAST2 system. (43) Thus, an all-electronic system that should reduce errors as well as delays and costs of data conversion and processing is now in place for all plan years beginning on or after January 1, 2009. Nearly all filings submitted through EFAST2, including schedules and attachments, are available to the general public through the Department of Labor web site, generally within one day of transmittal. (44)

The primary focus of this study is on large private pension plan annual returns filed for reporting year 2008, the final year of the period in which the part-paper, part-electronic, EFAST filing system was used. Forms 5500 and accompanying schedules were substantially revised in 2000 to facilitate the EFAST filing system, and those changes were motivated in large part by the inability to effectively monitor DFE investments under the prior reporting system.
  [C]ontinuation of the current rules would result in inadequate
  reporting to the Department [of Labor], would mean that the
  Department would continue to be unable to correlate and effectively
  use the data regarding the more than $2 trillion in plan assets
  invested by plans in DFEs or entities eligible to file as DFEs, and,
  therefore, in the Department's view, would be adverse to the
  interests of participants and beneficiaries in the aggregate. (45)

It should be emphasized at the outset that this matching of direct and indirect investments can yield only a very rough and incomplete picture of large private pension plan investments, considered either singly or in the aggregate. The source data for both pension plans and DFEs come from Form 5500 Schedule H, which, as explained earlier, reports aggregate holdings in specified broad categories of investments (such as U.S. government securities, corporate bonds, preferred stock, common stock, real estate, etc.). (46) Plan holdings of common stock, for example, could be broadly diversified (along the lines of an equity index fund) or concentrated in one or a few sectors or industries. (47) The stocks could represent ownership stakes in either domestic companies or foreign enterprises. Similarly, the real estate category offers no breakdown between improved and unimproved realty, much less does it give any clue to property location or relevant markets. So, while this study fills gaps in our knowledge of the allocation of pension plan investments among broad categories of asset types, it has little to say about the risk and return characteristics of pension plan investment portfolios. As noted earlier, a large pension plan is required to file an itemized schedule of its investment assets with its annual report, (48) but that detailed specification of individual investment holdings was not, during the period of the EFAST filing system, submitted in a format that would support routine electronic data capture. (49) Unfortunately, that limitation continues to this day even under the all-electronic EFAST2 filing system. (50)

The remaining sections of this part provide additional context that will aid in understanding the results of this study. First, the types of indirect investment vehicles and the consequence of DFE classification are explained. Next we present an overview of the extent to which private pension plans utilize indirect investment vehicles. Finally, before turning to the methodology used to attribute DFE assets to their investor-plans, aggregate descriptive statistics concerning DFE investments are presented.

C. Types of Indirect Investment Vehicles

Disclosure of plan finances facilitates monitoring and oversight, as a means to the end of promoting proper investment and disposition of plan property. ERISA imposes stringent and unalterable federal obligations of loyalty and prudence on employee benefit plan fiduciaries, a broad functional category that includes any person to the extent that he "exercises any authority or control respecting management or disposition of [the plan's] assets." (51) To bring sunlight to bear on financial management, the annual report must include "a statement of the assets and liabilities of the plan aggregated by categories and valued at their current value, and the same data displayed in comparative form for the end of the previous fiscal year of the plan." (52) Hence both fiduciary duties and disclosure obligations are keyed to the existence and extent of "plan assets." Until 2006, however, the statute left this key category undefined, leaving it to the Department of Labor to fill in the meaning of the term by rule." (53)

The regulatory definition of plan assets, which applies for purposes of both ERISA's information forcing and fiduciary obligation provisions, sets out the general rule:
  Generally, when a plan invests in another entity, the plan's
  assets include its investment, but do not, solely by reason
  of such investment, include any of the underlying assets of
  the entity. However, in the case of a plan's investment in
  an equity interest of an entity that is neither a
  publicly-offered security nor a security issued by an investment
  company registered under the Investment Company Act of 1940
  its assets include both the equity interest and an undivided
  interest in each of the underlying assets of the entity, unless
  it is established that--

  (i) The entity is an operating company, or

  (ii) Equity participation in the entity by benefit plan investors
  is not significant.

  Therefore, any person who exercises authority or control respecting
  the management or disposition of such underlying assets, and any
  person who provides investment advice with respect to such assets
  for a fee (direct or indirect), is a fiduciary of the investing
  plan. (54)

This standard creates the prospect that the managers of an independent entity could, if employee benefit plans own a sufficient equity stake in the entity, be held accountable under ERISA for failure to operate the entity "solely in the interest of the [investor-plans'] participants and beneficiaries". This derivative or look-through fiduciary status might at first seem startling, but consideration of the limits of the rule shows that it was designed to prevent evasion of ERISA's oversight of fiduciary conduct through the use of financial intermediaries.

The look-through rule does not apply to an equity interest that is a publicly-offered security or is issued by a registered investment company (e.g., mutual fund shares), regardless of the extent of an employee benefit plan's proportionate ownership of the entity. In such cases the periodic disclosure obligations imposed by federal securities laws with respect to the finances and operations of the entity provide a benchmark against which the propriety of the plan's equity ownership of the entity can be assessed. (55) Where federal securities laws do not apply to a plan's ownership interest in another entity, the look-through rule is triggered only if the entity is not an "operating company" and benefit plan investors own a "significant" share of its equity. An "operating company" is defined as "an entity that is primarily engaged, directly or through a majority owned subsidiary or subsidiaries, in the production or sale of a product or service other than the investment of capital." (56) Significant equity participation means that benefit plan investors own twenty-five percent or more of any class of equity interest in the entity. (57) Taken together, these conditions indicate that an investment vehicle which may be controlled by one or more employee benefit plans offers no escape from ERISA's unyielding standards of fidelity and care, nor from the reporting and disclosure obligations that implement those standards. Moreover, the look-through rule applies regardless of the form of organization of the investment entity (e.g., trust, joint venture, partnership, limited liability company, or corporation). Hence, ERISA fixes the scope of financial disclosure with reference to the persons who control plan funds and the extent of their control.

Consistent with the look-through rule, the instructions for completing the annual report financial information (Form 5500, Schedule H) state:
  If the assets of two or more plans are maintained in a fund or
  account that is not a DFE [direct filing entity], a registered
  investment company, or the general account of an insurance company
  under an unallocated contract ..., complete Parts I and II [balance
  sheet and income statement] of the Schedule H by entering the plan's
  allocable part of each line item. (58)

In contrast, a plan that utilizes an indirect investment vehicle that qualifies as a DFE may simply report the value of the plan's interest in the entity. In principle, there is no need to itemize the plan's allocable share of the DFE's underlying assets because the DFE files its own Form 5500 and accompanying financial information. (59) In practice, however, the indirect investments reported by DFEs have not been routinely or comprehensively matched with other assets owned directly by a plan that holds an interest in the DFE (an investor-plan).

A pension plan follows simplified financial reporting rules for investments in any of four types of DFEs: (1) master trust investment accounts; (2) some common or collective trusts maintained by banks or trust companies; (3) some insurance company pooled separate accounts; and (4) certain investment entities that hold plan assets (under the look-through rule described above), which may include real estate investment funds, hedge funds, and private equity funds. Pension plan sponsors share an impetus to consolidate funds for investment purposes, thereby obtaining the financial advantages of economies of scale and increased diversification, so long as that pooling will not jeopardize the favorable tax treatment of their plans. (60) As explained below, these four DFE varieties are common mechanisms to consolidate funds for investment.

A master trust pools assets of two or more plans sponsored by a single employer or by a group of commonly controlled employers, with a bank, trust company, or similar regulated financial institution that is subject to periodic examination by a federal or state agency serving as trustee. (61) (The regulated financial institution that serves as trustee may exercise discretionary authority over asset management in accordance with the terms of the master trust agreement, or it could instead function as a so-called "directed trustee" carrying out the instructions of the plan's named fiduciary. (62)) This definition of "master trust," it should be noted, only applies "[for purposes of annual reporting"--the term master trust lacks a single fixed meaning. (In other contexts it describes different types of collective investment devices, including trusts combining assets accumulated under plans of unrelated employers. (63)) Typically, a master trust is composed of several distinct asset pools, the beneficial ownership of which is shared in varying proportions by the plans that participate in the master trust, and each such subsidiary "master trust investment account" (MTIA), rather than the encompassing master trust itself, is a DFE.
  The assets of a master trust are considered for reporting purposes to
  be held in one or more "investment accounts."  A "master trust
  investment account" may consist of a pool of assets or a single
  asset. Each pool of assets held in a master trust must be treated as
  a separate MTIA if each plan that has an interest in the pool has the
  same fractional interest in each asset in the pool as its fractional
  interest in the pool, and if each such plan may not dispose of its
  interest in any asset in the pool without disposing of its interest
  in the pool. A master trust may also contain assets that are not held
  in such a pool. Each such asset must be treated as a separate MTIA.

Accordingly, although several plans of one employer or of one group of commonly controlled employers can employ a single master trust administered by a particular bank as trustee, if the trust maintains multiple accounts (representing distinct underlying asset pools), and there is any variation in the proportionate beneficial interests of the investor-plans between those accounts, then a separate Form 5500 must be filed for each such MTIA.

In contrast to a master trust, participation in which is (for purposes of annual reporting (65)) restricted to plans maintained by commonly controlled businesses, a common or collective trust (CCT) is a fund maintained by a bank, trust company, or similar regulated financial institution for the collective investment of funds contributed by unrelated participants, which may be employee benefit plans or other persons. A CCT may hold funds from plans maintained by unrelated employers, (66) and it may also contain other funds held by the financial institution in a fiduciary capacity, whether as trustee, executor, guardian, or custodian under state laws that correspond to the Uniform Gift to Minors Act (UGMA). (67) For tax reasons, a CCT ordinarily constitutes either a common trust fund or a type of collective trust sometimes called a group trust.

A common trust find receives special treatment under the Internal Revenue Code: it is not subject to tax as an entity (as either a corporation or a complex trust) but instead reports to its participants their proportionate shares of the fund's ordinary income (loss), short and long-term capital gains (losses), and qualified dividend income for the calendar year, whether or not distributed or distributable. (68) Participating qualified plans, of course, do not pay tax on their shares of the common trust fund's income, but the pass-through of the tax results of operations is important to taxable participants, which may include estates of decedents or incapacitated individuals, private trusts, and minors receiving property under the UGMA.

A group trust pools the assets of several qualified pension or profit-sharing plans, including plans with different terms maintained by unrelated employers. If certain conditions are satisfied, including adoption of the group trust as part of each participating retiree benefit plan and express language in both the group trust instrument and each participating plan barring diversion of assets attributable to one participating plan to employees or beneficiaries under another participating plan, then the participating trusts retain their tax-exempt status and the group trust also constitutes a qualified trust. (69) The exemption for such group trusts originated in 1956, (70) but has been continued and expanded over the years, so that participants may now include, in addition to qualified pension, profit-sharing and stock bonus plans, individual retirement accounts, eligible governmental deferred compensation plans under I.R.C. [section] 457(b), custodial accounts and retirement income accounts under [section] 403(b) tax-sheltered annuity plans, and governmental plans specified in [section] 401(a)(24). (71) CCTs (both common trust funds and group trusts) may also qualify for certain exemptions under the federal securities laws. (72) The authorization for national banks to operate collective investment funds is closely coordinated with their special treatment under federal tax and securities laws. (73)

A pooled separate account (PSA) is a collective investment fund like a CCT, but one that is managed by a state-regulated insurance company. (74) The PSA was developed in the 1960s to allow insurance companies to offer an investment vehicle for pension plan assets that would not be subject to the stringent investment constraints (particularly limits on holding common stock) imposed by state insurance laws and could provide a higher return than the insurer's general asset account. (75) The insurance company does not guarantee preservation of principal or a minimum investment return on funds invested in a PSA; plans that participate in the PSA are credited with units representing a proportionate share of the assets in the separate account and are entitled upon withdrawing funds to a redemption payment that reflects the investment return and market value of the account assets. To offer a competitive pension investment alternative, PSA income must escape tax at the insurance company level. Under the special tax regime applicable to life insurance companies, gains and losses on assets held in the separate account are not taxed. (76) Similarly, income produced by PSA investments (dividends, interest, rents, etc.), to the extent credited to the account, is not taxed as income of the insurance company. (77) PSAs may also qualify for certain exemptions under the federal securities laws. (78) A PSA may hold funds from plans maintained by unrelated employers, but to qualify for the securities law exemptions participation must be limited to qualified pension, profit-sharing, or annuity plans, and certain governmental retirement plans. (79) Hence, welfare plan involvement would trigger loss of the securities law exemptions. Observe that the requirement that all plans participating in a master trust must be sponsored by a single employer or related group of employers means that an MTIA may invest in a CCT or PSA, but not vice versa. (80)

Both CCTs and PSAs predate ERISA, and Congress anticipated that many employee benefit plans would turn to them for investment services. The statute provides that if some or all of the assets of a plan are held in a CCT or PSA, then the investor-plan's annual report "shall include the most recent annual statement of assets and liabilities" of the CCT or PSA, but it allows the Department of Labor, by regulation, to dispense with plan filing "if such statement or other information is filed with the Secretary by the bank or insurance carrier which maintains the common or collective trust or separate account." (81) A CCT or PSA may or may not be a DFE. (This is in contrast to an MTIA, which is an obligatory DFE.) If a CCT or PSA files its own Form 5500 accompanied by Schedule D, to identify the participating plans, and Schedule H. reporting financial information for the CCT and PSA, then the investment fund is a DFE and each investor-plan need only identify the DFE and report the current value of and net investment gain or loss relating to the plan's interest in the CCT or PSA. (82) If the CCT or PSA does not file as a DFE (and so does not submit Schedules D and H), then an investor-plan must report with its financial information (Schedule H for a large plan) "the current value of the plan's allocable portion of the underlying assets and liabilities of the [CCT or PSA] and the net investment gain or loss relating to the units of participation [held by the plan in the CCT or PSA]" along with identifying information relating to the CCT or PSA. (83)

The remaining variety of DFE that may be utilized by pension plans is known as a "103-12 Investment Entity" (or 103-12 IE), after the number of the Department of Labor regulation that authorizes separate filing. This reporting option is available to any investment vehicle other than a CCT or PSA, regardless of the entity's form of organization (joint venture, partnership, limited liability company, etc.), if the entity holds plan assets of two or more plans that are not members of a related group of employee benefit plans. (84) The definition of plan assets provides that significant equity ownership of an investment entity by employee benefit plans causes the underlying assets of the entity to be classified as plan assets, making any person who exercises authority or control respecting the management or disposition of such underlying assets a fiduciary of the investor-plans. (85) This look-through rule is triggered where aggregate ownership by employee benefit plans constitutes twenty-five percent or more of any class of equity interests in the entity, but a DFE filing as a 103-12 IE requires two or more unrelated plans to be equity owners. If such a look-through investment vehicle does not file as a DFE, then an investor-plan must include on its annual report financial information relating to the plan's allocable share of the underlying investments and transactions of the entity. (86)

Each of these four types of DFE (MTIA, CCT, PSA, and 103-12 IE) can be utilized by either large (100 or more participants) or small (less than 100 participants) pension plans. They can each also be used as indirect investment vehicles by funded welfare plans. In practice, however, welfare plan utilization seems to be quite limited. A DFE is required to identify each plan that participates in it at any time during the DFE's reporting year on Part II of Schedule D. (87) That identification calls for a report of the employer identification number (EIN) and plan number (PN) of each investor-plan. For each DFE included in our study that had non-zero assets at the close of the DFE's year we tried to match reported investor-plan identifiers to a 2008 Form 5500 filing by the investor-plan, and where a match was found we recorded whether the investor was a large pension plan, small pension plan, welfare plan, another DFE, or an investor of unidentified type. From the summary results reported in Table 1 it is readily seen that very few welfare plans are identified as investors in any of the four DFE types. It is also apparent that DFEs--especially CCTs and PSAs--report a very large number of investors on Schedule D, Part II, that could not be associated with the EIN and PN of a pension or welfare plan that filed a Form 5500. While the explanation for this phenomenon is not clear, it seems likely that some of these unidentified investors are single-participant plans that are not required to file Form 5500 with the Department of Labor, instead filing Form 5500-EZ with the IRS. (88)
Table 1: Summary of Reported DFE Investors by DFE Type. 2008

                                 Identified investors

DFE type    No. DFEs  Total no.  Pension    Large  Welfare   DFEs
          (non-zero)   Reported    plans  pension    plans
                      investors             plans

MTIA           1,485      5,316    1,518    3,525      315     36

CCT            2,877     93,510   55,885   28,139      380  2,907

PSA            1,819  1,051,556  818,938  174,904      387    124

103-12           402      6,698    3,612    2,096      147    325

DFE type  Unknown  Unidentified

MTIA            9           108

CCT            92        34,246

PSA         1,936       230,171

103-12          9         2,605

In addition to DFEs, ERISA allows a plan to invest in a registered investment company (including, most commonly, mutual funds), or in the general account of an insurance company, without treating the underlying assets of the fund or account as plan assets. (89) As a result, the look-through rule does not apply, and the investor-plan is not obligated to report its share of the assets, liabilities, or investment results of the mutual fund or insurance company. Moreover, because a mutual fund is subject to regular financial disclosure under federal securities laws, while an insurance company is subject to state regulation and periodic examination, the mutual fund or insurance company is not--unlike investment vehicles that are DFEs--obligated to file an annual report under ERISA. (90)

D. Pension Plan Utilization of Indirect Investment Vehicles

To what extent do private pension plans utilize these types of indirect investment vehicles? Figure 1 shows the aggregate results for large (100 or more participants at the start of the plan year) defined benefit (DB) plans in 2010, and Figure 2 gives the comparable overview for large defined contribution (DC) plans of all types.

In 2010, almost half (49.4%) of DB plan assets consist of MTIA interests, while the second-largest DB asset category consists of interests in another type of DFE, investments in CCTs (11.7%). Shares of registered investment companies (mutual funds) are the fourth-largest asset class (7.3%), while large DB plans invested very little through insurance companies (1.4% in pooled separate accounts and only 0.6% in general accounts), or 103-12 investment entities (1.8%).

The composite asset allocation picture is quite different for large DC pension plans (Figure 2). Here the largest single asset category is mutual fund shares (42.1% in 2010), followed in second place by interests in MTIAs (20.4%). The third largest asset category consists of CCT interests (9.9%), while stakes in PSAs come in sixth (3.5%). Insurance company general account assets are significant for large DC plans (4.4%), while 10312 investment entities contribute a miniscule fraction of average holdings (less than 0.1%).

A more nuanced picture emerges if private pension plans are subdivided into categories based on the size of each plan's total assets. Ranked by asset size, there is tremendous variability in "large plans" (meaning 100 or more participants). Figure 3 shows the utilization of six indirect investment vehicles by large DB plans in 2008, grouping the plans into ten categories (deciles) according to the size of their total assets. There are 1053 plans in each decile (because there were 10,532 large DB plans in 2008 that reported non-zero assets), but average total plan assets in each decile increases from only $1.56 million in the lowest decile, to $149 million in the second-highest category, rocketing to $1.57 billion in the top decile. (Note that the dotted line showing mean total assets is plotted against a logarithmic scale on the secondary vertical axis.) MTIA shares grow rapidly in the highest asset categories (top three deciles); the dominance of master trusts is clearly attributable to the investment technique of a few hundred plans with huge portfolios. CCT usage grows slowly but steadily with plan asset size, roughly doubling (from about 7% to 14%) between plans having the smallest and the largest amounts of investment assets. Conversely, reliance on mutual funds drops dramatically in the upper asset ranges, while use of insurers as financial intermediaries, whether through a pooled separate account or via investment in the insurance company's general account, steadily declines in the upper half of the asset spectrum.

Figure 4 presents the corresponding picture for large DC plans (of all types) in 2008. There are 7002 plans in each decile (because there were 70,020 large DC plans in 2008 that reported non-zero assets), and average total plan assets in each decile increases from only $320,000 in the lowest decile, to $255 million in the top decile. (Again in Figure 4 the dotted line showing mean total assets is plotted against a logarithmic scale on the secondary vertical axis.) Interestingly, MTIA utilization is insignificant except in the very largest DC plans: it 'jumps from almost nothing to twenty-five percent of total assets between the second-highest and the highest asset classes (ninth and tenth deciles). While mutual funds investmentsdominate all DC plan asset ranges, their share falls sharply (from 53% to 33%) at the very top (between the ninth and tenth deciles). As with DB plans, usage of CCTs increases steadily with plan asset size, while PSA usage declines over the upper asset ranges. Unlike the DB pattern, investments in insurance company general accounts do not appear to be inversely related to a DC plan's total assets.
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Title Annotation:I. Introduction to II. Background D. Pension Plan Utilization of Indirect Investment Vehicles, p. 591-625
Author:Wiedenbeck, Peter J.; Hinkle, Rachael K.; Martin, Andrew D.
Publication:Virginia Tax Review
Date:Mar 22, 2013
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