The United States House of Representatives approved the Pension Protection Act of 2006 (the "Pension Act") on July 28, 2006, the United States Congress approved the Pension Act on August 3, 2006 and the President is expected to sign the Pension Act into law.  Section 611(f) of the Pension Act adds a definition of "plan assets" to ERISA (as defined below), and as a result, significantly decreases the likelihood that an investment fund would be deemed to be holding "plan assets." 

Background
Neither the United States Employee Retirement Income Security Act of 1974, as amended ("ERISA"), nor the United States Internal Revenue Code of 1986, as amended (the "Code") had previously defined "plan assets."  In late 1986, however, the United States Department of Labor (the "DOL") issued regulations (the "Plan Assets Regulation") relating to the definition of "plan assets."  Under the Plan Assets Regulation, when a pension, profit-sharing and other employee benefit plan to which ERISA applies or a tax-qualified retirement plan described in Section 401(a) of the Code, a tax-qualified annuity plan described in Section 403 of the Code and an individual retirement account or individual retirement annuity as described in Section 408 of the Code (each a "Plan") acquires an "equity interest" in an entity (such as by investing in the shares or limited partnership interests of an investment fund), and the equity interest is neither a "publicly-offered security" nor a security issued by an investment company registered under the United States Investment Company Act of 1940, as amended, the assets of the Plan will include not only such equity interest, but also an undivided interest in each of the underlying assets of such entity (the "look-through" rule). 

An exception from this "look-through" rule in the Plan Assets Regulation would apply such that the underlying assets of an entity in which a Plan makes an equity investment will not be considered "plan assets" if less than 25 percent of the value of all classes of equity interests in the entity, disregarding equity interests held by persons with discretionary authority or control with respect to the assets of the entity or who provide investment advice for a fee with respect to such assets, and their respective affiliates, are held by (x) Plans, (y) other employee benefit plans not subject to ERISA (for example, governmental or foreign employee benefit plans) and (z) other entities whose assets are considered "plan assets" under ERISA and the Plan Assets Regulation (collectively, "Benefit Plan Investors") (the "25% Test").

As a consequence of this "look-through" rule, if an investment fund did not meet the 25% Test or any other exception, all of the investments by the investment fund in another investment fund would count towards the 25% Test as a Benefit Plan Investor. 

If the assets of an investment fund were deemed to be "plan assets," then various prohibitions with respect to the operation and administration of the fund and the duties, obligations and liabilities of the investment manager under ERISA, would apply to transactions entered into by the investment fund, as though such transactions were directly entered into by the Plan investors. 

Changes to the Definition of Plan Assets
The following changes to the 25% Test have been made by the Pension Act:

1. Benefit Plan Investors would include only Plans (i.e., employee benefit plans subject to ERISA or Section 4975 of the Code) and not other benefit plan investors described in (y) above (i.e., governmental or foreign employee benefit plans). 

2. Other entities whose assets are considered "plan assets" (e.g., an investment fund that does not meet the 25% Test or another exception) will only be considered to hold "plan assets" to the extent of the percentage of the equity interests owned in such entity by such benefit plan investors (i.e., if 60% of the investment fund's investors are Plan investors, 60% of the investment fund would be considered "plan assets" when investing in another investment fund (e.g., a fund of funds)). 

Examples

1. An investment fund markets primarily to non-US investors.  The investment fund consists of $1,000.  Plans (US pension plans) own $50 of the total value of equity interests in the investment fund.  Non-US pension plans own $500 of the total value of equity interests in the investment fund.  Under the current regulations, since 55% (greater than 25%) of the equity interests in the investment fund are owned by Benefit Plan Investors, the "look-through" rule would apply.  Under the new definition, since only 5% (less than 25%) of the equity interests in the investment fund are owned by new Benefit Plan Investors, the "look-through" rule would not apply.

2. Fund A consists of $1,000 of which Plans own $300.  Fund B consists of $1,000 of which Plans own $300.  Fund A, Fund B and Fund C (which does not have any Plan investors) are investors in Fund D with each of Fund A, B and C contributing $500. 

Under the current regulations, (i) since 30% (greater than 25%) of each of Fund A and Fund B's equity interests are owned by Benefit Plan Investors, the "look-through" rule would apply to Fund A and Fund B, (ii) since 0% (less than 25%) of Fund C's equity interests are owned by Benefit Plan Investors, the "look-through" rule would not apply to Fund C, and (iii) since 67% (greater than 25%) of Fund D's equity interests are owned by Benefit Plan Investors (Fund A and Fund B), the "look-through" rule would apply to Fund D (even though only 20% of the equity interests in Fund D are indirectly owned by the ultimate Plan investors). 

Under the new definition, (i) since 30% (greater than 25%) of each of Fund A and Fund B's equity interests are owned by new Benefit Plan Investors, the "look-through" rule would apply to Fund A and Fund B and (ii) since 0% (less than 25%) of Fund C's equity interests are owned by new Benefit Plan Investors, the "look-through" rule would not apply to Fund C.  Fund A and Fund B would each be deemed to be making an investment of $150 with "plan assets" (30% of $500) and $350 with non-"plan assets" in Fund D.  Since 20% ($150 each from Fund A and Fund B for a total of $300 of $1,500 total in Fund D) (less than 25%) of Fund D's equity interests are deemed to be owned by new Benefit Plan Investors, the "look-through" rule would not apply to Fund D.

Conclusion
Fiduciaries of a Plan should note that when the Pension Act is enacted, the number of investment funds that the Plan may invest in should increase and the investment funds that a Plan is currently invested in may change their mix of investors.  Plan fiduciaries should also note that when the Pension Act is enacted, fewer investment funds will be deemed to hold "plan assets" subject to certain fiduciary duties and other obligations.  Fiduciaries should consider such potential changes and act accordingly. 

In addition, managers of investment funds should consider the impact of the Pension Act on the availability of additional potential investors in their funds.