ERISA Opinion No. 2000–10A
The issue was whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership in which the IRA owner and his relatives are partners would give rise to a PT.
The transaction at issue involved a family partnership (the “Partnership”), a general partnership that was an investment club. Leonard Adler (“Adler”) and some of his relatives were invested in the partnership, both directly and indirectly through another general partnership. Adler planned to open a self-directed IRA for $500,000. At the time he planned to direct the investment, the Partnership would become a limited partnership. Adler would become the only general partner in the Partnership and would own 6.52% of the total partnership interests. He would not have any investment management functions. Rather, a registered investment advisor, Madoff Investment Securities, would be retained to select investments for the Partnership’s assets. None of the funds contributed by the IRA would be used to liquidate or redeem any of the other partners’ interest in the Partnership. In exchange of its investment, the IRA would own approximately 40% of the partnership interests.
The Department’s opinion was that the IRA’s purchase of an interest in the Partnership would not be a prohibited transaction. The Department acknowledged that the IRA was a “plan” and that Adler was a fiduciary. Adler was a disqualified person because of his roles as both the IRA fiduciary and the general partner of the Partnership which held the “plan assets” of the IRA. (This “plan asset” issue is addressed further below.) The investment transaction would be between the Partnership and the IRA. Adler’s ownership of the Partnership (6.52% directly plus 40% via the IRA) did not constitute a majority interest and therefore the Partnership itself was not a disqualified person. The parties had represented that Adler did not (and will not) receive any compensation from the Partnership and had not (and will not) receive any compensation due to the IRA’s investment in the Partnership and the Department’s views were expressly based on those representations. The Department observed that, if a conflict of interest between the IRA and the fiduciary arose in the future, there would be the potential for a PT violation. The PT rules, however, are not violated merely because the fiduciary derives some incidental benefit from a transaction involving IRA assets.
The Department noted that, by virtue of the contemplated investment by the IRA in the Partnership, there will be “significant investment” in the Partnership by the IRA. Under the Department’s plan asset rules, investment is “significant” if 25% or more of an entity’s interests are held by one or more IRAs or other benefit plan investors. Accordingly, the Partnership will be deemed to hold the assets of the IRA. As a result, any person who exercises discretionary authority or control with respect to assets of the Partnership will be a fiduciary of the IRA and subject to the restrictions of the PT rules. The Department was essentially confirming to Adler that the PT rules would remain relevant to the IRA’s investment in the Partnership on an continuing basis.
The PT rules must be an important consideration in evaluating any transaction to be undertaken by an IRA that involves a party related to the IRA owner. Depending upon the circumstances and the relationships among the parties, a co-investment by an IRA and parties related to the IRA may not run afoul of the PT rules. Co-investment opportunities may present challenges beyond the PT rules. An IRA owner considering a co-investment opportunity should also be aware that certain investment restrictions may be imposed by the IRA custodian. For example, many IRA custodians will not agree to hold real estate directly under an IRA. Other common restrictions relate to illiquid assets, which would include many limited partnership interests. In evaluating any co-investment opportunity for an IRA, it would be wise to consult with counsel, as well as the IRA custodian, to determine a legally and practically viable approach.