A U.S. Department of Labor ruling Wednesday allows private equity funds to market to the trillion-dollar private qualified retirement plan market for the first time—a huge victory for the industry.
The move “will help Americans saving for retirement gain access to alternative investments that often provide strong returns,” Labor Secretary Eugene Scalia said in a statement.
But the ruling is fraught with legal liability for plan sponsors and any advisors who recommend these funds to qualified plans, said James Watkins, an attorney and CEO of Atlanta-based InvestSense LLC, in an interview with Financial Advisor. InvestSense provides fiduciary oversight to retirement plans and trusts.
“All the 401(k) and 403(b) actions/settlements prove that far too many plan sponsors cannot even select cost-efficient and otherwise prudent funds for their plans. So now [the] DOL says they can include private equity?” (Watkins is a former broker-dealer compliance director.)
In Watkins’s own city of Atlanta, Emory University just settled an ERISA class action lawsuit for $17 million earlier this week. The university had allegedly breached its duties of loyalty and prudence under ERISA by causing plan participants to pay excessive fees for both administrative and investment services in the plan. Emory denied it committed any fiduciary breach in its operation of the plan.
With 401(k) and 403(b) actions and settlements already rising sharply because of excessive fees and imprudent investment selection, Watkins said he is warning sponsor clients that including private equity in retirement plans will make them vulnerable to litigation.
Disclaimers Might Not Help
Even advisors who use fiduciary disclaimers in an attempt to blunt their legal liability are being successfully sued for fraud, negligence, misrepresentation and breach of contract, Watkins said.
“I’ve gotten tons of calls from plan sponsors and advisors and I ask: ‘Are you calling about private equity? Don’t go there.’ ERISA requires that each investment in a qualified retirement plan be prudently evaluated. So it is the duty of advisors or sponsors to do separate evaluations of each investment in a plan, and you’ve got a lack of transparency with private equity.”
Says Who?
There are no independent audit or reporting services such as Morningstar to evaluate private equity funds, so sponsors and advisors often rely on the funds themselves for due diligence.
“If I was an attorney representing plan participants,” Watkins said, “the first question I’d ask firms and advisors is: ‘Where did you get the information. The only information you relied on came from the party you were evaluating.’ As I’ve told my plan sponsors, this is a trap. You have no way to independently verify this. You will be liable.”