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.”

Beyond the relative lack of transparency, the costs and risks attached to private equity will continue to be sponsors’ and advisors’ downfall, he said.

Private equity funds usually charge plans a flat fee and then get a percentage of the profit. “Typically, the private equity fund will charge a flat fee of say $50,000 [depending on the size of the plan] and charge another 20% profit tied to performance,” Watkins said.

The fees can be hard to justify given the fact that actively managed funds, on average, do not beat passively managed investments such as ETFs and mutual funds.

Ripe Commissions
“As Vanguard’s John Bogle said, ‘You get what you don’t pay for,’” Watkins said. “Many of the advisors to plans also charge 7%—a very nice commission for selling these private equities.

“Unfortunately, in a lawsuit, there is a good chance plan participants will lose, the sponsors will lose, but the broker will still get his or her 7%. It’s one of the higher commissions.”

Even registered investment advisors who don’t accept a commission can be sued, the attorney said. “I’d ask advisors the same question: What info did you have, who provided it. Inevitably, it always comes back that the private equity fund provided the information.”

Public pension funds that manage employees’ retirement savings have a long history of investing in private equity. But 401(k) plans have stayed away because of the complex regulations and their concerns about being sued.

The Department of Labor’s ruling was praised by Jay Clayton, chairman of the Securities and Exchange Commission, which is considering ways to let retail investors access asset classes that have been largely reserved for the wealthy.

Under current SEC regulations, firms such as Apollo Global Management Inc., Blackstone Group Inc., Carlyle Group Inc. and KKR & Co. are mostly limited to raising money from high-net-worth investors and sovereign wealth funds and pension funds. But that, too, could change soon if the SEC lifts qualified plan prohibitions.