With the U.S. Department of Labor’s recent proposed rule, Fiduciary Duties in Selecting Designated Investment Alternatives, retail investors’ access to private assets comes ever closer to reality, though not without controversy. The battle lines are unsurprising: Private asset managers are enthused about the prospect, consumer advocates less so. At least two academic articles, here and here, have warned of the risks and other dangers of retail private funds.

In a new article, I focus on the particular fit between private equity and defined contribution (DC) retirement plans, as largely regulated by the federal Employee Retirement Income Security Act (ERISA). I offer two primary arguments for why the current efforts to allow (DC) plans to invest in private assets are likely to be less successful than their proponents hope.

First, current reform proposals implicitly assume that the primary barrier to the inclusion of private investments in DC plans is plan fiduciaries’ fear of being sued. The proponents of private equity essentially propose to shield plan sponsors from class-action litigation on the belief that 401(k) menus will then add private equity. This is a misunderstanding of how ERISA incentives function. A safe harbor for an asset rarely eliminates risk, much less provides any incentive for plans to adopt that asset. History is instructive here: Multiple agency and legislative safe harbors have been adopted to encourage in-plan annuities, all to essentially no effect. If safe harbors cannot move the needle on annuities—a product widely acclaimed for enhancing retirement security—they are, standing alone, unlikely to do so for a much more controversial asset class such as private equity. By contrast, plans’ embrace of target-date funds, which ostensibly were also the beneficiaries of a safe harbor, was driven by a complex chain of regulatory pushes, starting with IRS antidiscrimination rules.

Second, there are serious and fundamental structural incompatibilities between private equity and defined contribution plans, largely due to the illiquid nature of private equity. In a 2020 report, Professors Scott and Gulliver argued that these issues can be addressed with policy fixes and financial engineering such as in-plan loans and limited-exposure funds.

Although I agree that in-plan loans should be a mandatory feature of DC plans, I argue that the problems created by private equity’s illiquidity run deeper. Because private equity assets are not publicly traded, their reported value relies on periodic manager-made estimates of net asset value rather than real-time market discovery. This makes it difficult, if not impossible, for the typical biweekly investments of 401(k) plan contributions to be made fairly. If an NAV estimate is too high, the employee buying into the fund today receives too few units. If it is too low, the existing participants are diluted. This valuation gap persists during the withdrawal phase as well. Retirees receiving (often required) distributions need accurate NAVs to avoid being shortchanged or overpaid. While private equity has traditionally overcome these issues through manager-timed pro rata capital calls and distributions, such an irregular cash-flow model is fundamentally at odds with the regularity of payments into defined contribution retirement plans, and reliance on manager-led valuations poses risks that are now being realized in the private debt arena.

I do not contend that the inclusion of private equity is inherently a bad for America’s retirement savings system. However, the large-scale adoption—much less the socially constructive deployment—of private assets in defined contribution plans requires more than policy patches such as litigation safe harbors. Rather, it demands a reassessment of how an illiquid asset can be reconciled with a savings scheme that is traditionally, though not inevitably, liquid. Indeed, the answer to successful integration of private assets with DC plans may not be more liquid private asset vehicles, but less liquid DC plan accounts.

Moreover, any such integration must also address equally fundamental challenges of ensuring that accountability mechanisms either under ERISA or otherwise can be meaningfully applied to an asset class that operates under a governance logic entirely distinct from that of publicly traded securities and the funds that hold them. Here too, the best solutions may well differ from what has been proposed so far. For instance, as I note, the very litigation that the DOL’s rule seeks to protect plan fiduciaries from has often pushed plans to adopt assets with higher returns. If PE inclusion will truly produce higher returns for plan participants, PE may well benefit from more fiduciary litigation, not less.

James An is a professor at Suffolk University Law School. This post is based on his recent article, “Private Equity in Retirement Savings,” available here.