President Trump recently signed an executive order calling for increased access to alternative assets – including private equity – for 401(k) plans. It won’t be long until we see this policy shift take effect, but as retirement capital floods in, funds will also face increased regulatory scrutiny.
Government departments and federal regulators worked quickly following Trump’s order, reassessing their positions on alternative assets and taking a far more encouraging, relaxed stance than before. As a result, they have effectively opened a $12 trillion retirement market to the private equity sector.
The reaction from firms has, unsurprisingly, been extremely positive. Investment giants such as Apollo Global and BlackRock are downright ecstatic. As a capital source, individual investors “have the potential to be as large as institutions in the same sorts of products, and they will not take anywhere near 40 years to get to that size,” said Apollo’s Marc Rowan on a recent earnings call.
Others have been more reserved, with 401(k) plan administrators and pension consultants stressing the need for clear guidance on valuation practices, liquidity management, and fiduciary obligations before fully embracing the change. While this is certainly an exciting shift for the sector, I have no doubt that it will bring its fair share of challenges.
For starters, retail investors will want assurances that their money is in good hands. They will be used to the real-time stock fluctuations and minute-by-minute portfolio updates of the public markets, and private equity firms will be hard-pressed to match that level of accuracy and frequency considering their assets aren’t traded daily and are far less liquid.
Equally, PE firms that begin accessing capital from ordinary Americans’ pension plans are bound to face fiercer media attention. Any instances of mismanagement, loss or failed transactions will be covered extensively – and that’s without mentioning any breaches in compliance or any left-field investment tactics.
Put simply, private equity will find itself under the spotlight, and with increased public exposure comes intensified regulatory scrutiny.
Stricter oversight ahead
As 401(k) providers ramp up investments in alternative assets, they will come under substantially higher fiduciary pressure. The Employee Benefits Security Administration (EBSA) – the body responsible for regulating 401(k) plans – is already known to take a tough stance on failure of fiduciary responsibility. It recovered $741.9 million from enforcement actions last year, while barring and removing nearly 40 fiduciaries.
EBSA is likely to exercise even closer oversight as plan providers increase their exposure to alternative assets, pushing them to demand more transparency from the private equity funds they invest in. Whether 401(k) sponsors request detailed disclosure presentations on fees, investment strategy, or performance, they’ll heap on the pressure to comply with EBSA.
Other regulators will have similar instincts – greater public attention will also pressure the SEC to penalize any instances of malpractice. The Commission was already trying to introduce stricter rules for private equity before the order, proposing new private fund advisor rules in 2023. The regulations, which introduced quarterly performance and fee reports, were ultimately quashed by an appeals court last year, but it’s not hard to imagine a renewed effort on the legislation once retirement cash starts flowing into funds.
So, here’s the bottom line: private equity is in for an era of heavier oversight – from investors, the media, 401(k) plan providers and regulators alike. The screws are set to tighten, and firms must prepare accordingly.
Managing complex compliance requirements
In this new era, PE funds will face new challenges that could significantly slow them down. They could come up against more demanding investor communications requirements, more frequent reporting schedules, and an ever-more intricate compliance landscape.
With all this to tackle, finding efficiencies will be crucial. I know firsthand what it’s like to be a lawyer in the funds space, and I also know how much admin and bulk is already on the desks of specialist counsel. Hard work alone won’t be enough to deal with the compliance tasks ahead – and whether by leveraging technology – AI or otherwise – legal teams supporting funds will require speed to clear the backlog. (Disclosure: I am the founder of a legal tech company that supports funds professionals and automates their repetitive tasks.)
A better approach is long overdue. Private equity firms are already fined millions upon millions of dollars for failing to keep on top of their regulatory obligations. In fact, industry giants including TPG, Carlyle, and Blackstone were all penalized for recordkeeping violations just this January. Now is the right time to tighten up processes and implement efficiencies that help firms avoid these breaches.
Ultimately, smoother legal operations could also help keep investors on board. It’s no secret that funds have had a tough time of late. Data from Preqin shows that global buyout AuM dropped for the first time in decades last year, proving that many investors have become disillusioned with the sector’s performance. Given how tough fundraising has been, the 401(k) shift could be a real lifeline, offering a new source of sorely needed dry powder.
At the end of the day, this legislation change is not something for PE to fear. It’s a huge opportunity for the industry, so long as firms are proactive in tackling the incoming compliance headaches.
For US private equity, a retail investment spike is coming, and regulatory oversight will intensify in a way the sector has never experienced before. For the firms that want to capitalize on this new source of capital, preparation will be key.
Amr Jomaa is the CEO and founder of Navys, an AI-powered operating system for legal teams.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.
