PRIVATE CREDIT IS REELING, BUT NEW RULE MAY ALLOW IT INTO 401(K)S / THE WALL STREET JORNAL

Private Credit Is Reeling, But New Rule May Allow It Into 401(k)s

Labor Department intends to help employers avoid lawsuits stemming from the alternative investments they offer employees in retirement plans

By Anne Tergesen  and Dylan Tokar

President Trump speaking to reporters after stepping off Air Force One. Mark Schiefelbein/Associated Press

The Trump administration proposed a regulation on Monday that is intended to open 401(k)s and similar retirement plans to private equity and private credit.

It is a victory for the Wall Street firms that have lobbied to get these higher-cost alternative investments into the $14.2 trillion 401(k) market. 

But it comes at an inopportune time for the industry, as investors pull money from some private-credit funds.

The proposed regulation by the Labor Department aims to curb the litigation that dissuades employers from broadening their 401(k) investment menus beyond the typical mix of stock and bond funds. 

It could usher in a new openness among employers to consider alternative investments, from private credit to infrastructure funds, though adoption is likely to be relatively slow given the gradual pace of change in the 401(k) market.

Private-market fund managers argue that regular investors should have access to assets that have long been restricted to pensions, endowments and the wealthy, especially in an era in which there are fewer publicly traded companies to invest in.

Treasury officials including Secretary Scott Bessent wanted to make sure the regulations didn’t make it easy for fund managers to saddle 401(k) holders with underperforming investments, according to people familiar with the matter. 

The concerns were heightened as sentiment about the previously booming private-credit industry began to sink.

Bessent said in February that the Treasury was working with the Labor Department on the rule to ensure that “if there is something rotten, it is not going to be handed to the individual investors.”

The rule proposed Monday makes clear that so-called continuation funds, where a firm buys a fund from its own affiliate using its own proprietary valuation methods, wouldn’t be eligible for litigation protection under the Labor Department’s proposed rule.

Investors have grown concerned that artificial intelligence will upend the software industry, which has been a big recipient of loans from private-investment firms. 

Executives in the private-credit world say there is an overreaction to a few bad investments, and that their industry is healthy.

Although federal law doesn’t prohibit the use of alternative investments in 401(k)s, legal experts say the fear of being sued has made it difficult for private-markets managers to break into the 401(k) market with offerings that cost more than funds that invest in publicly traded stocks and bonds.

President Trump signed an executive order on 401(k)s in August, saying the lawsuits and regulations issued under the Biden administration “have denied millions of Americans opportunities to benefit from investment in alternative assets” that are staples in pension plans.

The law governing 401(k) plans requires companies to act in the best interests of plan participants, a vague standard that has opened the door for employees to launch hundreds of lawsuits against employers over the past two decades. 

Many of the suits alleged excessive fees, and some have resulted in settlements for workers at companies including Boeing and Lockheed Martin. 

Lawyers for plaintiffs say the suits have contributed to the long-term decline in 401(k) fees.

The new rule gives 401(k) plan sponsors more detailed guidance on how to choose investments. 

The Labor Department said plan sponsors who follow prescribed processes would have a “safe harbor” that aims to protect against lawsuits. 

The department identified six factors that must be considered, including risk-adjusted performance, liquidity, fees, and valuation methods.

An official said the Labor Department hopes these rules will provide clarity that cuts down on “litigation abuse.”

The rule doesn’t single out any specific type of investment. 

Instead, it is intended to apply equally to all, from the stock and bond funds that dominate 401(k) menus to alternatives, including private markets and cryptocurrencies, said Brian Graff, chief executive of the American Retirement Association, which represents the 401(k) industry.

The rule lays out procedures for how retirement plan fiduciaries could pick private investments and receive protection from lawsuits. 

For example, it says a 401(k) plan sponsor must secure representations that a private fund manager uses an independent valuation of its investments at least quarterly and manages liquidity risks in similar ways to Securities and Exchange Commission-regulated investments.

It makes it clear that selecting alternative assets for reasons including providing diversification may justify higher fees.

The Labor Department said Monday it would hold a 60-day public-comment period before issuing a final version, perhaps by year-end.

Richard Nowak, a partner at law firm Mayer Brown, said he expected the new guidance would help decrease class-action litigation around retirement fund choices over time, although not immediately.

“Plan sponsors and fiduciaries will now be able to point to these regulations as further evidence that they engaged in a prudent process,” he said.

Fred Reish, a lawyer who specializes in employee benefits, said he thinks more employers will add private investments to diversified funds within 401(k) plans. 

But the growth rate will be slow until the nation’s largest target-date fund providers get on board. 

“That will be the game-changer,” he said.

Target-date funds hold a diversified portfolio and shift money from stocks to bonds as investors age. 

They are typically the default investment for new hires who are automatically enrolled.

Daniel Aronowitz, the head of the Labor Department’s Employee Benefits Security Administration, which regulates employer-sponsored 401(k) plans, vowed to “end the era of regulation by litigation” in testimony before a Senate committee in June.

Anne Tergesen has long covered retirement and personal finance, first at BusinessWeek magazine and since 2008 at The Wall Street Journal. She writes frequently about the myriad ways in which retirees with zero to millions in savings spend their time and money. Her work also explores topics relating to longevity, aging and how people can better prepare for later life. Anne is obsessed with 401(k)s and how plans that put saving and investing on auto-pilot remove the need for workers to rely on willpower alone.

Anne was a Knight-Bagehot Fellow at Columbia University, where she studied finance and economics. She was a finalist for a Gerald Loeb Award and received a Best of Knight-Bagehot Award and a Front Page Award from the Newswomen's Club of New York. She loves to travel and hike with her family, especially in the Sierra Mountains.

Dylan Tokar covers financial regulation, money laundering and government investigations for The Wall Street Journal in New York. His reporting is often focused on the intersection between Wall Street and Washington, D.C. He also has an interest in how the financial system works for consumers—or doesn’t.

Dylan has written extensively about corporate crime and the murky world of illicit finance. He previously covered the world of corporate compliance, including how companies manage the risks associated with bribery and corruption, economic sanctions and other laws and regulations.

In his current role, Dylan covers an alphabet soup of regulators and law enforcement agencies, from the U.S. Securities and Exchange Commission to the Treasury Department and the Federal Reserve.

Prior to joining the Journal, he reported on cross-border investigations and the legal industry from Washington, D.C., New York and London.

Nathan Kirsh built Restaurant Depot from one warehouse in Brooklyn in 1976 and after getting his business start in South Africa.