According to Financial Times News, a White House executive order in August 2024 called for agencies to “democratize” access to private equity and private credit for 401(k) retirement savers. This move accelerates a decade-long trend of shifting private equity from institutional pools to everyday investors. The authors, Oxford professor Ludovic Phalippou and Texas A&M law professor William Magnuson, argue this could backfire on the industry that lobbied for it. For nearly a century, private markets have operated under light-touch rules, assuming their wealthy, institutional investors were sophisticated. The entry of retail investors fundamentally changes that legal assumption and exposes the industry to new forms of accountability.
Legal equilibrium unravels
Here’s the thing: private equity has built its entire playbook around a specific type of client. Institutional investors—think pension funds, endowments—often let questionable fee structures or valuation games slide. Why? Because making a fuss can get you cut off from the next hot fund. It’s bad for business relationships and careers. But mom-and-pop investors in a 401(k)? They have zero reason to play nice. They don’t care about preserving a relationship with a fund manager. If they feel misled, they’ll just sue. And that changes everything. The legal shield of “sophisticated investor” vanishes, and the whole system built on handshake deals and complex contracts starts to look incredibly vulnerable in a courtroom.
IRR, fees, and fine print
So what exactly are these retail investors going to sue over? The list is long, but let’s start with the big one: performance metrics. The industry’s favorite number, the Internal Rate of Return (IRR), is basically a math trick. It’s highly sensitive to early, small cash flows and can make a fund look like a superstar even when long-term returns are just okay. Presenting IRR as an annual return to a teacher or a firefighter? A plaintiff’s lawyer will have a field day. Then there are the fees. The classic “2 and 20 with an 8% hurdle” sounds straightforward. But then there’s the catch-up clause, which often means once returns hit about 10%, the manager gets paid as if the hurdle never existed. It’s an investor protection that doesn’t really protect. In an institutional setting, everyone knows the game. For retail? It looks like a rip-off.
Liquidity illusion and valuation games
And don’t get me started on liquidity. Retail funds are often sold as “semi-liquid,” which sounds a bit like a mutual fund. In reality, redemptions can be capped at tiny percentages and are totally at the manager’s discretion. In a crisis, you might be locked in for five years or more. Now, is that a problem if you know the rules? No. But if you’re sold a product for your retirement account without understanding that “semi-liquid” means “you probably can’t get your money,” that’s a major problem. Then there’s the valuation shell game. Funds can buy stakes in other private equity funds at a discount and immediately mark them up to full price, booking a fake gain. This game has moved from institutional to retail funds, as noted in this analysis. If a retail investor buys in at that inflated price, that’s a direct, tangible loss they can point to in court.
Democratizing legal risk
The irony is thick. Private equity wanted access to the massive pool of retail capital without taking on the disclosure and governance rules of public companies. But in doing so, they may have jumped from the frying pan into the fire. Regulators might move slowly, but courts don’t. Once a critical mass of everyday investors realizes the gap between marketing and reality—especially after a market downturn—the class action lawsuits will start flying. The industry thought it was democratizing access to assets and fees. What it actually democratized, as academic research and legal scholarship suggests, is legal risk. They invited in a new class of investor who has nothing to lose by litigating. That’s a whole new ballgame, and the industry might deeply regret stepping onto the field.
