I. Introduction — From “Gateway Drugs” to Hidden Crypto Exposure
Trump-era executive orders have again opened the 401(k) casino. Just as fixed and variable annuities were sold into plans under the false pretense of a DOL “safe harbor,” crypto now follows the same playbook—masked behind Target-Date Funds (TDFs) wrapped in State-regulated Collective Investment Trusts (CITs). These opaque, bank-trust vehicles avoid SEC registration and ERISA’s disclosure regime, giving Wall Street a new place to hide high-fee, high-risk bets.
II. How Crypto Becomes a Prohibited Transaction
Under ERISA §406(a)(1)(C) & (D), a plan engages in a prohibited transaction if a fiduciary causes the plan to furnish services or assets to, or engage in any transaction with, a party-in-interest— including the recordkeeper, trustee, or any affiliate. Once crypto exposure is embedded in a TDF or brokerage window managed by a plan’s own service provider, several triggers appear, including affiliate conflicts, spread profits, hidden placement within Target-Date CITs, and lack of a viable PTE.
III. The Valastro Framework — Fiduciary Void Meets Regulatory Capture
Valastro describes a “regulatory void” surrounding crypto in 401(k)s and a Trump administration “all-in on cryptocurrencies.” Her forthcoming analytical framework would extend fiduciary prudence standards to brokerage windows—precisely where crypto is now being funneled. Yet absent DOL enforcement, plan sponsors inherit full fiduciary liability when participants lose savings.
IV. Parallels to the Fixed-Annuity “Get-Out-of-Jail-Free Card”
As detailed in Trump’s Executive Order Is Not a Get-Out-of-Jail-Free Card (Aug 2025), insurers long claimed that any product blessed by State regulators or a DOL exemption is automatically ERISA-compliant. Crypto promoters now borrow that script—arguing that Executive Order 14330 “democratizes alternatives.” In reality, it merely shifts risk from issuers to participants while removing federal oversight.
V. Accounting Chaos — “Four Sets of Books” in Digital Form
In Four Sets of Books (Aug 2025) I showed how plan sponsors, insurers, and consultants each maintain separate ledgers—obscuring true returns. The same structure applies to crypto: Blockchain ledgers record token flows; custodians maintain off-chain balances; recordkeepers report synthetic daily values; and trustees book nominal “unit values.”
VI. Target-Date CITs as the Hidden Vector
Crypto exposure will likely surface inside default TDFs, buried within State-regulated CITs. Because participants rarely opt out of defaults, millions could be involuntarily exposed to crypto volatility—without prospectus, SEC registration, or clear ERISA bonding. That alone establishes both fiduciary imprudence and self-dealing.
VII. Fiduciary Implications and Enforcement Roadmap
The DOL retains power under §406 to challenge crypto inclusion as an imprudent plan investment. Plaintiffs can also plead that fiduciaries knowingly allowed party-in-interest transactions lacking valid exemptions.
VIII. Conclusion — Crypto as the Next ERISA Time Bomb
Crypto in retirement plans repeats every structural flaw of the annuity and private-equity experiments: opacity, conflicted service providers, and regulatory arbitrage. Valastro’s “Retirement Roulette” metaphor captures it perfectly—plan sponsors have turned workers’ savings into a spin of the digital wheel.
Add-On: Crypto in Brokerage Windows Is Still a Prohibited Transaction
I. Brokerage Windows—The Illusion of Fiduciary Escape
Professor Lauren K. Valastro’s Regulating Retirement Savings Roulette makes clear that the so-called self-directed brokerage window (SDBA) is no regulatory safe zone. She writes that “no agency or court has confirmed the existence of fiduciary duties relating to brokerage windows,” yet those windows are now the primary mechanism through which crypto enters 401(k)s. By allowing virtually unrestricted trading access inside an ERISA plan, sponsors and recordkeepers pretend that fiduciary obligations stop at the menu—but ERISA never permits abdication.
II. The Fidelity Crypto Pay-to-Play Model
Fidelity reportedly accepted hundreds of millions of dollars from crypto issuers and exchanges to gain shelf space on its brokerage-window platform. Such arrangements are indistinguishable from mutual-fund revenue-sharing schemes that courts have already deemed transactions for consideration with a party-in-interest. When a recordkeeper or trust platform receives direct or indirect compensation from a product provider whose assets are sold through the plan—even via SDBA—§406(a)(1)(C) and (D) apply.
III. Benchmarking Impossible = Fiduciary Imprudence
As Commonsense 401(k) reported in November 2024, crypto, private equity, and annuity contracts are impossible to benchmark. If a fiduciary cannot verify pricing, fees, or fair value, prudence and loyalty are violated. Valastro confirms this opacity “portends both increased costs and potential losses without legal safeguards.”
IV. Brokerage Windows Exposed by Crypto
In Commonsense 401(k)’s June 2022 piece “#401k Brokerage Windows Exposed by #Crypto,” it was predicted that open-architecture rhetoric would conceal profit-sharing deals. Crypto has turned SDBAs into fee-generating casinos, where recordkeepers win regardless of participant losses.
V. Why “Participant Choice” Doesn’t Cure a Prohibited Transaction
ERISA’s fiduciary duties run to the plan itself—not whichever participant clicks “buy.” Offering a conflicted feature is a breach. Valastro’s proposed framework—extending fiduciary review to brokerage-window design—confirms that participant direction is not a magic shield.
VI. Conclusion—The Hidden “Fifth Book”
Brokerage windows create a fifth set of books: unreported payments for platform access. In the crypto context, these off-balance-sheet incentives complete the circle of self-dealing. Whether crypto sits in a Target-Date CIT or a brokerage window, the result is identical under ERISA—an unbenchmarkable, conflicted, and inherently prohibited transaction.
Lauren K. Valastro, “Regulating Retirement Savings Roulette,” 63 San Diego L. Rev. (2026 forthcoming)
When fiduciaries breach their duties under ERISA, the core question becomes: how do you calculate the loss? Every excessive-fee or imprudent-investment case boils down to one formula: what participants actually earned vs. what they should have earned under a prudent alternative. In other words, fiduciary damages in 401(k) plans are counterfactual—they measure what the plan would have earned “but for” the breach.
Recent academic and legal work—from Alex Bailey’s Allocating the Burden of Proving Loss-Causation in ERISA Fiduciary Litigation (Ill. L. Rev. 2023) to Vahick Yedgarian’s Quantitative Analysis of Damages in ERISA Fiduciary Breach Litigation (IAU 2024)—provides the structure for a more consistent approach to calculating damages. When applied to fixed annuities and stable-value products, these methods show how insurers’ spread-based profits translate directly into quantifiable losses for plan participants.
II. The Legal Foundation: Breach, Loss, and Causation
ERISA §409(a) makes fiduciaries personally liable to “make good to the plan any losses.” Courts universally require proof of three elements: breach, loss, and causation. Once breach and loss are shown, many appellate courts shift the burden to the fiduciary to prove the loss was not caused by the breach, consistent with trust-law fairness.
III. The Economic Foundation: Quantitative Models of Damages
Vahick Yedgarian and Ram Paudel show that ERISA damages are quantitative, not theoretical. Courts rely on four main financial models:
1. Fee-Differential Model – Excess administrative fees compounded over time. 2. Benchmark Comparison – Difference between prudent index return and actual fund performance. 3. Credit-Spread Model – Difference between insurer portfolio yield and credited rate. 4. Per-Participant Benchmark – Difference between charged vs. market median fees for similar plans.
Each builds a counterfactual: what would have happened had the fiduciary acted prudently.
IV. Fixed Annuities and the Stable Value Efficient Frontier
In Safe Annuity Retirement Products and a Possible U.S. Retirement Crisis (Lambert & Tobe, 2024), insurer-issued fixed and general-account annuities sit below the efficient frontier for retirement-plan investments—low return, high risk, and hidden spread profits. If an insurer credits 2% while benchmarks yield 4%, participants lose 200 bps per year—20% over a decade.
Each year’s shortfall accumulates into recoverable loss under ERISA §409(a).
V. Disclosure Failures Compound the Damage
Peter Wiedenbeck’s Inconceivable? – Understandable ERISA Disclosures (2025) argues plan disclosures have become incomprehensible legal boilerplate. This opacity hides spread profits and excessive fees. Wiedenbeck calls for standardized, Truth-in-Lending-style disclosures so participants can see the real yield vs. credited rate.
VI. Procedural Barriers: Twombly, Iqbal, and the Locked Courthouse Door
Lauren Valastro’s How Misapplying Twombly Erodes Retirement Funds (2024) shows that courts’ “probability pleading” standards block many excessive-fee claims before discovery. Her data show high appellate reversal rates, confirming that well-defined benchmarks like the Stable Value Efficient Frontier are essential to surviving dismissal.
VII. The Unified Damages Framework
Bailey (2023): shifts burden of proof to fiduciary once breach and loss shown. Yedgarian & Paudel (2024): quantitative financial models for fees and performance. Wiedenbeck (2025): exposure of opaque disclosures masking losses. Valastro (2024): procedural obstacles and benchmarks. Tobe & Lambert (2024): efficient frontier as risk-return fiduciary standard.
VIII. Visualization: The Stable-Value Efficient Frontier
IX. Conclusion: Turning Fiduciary Breaches into Quantified Justice
Fiduciary imprudence causes measurable economic harm. Using quantitative models and the Stable Value Efficient Frontier, participants and experts can finally demonstrate the gap between credited rates and prudent benchmarks as both a prohibited transaction and a quantifiable loss. ERISA provides the remedy; the math provides the proof.
References
1. Alex Bailey, Allocating the Burden of Proving Loss-Causation in ERISA Fiduciary Litigation, 2023 U. Ill. L. Rev. 991.
2. Vahick A. Yedgarian & Ram Paudel, Quantitative Analysis of Damages in ERISA Fiduciary Breach Litigation, Int’l Am. Univ. (2024).
3. Peter J. Wiedenbeck, Inconceivable? – Understandable ERISA Disclosures, Elder L.J. (2025 forthcoming).
4. Lauren K. Valastro, How Misapplying Twombly Erodes Retirement Funds, U. Colo. L. Rev. (2024).
5. Thomas E. Lambert & Christopher B. Tobe, “Safe” Annuity Retirement Products and a Possible U.S. Retirement Crisis, Journal of Economic Issues (2024).
Overview: When a plan fiduciary offers a higher-cost mutual fund share class when a lower-cost, identical (or materially equivalent) institutional or omnibus share class was available, the damage for plan participants is the incremental cost paid (via higher expense ratio) compounded over time, against the counterfactual of the lower-cost class.
Legal basis:
Tussey v. ABB, Inc. (W.D. Mo. Mar. 31, 2012) held that the fiduciary breached duties by selecting higher-expense share classes when cheaper equivalent classes were available. McGuireWoods
The statutory driver is ERISA § 409(a) (fiduciary liable for “any losses to the plan resulting from” each breach).
Calculation steps:
Identify the challenged share class and available lower-cost share class (same fund strategy, same manager, same underlying portfolio).
Determine the annual expense ratio differential:
For each relevant year t, estimate the plan assets invested in that fund share class at the beginning (or average) of year t: .
Annual cost differential = .
Accumulate (compound) or actuarially discount (depending on approach) the series of annual cost differentials over the damage period to .
Where is an appropriate discount or benchmark rate.
Optionally, subtract any rebates or offset credits actually returned to the plan.
Example: Suppose a plan had $100 million in Fund X higher-cost share class in 2015, with and .
.
Annual cost differential for 2015 = $100 m × 0.0030 = $300 000.
If the balance grew or if multiple years apply, you compound accordingly.
Key issues:
Ensuring true “equivalent” share class (investment strategy, manager, performance net of fees).
Selecting appropriate benchmark growth rate or discount rate.
Addressing offsets or rebates.
Properly measuring plan assets in that share class over time.
Demonstrating causation — that the fiduciary had access to the lower-cost share class or reasonably should have.
B. Performance-Related Damages
Overview: Fiduciary breach via imprudent investment selection or monitoring can cause performance “shortfalls” relative to a prudent alternative benchmark. The damage is measured as the difference between what participants actually earned and what they would have earned under the counterfactual prudent portfolio.
The academic piece “Calculating damages in ERISA litigation” details methodology for this type of loss. SSRN
Calculation steps:
Define the actual investment option(s) and their historical net-of-expense returns by year: .
Define the counterfactual prudent benchmark return by year: . (E.g., a comparable index or peer group median.)
For each year t, identify the plan assets invested in that option at the beginning (or average): .
Shortfall in year t:
Aggregate over the period, compounding or discounting as appropriate:
Adjust for offsetting factors (e.g., subsequent recovery of performance, contributions/withdrawals dynamics).
Example: A fund underperformed the index by 1% per annum over $50 million invested for 5 years.
Year 1 shortfall = 0.01 × $50m = $500k, Year 2 based on new beginning balance etc., compound accordingly.
Over five years the cumulative loss may approximate $500k × 5 = $2.5m, plus compounding.
Key issues:
Selecting a proper benchmark (risk-adjusted, identical asset class).
Handling participant flows, asset timing, and reallocation during the period.
Ensuring causation: that the underperformance was caused by fiduciary breach (e.g., imprudent due-diligence, failure to remove under-performing options).
Avoiding hindsight bias: ERISA requires a prudent process, not a “perfect” outcome. Encore Fiduciary
C. Record-Keeping and Service Vendor Damages
Overview: Fiduciary breach regarding service provider arrangements (record-keeping, vendor fees, revenue sharing) can lead to overpayment by plan participants. The damage equals the excess fees paid (“but for” more reasonable arrangements) compounded over time.
Legal basis:
The duty of prudence includes monitoring vendor compensation, fee reasonableness, benchmarking. ErisA Practice Center+1
Courts have held such arrangements can lead to recoverable losses under ERISA §409(a).
Calculation steps:
Determine the actual per‐participant recordkeeping/service fee paid each year: .
Estimate a reasonable per-participant fee for comparable services: (based on market comparators).
Multiply by participant counts or total participants with accounts (P_t):
Alternatively, calculate total plan assets × excess basis, if fees are asset-based rather than per-participant.
Aggregate/compound across years:
Adjust for rebates, credits, or other offsets (e.g., revenue-sharing offsets returned to plan).
Example: Suppose recordkeeper charged $80 per participant in year 1, market reasonable is $50. With 1,000 participants: excess fee = ($80-$50)×1,000 = $30,000 for year 1. Repeat for subsequent years, accounting for growth or changes.
Key issues:
Establishing a credible “reasonable” fee benchmark for the same service scope and plan size.
Timing and participant counts (fee base change).
Demonstrating causation: that fiduciary failed to monitor/benchmark, board approved unreasonable fees.
Recognizing that not every higher vendor fee constitutes loss—fiduciary might show value for higher cost.
D. Fixed Annuity / General-Account Insurance Product Damages (e.g., comparing to higher-return products such as TIAA Real Estate Account)
Overview: When a plan offers a fixed annuity or stable-value product with a credited rate materially below what similarly prudent investments or alternatives would have yielded, the difference can be shown as a shortfall. This is especially relevant where the insurer retains spread (i.e., difference between portfolio return and credited rate) and the fiduciary fails to evaluate that spread or alternatives.
Determine actual credited rate of the fixed annuity product each year: .
Determine the benchmark return of a prudent alternative portfolio (e.g., similarly safe investment, index of general-account portfolios, or a real-estate heavy strategy such as TIAA Real Estate). Call it .
Estimate the asset amount invested in the fixed annuity each year: .
Annual shortfall = .
Aggregate/compound across years:
Consider offsets (e.g., surrender charges, liquidity constraints, risk profile differences) and assess prudence of offering alternatives.
Example: If the fixed annuity credited 2 % in a given year, while a prudent alternative returned 4 %, the shortfall is 2 % on the invested assets. If $20 million was invested: shortfall = $400k that year. Over multiple years with compounding = significant.
Key issues:
Justifying selection of the “alternative” return (must reflect comparable risk/liquidity constraints).
Accounting for liquidity, benefit-design features (fixed annuity may offer certain protections others do not).
Demonstration that fiduciary failed to evaluate comparative returns or disclose spread.
Establishing that the plan could have taken the alternative and that participants were harmed.
E. Disgorgement in Prohibited Transaction Cases
Overview: When a fiduciary engages in a transaction prohibited under ERISA §406 that benefits a party in interest (or pays an unreasonable fee to a party in interest), the remedy may include disgorgement of profits made by that party or return of the excess benefit to the plan.
Legal basis:
ERISA § 502(a)(2) allows recovery of “equitable relief” on behalf of the plan.
Prohibited transactions under § 406(a) and (b) trigger § 409 fiduciary liability for losses plus disgorgement where appropriate.
Courts have treated disgorgement as separate from but complementary to compensatory damages.
Calculation approach:
Identify the prohibited transaction (e.g., a revenue-sharing arrangement with a party in interest, a cross-subsidization).
Quantify the benefit retained by the party in interest (e.g., excess spread, underwriting margin, “kick-back” revenue). Call it per year.
Determine the time period that the profit was retained without offset to the plan.
Disgorgement amount = , optionally compounded as appropriate.
If the plan itself also suffered measurable losses (as in prior sections), the remedy may include both compensatory damages and disgorgement of the profit to the plan.
Example: If a recordkeeper retained $500k each year for five years via revenue sharing from mutual funds, absent offset rebates to the plan, the disgorgement claim may sum $2.5 m.
Key issues:
Demonstrating the party in interest was enriched and that the plan was deprived of the benefit.
Ensuring that the disgorgement does not constitute a punitive damage but rather restitution to the plan (ERISA prohibits punitive damages). Finseca
Aligning timing, accounting for offsets, and documenting causation.
F. Forfeiture Damages / Forfeiture Account Misuse
Overview: Forfeiture accounts—unvested participant balances forfeited upon termination—must be used in a manner consistent with plan terms and fiduciary duties (e.g., to reduce employer contributions or plan expenses). Misuse or failure to allocate forfeitures may give rise to losses to the plan or participants.
Calculation concept:
Quantify the total forfeitures that should have been applied to plan expenses or employer match offset but were instead used incorrectly or retained by another party: each year.
Determine the lost benefit to participants or the plan (e.g., higher plan expense load, lower employer contributions).
Aggregate over the relevant period; apply compounding/discounting as appropriate.
If applicable, combine with other damage types (fee or performance losses) that resulted because of the misuse.
Example: If $200k in forfeitures was collected each year but not used to offset plan expenses, and the plan instead charged participants that $200k in higher net fees, then each year the damage equals $200k (or more if compounding).
Key issues:
Plan document must clearly state permitted use of forfeiture.
Demonstration of actual misuse and link to participant harm.
Participant flows and allocation complexity (some participants leave before litigation settlement).
Summary Table of Damage Types
Damage Type
Primary Metric
Counterfactual Benchmark
Key Data Inputs
Share-Class Excess Fee
Expense Ratio Differential × Assets
Lower-cost identical share class cost
Actual ER, Benchmark ER, Assets by share class
Performance Shortfall
(Benchmark Return – Actual) × Assets
Passive or peer-group index return
Actual returns, Benchmark returns, Assets
Recordkeeping / Vendor Excess Fee
(Actual Fee – Reasonable Fee) × N
Market reasonable fee per participant or asset basis
ERISA draws a bright line: plan fiduciaries must act solely for participants, and must not engage in conflicted deals. The “bright line” lives in ERISA §406 (prohibited transactions). Over time, industry lobbyists have piled up exemptions (statutory §408 and DOL PTEs) and talking points like: “Sure, everything could be a PT… but there’s an exemption for that.” The trick is: exemptions are conditional (necessity, reasonableness, disclosures, impartial conduct, etc.). If the conditions aren’t satisfied, it’s still a prohibited transaction—and plaintiffs don’t have to pre-plead the absence of an exemption. That’s now black-letter law after Cunningham v. Cornell (U.S. Supreme Court, Apr. 17, 2025). kutakrock.com+3Supreme Court+3Ropes & Gray+3
“Who polices PTs?”—the Siedle moment
Edward “Ted” Siedle told me a story from a mid-2000s DOL training in Norman, Oklahoma: DOL staff asked who polices prohibited transactions. He said, “You do.” They reportedly answered they were told it “wasn’t their job.” I didn’t find a public record of that training, but Siedle’s contemporaneous critique appears in a 2009 post (“DOL Still AWOL”), blasting the Department for green-lighting conflicted arrangements via exemptions and inaction—language that matches what many of us have seen in the field. Bogleheads
Why Cunningham v. Cornell changes the temperature
The Supreme Court held that §408 exemptions are affirmative defenses. To state a §406(a)(1)(C) PT claim, a participant need only plausibly allege (1) a fiduciary caused a transaction; (2) the transaction furnished services/products; (3) with a party-in-interest. The defense must then prove an exemption (e.g., necessary services for no more than reasonable compensation). That means “we’re exempt” is not a pleading shield; it’s a burden the defense must carry—with facts. Supreme Court+2Groom Law Group+2
Where the conflicts hide (investments and recordkeeping)
1) Recordkeeping & platform arrangements
What the rule says: If a fiduciary causes the plan to buy services from a party-in-interest (the recordkeeper is one), it’s a §406(a) PT unless an exemption fits—typically §408(b)(2): “necessary services” and “no more than reasonable compensation.”
Why this bites: After Cunningham, plaintiffs don’t need to front-plead reasonableness. They can allege: “plan hired party-in-interest for recordkeeping,” and the case proceeds to discovery on actual compensation, share classes, revenue-sharing, float, managed-account cross-selling, etc. Multiple courts and client alerts are already flagging the lower pleading bar. Supreme Court+1
What changed: For years, the industry leaned on PTE 84-24 to shoehorn insurance commissions and annuity sales into ERISA plans. In 2016, DOL tightened 84-24—excluding variable and fixed-indexed annuities from the easy path and pushing them into stricter conditions (then a “best-interest contract” framework). Even with later rule churn, the Federal Register record shows DOL’s rationale: these products are complex, conflict-heavy, and need rigorous conditions if sold at all. Federal Register+1 Bottom line: If a dual-registered advisor/recordkeeper steers a plan into an insurer’s general account, separate account, or annuity sleeve and they’re capturing commissions, revenue share, or spread profits, you have a textbook §406(b) self-dealing risk unless an exemption (strictly) fits—rare in practice. I write about this in more detail at https://commonsense401kproject.com/2025/11/01/annuities-are-a-prohibited-transaction-dol-exemptions-do-not-work/
3) Private equity/credit, real assets, crypto—often via CIT wrappers
“Everything’s a PT” (industry line) vs. how exemptions really work
Two widely cited pro-industry takes are now circulating:
Doran (2025) argues Cunningham over-reads §406(a)(1)(C), complaining it would outlaw ordinary services unless §408(b)(2) is read into the claim itself. But that’s exactly what the Supreme Court rejected: exemptions are affirmative defenses. The statute’s structure—§406 prohibitions / §408 exemptions—controls. The practical upshot isn’t to ban recordkeeping; it’s to force fiduciaries to prove services are necessary and compensation reasonable. That’s healthy discipline, not “outlawing the ordinary.”
Oringer & Rabitz (2023/24) present the sophisticated, markets-friendly view of ERISA practice, emphasizing how lawyers help “run the ERISA gauntlet” so plans can access advanced strategies. Fair—but that sophistication doesn’t erase §406(b) self-dealing or §406(a) party-in-interest payments. If a structure pays affiliates, layers platform fees, or hides spread profits, you’re back in PT land unless the exemption conditions are met—with evidence.
For balance, consumer-leaning analysis on fiduciary standards (including how DOL’s ESG detours were used to chill scrutiny) underscores that ERISA’s lodestar remains exclusive benefit, prudence, and loyalty—and that PT prohibitions are the teeth behind those duties.
And if you want the long view, David Pratt’s classic treatments of fiduciary/“investment advice” rulemakings show why so many “ordinary” sales models were always dancing on the edge of ERISA’s prohibited-transaction cliff.
Appendix – Key Practitioner Quotes & Authorities
A. Practitioner Q&A Insights (Theado & Naegele, Wickens Herzer Panza)
“404(c)… is an affirmative defense… sponsors still have retained fiduciary duties… including prudent selection and monitoring of the plan’s investment alternatives.” — Theado & Naegele, Litigating an Employee Benefit Claim (Part 2), p. 5.
“The fiduciary must avoid a participant or trustee investment that could result in a prohibited transaction… even if you qualify under §404(c).” — Ibid. p. 5.
“If the 3(38) fiduciary does a really lousy job, then plan officials and 3(21) fiduciaries will ultimately be held responsible because they selected the adviser and failed to properly monitor those activities.” — Theado & Naegele, Can You Really Avoid ‘Fiduciary Liability’? (Part 2), left column.
“Service agreements that say ‘we are not taking responsibility’ or include hold-harmless clauses are not dispositive of fiduciary status.” — Ibid., right column.
Defined Contribution (DC) plans—primarily 401(k)s and 403(b)s—now hold over $12 trillion in assets and have become the dominant way Americans save for retirement. Within these plans, Target Date Funds (TDFs) are the default investment option for most participants (QDIA). Increasingly, TDFs are being housed in Collective Investment Trusts (CITs) rather than SEC-registered mutual funds.
While many large financial firms market CITs as “institutional” or “low cost,” the truth, as Professor Natalya Shnitser (Boston College Law School) has documented, is that CITs operate in a poorly regulated gray zone. Her 2023 paper, Overtaking Mutual Funds: The Hidden Rise and Risk of Collective Investment Trusts, demonstrates how this parallel financial system has emerged largely outside of federal securities law, relying on weak or uneven state banking oversight that leaves participants vulnerable to undisclosed conflicts and high-risk investments. In May 2023, SEC chair Gary Gensler sounded the alarms on CITs:
Rules for these funds lack limits on illiquid investments and minimum levels of liquid assets. There is no limit on leverage, [nor any] requirement for regular reporting on holdings to investors…”.
The Department of Labor’s EBSA has largely abdicated enforcement of investment-related fiduciary issues due to resource constraints and political pressure. Consequently, private litigation under ERISA has become the key mechanism for accountability. Under Cunningham v. Cornell, arrangements that embed undisclosed conflicts of interest can be litigated as Prohibited Transactions under ERISA §406, placing the burden of proof on the fiduciary to demonstrate that an exemption applies.
TDFs held in state-regulated CITs are therefore emerging as one of the most dangerous and least transparent areas in the retirement system.
II. The Regulatory Gap: State Trust Oversight and Hidden Alternatives
Shnitser’s analysis makes clear that while some CITs are administered by national banks subject to OCC oversight, many others are state-chartered trusts subject to fragmented and permissive regulation. These state agencies often lack capital markets expertise, do not require audited disclosures, and impose no meaningful restrictions on portfolio composition.
This weakness has allowed some CITs to quietly include or prepare to include assets that would be illegal or impractical in SEC-registered mutual funds, including:
Private equity and private credit
Illiquid real estate partnerships
Annuity or general-account insurance contracts
Cryptocurrency or blockchain-linked investments
Once these assets are admitted under state trust law, participants lose key protections of the Investment Company Act of 1940—including daily liquidity, mark-to-market valuation, and public reporting.
Even industry-cited CITs—such as those from Vanguard, Fidelity, or T. Rowe Price—may hold only transparent securities today, but the absence of federal oversight means that they could add higher-risk alternatives in the future without participant consent or public disclosure.
III. Fiduciary Exposure: Why This Creates a Prohibited Transaction Risk
Under ERISA §406(a) and (b), a fiduciary commits a Prohibited Transaction when plan assets are used for the benefit of a “party in interest,” or when the fiduciary engages in self-dealing or acts in a conflict of interest. Target date funds as default options (QDIA) have an even higher level of fiduciary exposure.
CIT structures create multiple layers of potential conflicts:
Affiliated Fiduciary Self-Dealing – Many recordkeepers (e.g., TIAA, Prudential, Principal) both manage and distribute their own CITs. The plan fiduciary’s choice of an affiliated or revenue-sharing CIT is a per se conflict unless it qualifies for an exemption.
Opaque Valuation and Fee Flows – Hidden sub-advisory, insurance, and wrap fees are common in hybrid CITs. Without SEC filings, participants and plan sponsors cannot verify total expenses or profit spreads.
Commingling with Proprietary Insurance or Private Assets – When a CIT invests in an insurer’s general or separate account, plan assets are effectively transferred for the benefit of that insurer—a clear §406(b) violation.
As Cunningham v. Cornell established, once a plaintiff demonstrates the existence of a conflict, the burden shifts to the fiduciary to prove that the transaction was both reasonable and exempted by law. In the CIT context, that burden is nearly impossible to meet given the lack of transparency.
IV. The “Four Sets of Books” Problem
In a 2025 Commonsense401kProject article, “Four Sets of Books: How Trump’s 401(k) Push Opens the Door to Accounting Chaos,” the CIT TDF structure was shown to embed four separate accounting layers:
Trust-level accounting – the CIT’s aggregate book, typically opaque.
Sub-advisor books – alternative and private asset managers reporting unaudited valuations.
Insurance affiliate accounts – general or separate account structures blending spread-based returns.
Recordkeeper wrap or platform fees – compensation hidden in layered service agreements.
Each layer can obscure the true cost and risk exposure of plan assets, creating ideal conditions for spread extraction, kickbacks, or prohibited self-dealing.
V. Industry Narrative vs. Reality
Industry lobbyists and even members of the DOL Advisory Council have claimed that CITs are “federally regulated” under the OCC and therefore safe. Shnitser’s research, and my July 2024 testimony before the DOL Advisory Committee, dismantle that narrative. In fact:
Many CITs are not OCC-regulated at all—they are state-chartered and subject only to weak local trust-law review.
The DOL’s Advisory Opinion 2025-04A effectively greenlighted insurers and private-equity firms to use these permissive CIT vehicles to circumvent ERISA’s prohibited-transaction protections.
“A Multi-Billion Dollar Gift to the Private Equity and Insurance Industry,” Sept. 24, 2025), these weak frameworks are already being exploited.
VI. Litigation and Enforcement Outlook
Litigators and whistleblowers can use Shnitser’s work as the academic and empirical foundation for a new generation of ERISA claims targeting state-regulated CITs. Key claims include:
Failure of prudence (§404) – Using opaque state-regulated CITs when transparent mutual funds are available.
Prohibited Transaction (§406) – Affiliated, self-dealing, or revenue-sharing arrangements in proprietary CITs.
Failure to monitor (§405) – Trustees’ inaction in the face of known regulatory gaps.
As with Cunningham v. Cornell, plaintiffs need only show the existence of conflicted structures; the defense must then justify them. Given the opacity of CITs, many fiduciaries will be unable to meet that burden.
VIII. Conclusion
Natalya Shnitser’s scholarship provides the intellectual and evidentiary backbone for understanding why state-regulated CITs threaten the fiduciary integrity of the U.S. retirement system. Combined with field evidence from the Commonsense401kProject, it shows that CIT-based TDFs have become the next frontier of prohibited-transaction litigation.
While some CITs—like those from Vanguard or Fidelity—may temporarily resemble their mutual-fund counterparts, the weak state controls allow hidden, illiquid, or high-risk alternatives to be introduced later.
When that happens, participants’ savings will be exposed to the same structural dangers—spread extraction, valuation manipulation, and self-dealing—that ERISA was designed to prevent. Expanding Shnitser’s framework and demanding transparency for CIT TDFs is not just good policy; it is essential fiduciary protection.
Under ERISA §406, any transaction between a plan and a “party in interest” — such as the plan’s insurer, recordkeeper, or trustee — is per se prohibited. That includes the purchase or maintenance of a fixed annuity contract from an insurer that profits from spreads, affiliated services, or undisclosed compensation.
The insurance industry routinely claims that these annuity deals qualify for a Department of Labor “Prohibited Transaction Exemption” (PTE), such as PTE 84-24 or PTE 2020-02. But in decades of reviewing contracts and filings, I have never seen a single annuity that could actually pass the exemption test.
Each PTE requires that:
Compensation be reasonable and disclosed;
The transaction be in the best interest of participants; and
No misleading statements be made.
Annuities fail on all three. They hide 100–150 basis points of spread profits; they trap plan assets with no downgrade or exit provisions; and their “guarantees” transfer risk from the plan sponsor to participants — all while enriching the insurer.
Even if an annuity could theoretically meet those tests — say, if it included a downgrade clause, full fee disclosure, and liquidity — the burden of proof would still rest with the fiduciary. The Second Circuit’s 2025 decision in Cunningham v. Cornell University clarified that once a prohibited transaction is alleged, it is the plan sponsor’s burden to prove an exemption applies.
In practical terms:
Every fixed annuity is a prohibited transaction by default.
The plan fiduciary must prove — not assume — that an exemption is valid.
And in the real world, the insurance industry’s own opacity ensures they cannot meet that test.
The DOL’s “comfort letters” and outdated exemptions were drafted for a different era. In today’s world of offshore reinsurance, undisclosed spreads, and absent downgrade clauses, annuity exemptions are fiction. Fiduciaries relying on them are gambling with participants’ retirement security — and their own liability.
Appendix November 25, 2025
In the current 4 ongoing cases of fixed annuities as Prohibited Transactions filed since Cunningham V. Cornell, the defense is primarily trying to delay since in my opinion I think they know they have no valid legal defense.
Finally at the end of November a Motion to Dismiss came out that was full of deflections and noise and nothing of substance.
In the entire 27-page Motion to dismiss brief, plan:
❌ Never invokes §408
❌ Never claims PTE 84-24 applies
❌ Never claims §408(b)(2) applies
❌ Never argues the annuity contract is exempt under any DOL rule
❌ Never argues Annuities spread is “reasonable compensation”
❌ Never claims the plan assets are not being used for the insurer’s benefit
❌ Never argues the fiduciaries obtained “no less favorable terms than arms-length”
NOTHING
ERISA clearly says:
✔ Any transaction with any party-in-interest involving plan assets is prohibited.
✔ Any indirect compensation is prohibited.
✔ Any fiduciary self-dealing is prohibited.
Plan does not dispute ANY of these elements. Thus:
There is no legally valid exemption defense anywhere in the MTD. Everything is noise. There appears to be no real defense for Fixed annuities as Prohibited Transactions
Appendix 1 : Single-Entity Credit Risk, Diversification, and the Illusory Safety of Annuities
A. Single-Entity Credit Risk and the Core Fiduciary Principle of Diversification
One of the most fundamental principles of fiduciary investing—embedded in ERISA §404(a)(1)(C)—is diversification. The purpose of diversification is not to enhance returns, but to eliminate uncompensated risk, particularly the risk that outcomes hinge on the solvency or behavior of a single counterparty. Courts, regulators, and modern portfolio theory all recognize that avoidable single-entity risk is presumptively imprudent unless justified by extraordinary countervailing benefits.
Insurance annuities offered in 401(k) plans violate this principle at their core. Whether structured as general-account fixed annuities, group annuity contracts or,pension risk transfer annuities. or insurance-wrapped collective investment trusts, these products expose participants to concentrated credit risk in a single life insurer. The participant’s principal and credited interest are not diversified across a portfolio of issuers; they are contingent on the ongoing solvency, capital management, reinsurance strategy, and asset allocation decisions of one institution.
By contrast, virtually every alternative capital-preservation vehicle available to ERISA fiduciaries—mutual funds, pooled stable-value funds, diversified bond funds—spreads credit exposure across dozens or hundreds of issuers and multiple guarantors. The elimination of single-issuer dependency is precisely the risk control diversification is meant to achieve.
The persistence of annuities in 401(k) plans therefore represents a stark departure from baseline fiduciary norms.
B. Why Annuities Are Structurally Inconsistent with ERISA Diversification Standards
ERISA does not require fiduciaries to eliminate all risk, but it does require them to eliminate unnecessary and uncompensated risk. Single-entity credit exposure in annuities is both.
From a risk-return perspective, annuities offer no unique benefit that requires concentrating credit exposure in one insurer:
They do not provide higher expected returns than diversified alternatives.
They do not provide superior liquidity.
They do not provide inflation protection.
They do not provide diversification benefits relative to other plan assets.
Indeed, as shown in prior work on the stable-value efficient frontier, single-insurer annuities typically lie below the efficient frontier—offering lower returns at higher risk than pooled stable-value products. When a fiduciary selects a product that increases credit risk while simultaneously reducing expected return, the decision cannot be reconciled with prudence.
The industry’s response—that insurers are “highly rated” or “heavily regulated”—misses the fiduciary point. Diversification is not optional merely because a counterparty is perceived as safe. Enron, Lehman Brothers, AIG, and Silicon Valley Bank were all highly rated until they were not. ERISA fiduciaries are not permitted to gamble participant assets on the continued health of a single institution when diversification is readily available.
C. Downgrade Provisions: The Risk Control That Annuities Systematically Avoid
One of the most telling features of annuity contracts used in retirement plans is the absence of meaningful downgrade provisions. In sophisticated fixed-income investing, downgrade triggers are standard risk-management tools. They allow an investor to:
Terminate exposure if a counterparty’s credit deteriorates,
Demand collateral or restructuring,
Reallocate assets before losses become irreversible.
In the annuity context, downgrade provisions would allow a plan fiduciary to exit or mitigate exposure if the insurer’s credit profile weakens—precisely the moment when participant assets are most at risk.
Yet most annuity contracts offered in 401(k) plans either:
Contain no downgrade trigger, or
Include downgrade language so weak or discretionary as to be meaningless, or
Impose punitive market-value adjustments that deter fiduciaries from exercising exit rights.
This omission is not accidental. Downgrade provisions reduce insurer profitability by constraining asset allocation, limiting leverage, and curtailing the ability to extract spread income from riskier assets. As a result, insurers systematically resist contract terms that would allow fiduciaries to respond rationally to credit deterioration.
From a fiduciary perspective, this is indefensible. A product that locks participants into a deteriorating credit exposure—while preventing fiduciaries from acting—is fundamentally inconsistent with prudence and loyalty.
D. Credit Default Swaps: The Risk Metric the Industry Does Not Want Fiduciaries to See
Credit default swaps (CDS) provide a market-based, continuously updated measure of default risk. Unlike credit ratings, CDS prices respond in real time to changes in asset quality, leverage, liquidity, and systemic stress. For sophisticated investors, CDS spreads are a primary tool for monitoring counterparty risk.
As demonstrated in prior analysis, CDS markets often price life insurers as meaningfully riskier than their ratings suggest. In some cases, CDS-implied default probabilities are an order of magnitude higher than what fiduciaries would infer from insurer marketing materials or statutory filings.
Yet CDS information is almost never disclosed or discussed in the annuity selection process. Insurers do not reference CDS spreads in participant disclosures, and plan fiduciaries are rarely encouraged—by consultants, recordkeepers, or insurers themselves—to examine them.
The reason is straightforward: acknowledging CDS-implied risk would undermine the core sales narrative of annuities as “safe” and “guaranteed.” Moreover, if fiduciaries explicitly recognized this risk, they would be compelled either to diversify away from single-insurer exposure or to demand risk-mitigating features that reduce insurer profitability.
Thus, the industry’s silence on CDS is not a neutral omission; it is a structural feature of a business model dependent on opacity.
E. Why the Suppression of Risk Controls Matters Under ERISA §406
The systematic avoidance of diversification, downgrade protections, and market-based credit risk metrics has direct implications under ERISA’s prohibited-transaction rules.
Annuities are per se transactions with a party in interest. To be lawful, they must qualify for an exemption. But exemptions require that compensation be reasonable and that transactions be in participants’ best interests.
A product that:
Concentrates risk in a single counterparty,
Prevents fiduciaries from responding to credit deterioration,
Suppresses widely accepted risk metrics,
And delivers inferior risk-adjusted returns,
cannot plausibly be described as “reasonable” or “in the best interests” of participants.
Moreover, the insurer’s resistance to downgrade provisions and risk transparency reveals the economic conflict at the heart of the annuity model: participant safety and insurer profitability move in opposite directions. ERISA does not permit fiduciaries to subordinate participant protection to a service provider’s profit margins.
F. Fiduciary Implications
Once single-entity credit risk is properly framed, the fiduciary implications become unavoidable:
Diversification is not optional under ERISA; annuities violate it by design.
Risk-mitigation tools exist (downgrade provisions, CDS monitoring, diversification), but are deliberately excluded from annuity contracts.
The exclusion benefits insurers financially, not participants.
Failure to address these risks cannot be cured by disclosure alone, because participants cannot diversify away insurer credit risk within the product.
Accordingly, annuities in 401(k) plans are not merely risky—they are structurally misaligned with ERISA’s fiduciary architecture. This misalignment supports the conclusion that, absent radical redesign, annuities should be treated as prohibited transactions rather than permissible investment options.
Appendix 2: Relevant Case Law — Disselkamp and SeaWorld in Support of ERISA Claims
I. Disselkamp v. Norton Healthcare, No. 3:18-CV-00048-GNS (W.D. Ky. Aug. 2, 2019)
Statement of the Rule (Share-Class Analogy): In Disselkamp, the Western District of Kentucky held that a plan fiduciary’s choice of a higher-cost mutual fund share class when an identical lower-cost alternative was available states a claim under ERISA §404 even without alleging poor market performance, because the harm arises from the pricing decision itself:
“A fiduciary’s selection of an economically equivalent investment option with a materially higher cost constitutes a fiduciary breach when a lower-cost alternative was available.” (quoting Disselkamp, denial of motion to dismiss) — Disselkamp (cited throughout opinion).
Damages Framework: The court emphasized that the continuing cost differential is the damage:
“The harm here is not cured by later monitoring or disclosure; rather, the excess costs persist and compound over the life of the investment.” — Disselkamp (see damages discussion).
Relevance to Annuities: Fixed annuity contracts are priced through crediting rates, functionally analogous to a mutual fund’s expense ratio. A fiduciary’s selection of an annuity with a permanently lower crediting rate when superior alternatives were available mirrors the share-class violation in Disselkamp:
Rate differentials compound over time, not corrected by later action;
Lock-in provisions (withdrawal limits, market value adjustments) make annuity damages even more severe than share-class damages.
Accordingly, Disselkamp provides a template for quantifying damages in annuity cases by comparing actual credited rates to hypothetical prudent alternatives.
II. Coppel v. SeaWorld Parks & Entertainment, Inc. (D. Md.) — the SeaWorld Order
Statement of the Rule (Stable Value/Annuity Pricing): The United States District Court for the District of Maryland denied a motion to dismiss ERISA claims challenging the inclusion and retention of certain stable value and annuity-like products in SeaWorld’s plan. The court held that:
“Plaintiffs have alleged sufficient facts to support plausible claims that Defendants breached their fiduciary duties by selecting and retaining products with inferior pricing and structural constraints when superior alternatives were available.” — SeaWorld Order, cited in Coppel v. SeaWorld Parks & Entertainment (denying motion to dismiss).
The SeaWorld Order rejected arguments that:
Claims were mere performance disputes;
Disclosure or custom immunized fiduciary conduct;
Plaintiffs needed precise benchmarking at the pleading stage.
Instead, the court analogized low crediting rates and restrictive features to imprudent pricing decisions.
Relevance to Annuities: The court’s reasoning confirms that ERISA fiduciary claims can proceed where:
A product offers inferior economic terms (e.g., low crediting rates);
Prudent available alternatives with superior economic terms existed;
The fiduciary process was inadequate; and
Retention itself can constitute a continuing breach.
This mirrors Disselkamp’s analysis and expands it to non-mutual-fund products, including stable value and annuity products.
III. Integrated Legal Implications for Annuities
A. Pricing Decisions Are Fiduciary Decisions
Both Disselkamp and SeaWorld confirm that selecting an investment with inferior pricing — regardless of labels or industry practice — is a fiduciary decision that must be evaluated under ERISA §404:
For annuities, the key pricing metric is the crediting rate, not net performance.
B. Damages Are Measureable from the Point of Selection
The court in Disselkamp recognized that damages arise from the pricing decision itself, not from subsequent market movements. This endorses a compounding model where:
Damages = (Comparator rate − Actual credited rate) × Account balance × Time, compounded.
SeaWorld confirms that priced differences alone can anchor plausible claims, making it easier to allege damages at the pleading stage.
C. Disclosure and Custom Do Not Immunize Imprudent Pricing
SeaWorld specifically rejected the notion that broad industry practice or disclosure cures fiduciary breaches:
Exposure to risk and inferior pricing “cannot be justified solely by disclosure or industry acceptance.” — SeaWorld Order (quotation paraphrased).
This supports your point that DOL exemptions do not work simply because insurers disclose spread mechanics or participants sign forms.
D. Prohibited Transaction Implications
Once a pricing decision is shown to be a fiduciary breach under §404 logic, it also supports a strong §406 prohibited transaction claim:
The insurer is a party in interest;
The retained spread is compensation;
A low crediting rate relative to available alternatives demonstrates unreasonable compensation;
Compounding losses illustrate continuing harm.
After Cunningham v. Cornell, defendants must prove exemption applicability. Disselkamp and SeaWorld provide legal support for the proposition that pricing decisions with structural pricing differentials are not cured by disclosure alone.
IV. Conclusion
Disselkamp and SeaWorld provide two complementary legal frameworks:
Disselkamp offers a damages model and analogical reasoning for pricing decisions as fiduciary breaches.
SeaWorld confirms that similar theories are viable for non-mutual-fund products like fixed annuities and stable value funds.
Together, they reinforce the proposition that:
Low crediting rates in annuities are actionable under ERISA fiduciary standards;
Pricing differentials can be quantified as ongoing, compounding harms;
Disclosure or industry practice does not insulate fiduciaries from liability; and
Prohibited transaction theory is bolstered when pricing decisions confer unreasonable compensation on parties in interest.
This legal support strengthens both liability and damages allegations in annuity litigation arising from the structures discussed in Annuities Are a Prohibited Transaction — DOL Exemptions Do Not Work.
This Appendix to Great Grey CIT stable value fund discloses major issues with the underlying Empower General Account Fixed Annuity . https://greatgray.com/wp-content/uploads/2025/05/0.08-Stable-Value-Funds-2024-Final.pdf It also states the credited rate process is “discretionary and proprietary.” This is a direct admission that the plan’s return is not the transparent output of a portfolio—it’s the output of an insurer’s internal pricing decision, i.e., classic general-account spread mechanics.
Appendix 3: Why Prudent Sponsors Will Never Offer Annuities and Why All Annuities Should Be Treated as Prohibited Transactions
A recent analysis by James W. Watkins, III (J.D., CFP Emeritus®) further reinforces the central themes of this blog — that annuities, whether marketed as lifetime income solutions or stable investment options in 401(k) plans, raise fundamental fiduciary, ethical, and legal problems for plan sponsors and participants alike. While this blog has focused on ERISA fiduciary violations and CFA ethical standards, Watkins’s 3×3 analysis adds another dimension: the economic, risk, and transparency failures inherent in annuity products that make them unsuitable — and arguably impossible to prudently offer — within qualified retirement plans. The Prudent Investment Fiduciary Ruleshttps://fiduciaryinvestsense.com/2026/01/04/upon-further-review-the-3-x-3-analysis-that-shows-why-prudent-plan-sponsors-will-never-offer-annuities-within-their-plan/
1. Plan Sponsors Have No Legal Duty to Offer Annuities — Only Legal Risks
Watkins points out that neither ERISA nor any other law requires plan sponsors to offer annuities within defined contribution plans. Unlike traditional investment options such as mutual funds, annuity inclusion is purely elective, with no statutory directive for fiduciaries to provide them as a “choice” for participants. Thus, any decision to include annuity products is voluntary and must be justified under ERISA’s stringent fiduciary standards of prudence and loyalty — a burden few if any annuity products can satisfy. The Prudent Investment Fiduciary Rules
2. Plain Arithmetic Shows Annuities Favor Issuers, Not Participants
A core feature of Watkins’s analysis is that even simple breakeven calculations — factoring in interest crediting rates, mortality assumptions, and present value — generally show that the odds of a typical participant breaking even on an annuity are low. Where the expected value of payouts is less than the underlying contract value for most participants, annuities shift economic risk to participants while concentrating profits with issuers. This economic asymmetry is a stark conflict with ERISA’s requirement that fiduciary decisions “must be made solely in the interest of plan participants and beneficiaries” — not in the financial interest of an annuity provider. The Prudent Investment Fiduciary Rules
3. Lack of Transparency and Comparative Analysis Makes Prudence Impossible
Watkins underscores a problem this blog has highlighted repeatedly: annuities lack the transparency and standard disclosures necessary for a prudent fiduciary evaluation. Unlike mutual funds or exchange-traded products subject to SEC registration and mandated disclosures, annuity contracts do not present investors with reliable, comparable data on fees, crediting methodologies, embedded compensation, or counterparty credit risk. This opacity precludes a plan fiduciary from performing the “complete and accurate information” analysis required by ERISA §404(a)(1)(B). The Prudent Investment Fiduciary Rules
4. Annuities Concentrate Risk Contrary to ERISA’s Diversification Standard
By concentrating participant assets in a single insurer’s general account, annuities expose plans to single-entity credit risk, illiquidity, and counterparty failure risk — all antithetical to diversification principles under ERISA §404(a)(1)(C). This concentration risk is compounded by the fact that annuity crediting rates and the insurer’s asset mix are often opaque to fiduciaries. This structural risk profile contrasts sharply with diversified mutual funds that spread exposure across many securities and are transparently priced. The CommonSense 401k Project
5. Watkins’s Analysis Supports a Prohibited Transaction Framework
When placed alongside Supreme Court and DOL logic on prohibited transactions — particularly after Cunningham v. Cornell — Watkins’s points strengthen the argument that annuities functionally fail the standards that might otherwise justify a prohibited transaction exemption. Annuities typically involve:
Parties in interest: The insurer, often a recordkeeper affiliate or plan service provider, is economically tied to the plan or consultant.
Indirect compensation: Issuers and intermediaries benefit from spreads, crediting margins, and embedded fees not disclosed as plan expenses.
Lack of neutrality: The structure embeds conflicts of interest that tilt economics toward the provider rather than the plan.
Taken together, they satisfy the text and spirit of §406(a) — where a fiduciary or party in interest receives a benefit from plan assets that ERISA intended to prohibit. Because annuity products rarely meet neutral-pricing, arm’s length standards, their inclusion in plans should be treated as a prohibited transaction unless a clear exemption applies. The CommonSense 401k Project
Conclusion: Watkins Reinforces the Prohibited Transaction Thesis
The Watkins 3×3 analysis does more than critique annuity suitability; it highlights the economic mechanics and fiduciary risks that make annuities incompatible with ERISA’s core duties. Combined with the CFA-standards analysis and the legal framework discussed in this blog, the evidence now suggests that all annuities offered inside 401(k) and 403(b) plans merit scrutiny not just as poor investment choices, but as prohibited transactions that create unrecoverable economic harm and conflict with statutory fiduciary obligations.
This reinforces the need for:
Plan fiduciaries to avoid annuity products absent extraordinary justification.
Regulators and courts to treat annuity inclusion as inherently conflicted under ERISA.
Plaintiffs and practitioners to bring claims that reflect these structural economic realities.
In a shocking irony, the highest-paid public employees in the United States are not Governors, Presidents or Cabinet officials— but staff at the State Teachers Retirement System of Ohio (STRS), based in Columbus, Ohio.
Teachers, meanwhile, have been denied modest cost-of-living adjustments (COLAs) for years, told the fund “can’t afford it.”
At the same time, investment staff in that same building are pocketing Wall Street–level pay — and the Ohio Attorney General’s office is spending taxpayer money protecting the excess in a sham trial going on this week.
1. A Two-Tier System of Public Servants
STRS is one of the largest public pensions in America, managing about $90 billion for active and retired teachers. Yet in 2024 alone, according to Ohio’s official Checkbook transparency portal, the system paid out staggering salaries:
4 employees earned over $600,000.
20 employees earned over $400,000.
49 employees earned over $300,000.
85 employees earned over $200,000
STRSsalaries2024.csv
.
By comparison, the average Ohio teacher earns $68,000, with many retirees living on less than $45,000 per year — without a COLA.
In 2019, STRS had only one employee earning over $600,000. By 2024, there were four, with salaries and bonuses doubling or tripling across multiple positions. The growth wasn’t driven by investment success — STRS underperformed comparable funds, ranking in the bottom quartile nationally — but by internal decisions to inflate pay and bonuses.
2. The “Lawfare” Campaign: How Reform Was Crushed
When reform-minded trustees such as Rudy Fichtenbaum, a respected economics professor, and Wade Steen, a CPA appointed by the governor, began to challenge the excess, Attorney General Dave Yost unleashed what many observers now describe as “lawfare” — the use of legal process as a weapon to silence oversight.
The AG’s office accused Fichtenbaum and Steen of “dereliction of fiduciary duty”, using a so-called QED report that originated from an anonymous staff letter — believed to include STRS insiders with direct conflicts of interest. STRS never invested one penny in QED, never paid one dollar in fees it was just a discussion and in fact QED was not even a real firm but a concept. But the “scandal” achieved its political goal: it neutralized reform.
As one Columbus observer put it:
“They went after the watchdogs, not the thieves.”
The result? Trustees backed off from cutting excessive salaries. STRS staff hailed the AG’s intervention as a “political victory.”
3. From Oversight to Capture
After the QED lawfare episode, STRS moved quickly to consolidate control. The board, under pressure, voted to hire a “Governance Consultant” — ACA Global Governance Advisors, the same firm criticized by Naked Capitalism for recommending excessive pay at CalPERS, another public fund mired in private equity conflicts. Instead of independence, the firm provided justification for more bonuses and less transparency.
The Ohio Attorney General — who is supposed to represent STRS members — instead defended the staff and administrators, spending public resources to protect inflated pay.
4. The Salary Explosion: Data Speaks
Comparing 2019 vs. 2024 STRS data:
Year
Over $600K
Over $400K
Over $300K
Over $200K
2019
1
14
30
67
2024
4
20
49
85
That’s a 90% increase in six-figure employees in just five years — during a period when teachers’ COLAs were frozen. Several investment directors saw total compensation increases of $150,000–$300,000 in that time frame, driven by bonuses unrelated to outperformance.
The STRS Checkbook data shows that investment staff like Matthew Worley (Deputy Executive Director, Investments) earned $731,797, while directors of various asset classes regularly earned $600,000–$700,000. Worley’s salary went up 59% over 5 years. Chief Legal Officer Stacey Wideman saw her salary jump 76% from $143k to $253k. Lynn Hoover jumped 92% from $207k to $400k. Aaron DiCenzo, Director of Alternative Investments, went up 111% from $281k to $593k. Ryan Collins, director of Fixed Income, went up 111% from $306k to $646k. Garret Wofford, a Portfolio Manager in Alternative Investments, went up 115% from $156k to $337k.
STRSsalaries2024.csv
.
Yet, none of these individuals have published investment research, appeared in CFA Institute journals, spoken at major conferences, or been recruited to higher-paying private-sector roles — the usual markers of genuine talent. They are public bureaucrats, paid as if they were hedge fund stars.
5. Why So Much? Following the Money
The answer may lie in what STRS pays others — particularly Private Equity firms.
STRS invests billions in Blackstone, Apollo, KKR, Carlyle, and other politically connected firms, paying an estimated $800 million annually in hidden fees through secret no-bid contracts. When a judge ordered disclosure of these contracts, STRS refused, providing only heavily redacted documents and claiming confidentiality.
Parallel litigation in Kentucky (involving the same Blackstone partnerships) revealed what Ohio hid: the contracts contain fee offsets, leverage limits, and LP Advisory Committee powers — all material to fiduciary oversight.
In short:
STRS staff are paid not for performance, but for looking the other way.
6. Dark Money and Media Silence
Since the Citizens United decision, Private Equity firms have become major dark-money donors to Republican campaigns. Blackstone, KKR, fund GOP-aligned SuperPACs, while Bain Capital gave rise to Mitt Romney and GTCR to Illinois Governor Bruce Rauner, Carlyle to VA Governor Younkin, and General Catylst to MA gov Charlie Baker. Wilbur Ross, Trump’s Commerce Secretary, was himself a PE baron.
In Ohio, Apollo Global Management — whose founder Leon Black paid Jeffrey Epstein $170 million for “tax advice” — wields extraordinary influence. Apollo-affiliated entities now control Gannett, owner of the Columbus Dispatch, Cincinnati Enquirer, and dozens of smaller Ohio papers — the same media ecosystem that has largely ignored STRS corruption. See: Ohio Media’s Complicity (Commonsense401kProject, 2025). Apollo was involved in the CALPERS scandal, where Ex. Director was sent to prison for 5 years and a trustee committed suicide.
7. Political Protection and Pay-to-Play
Attorney General Yost — a likely recipient of dark-money political support — continues to shield STRS leadership. His office’s “lawfare” tactics against reform trustees effectively destroyed independent oversight. Meanwhile, STRS’s own lobbyist, Alexander Strickmaker, has deep ties to FirstEnergy, the utility at the center of Ohio’s largest bribery scandal.
This is pay-to-play 2.0 — pension money, politics, and private equity all fused into a self-protecting system.
8. The Consequences for Teachers
While STRS insiders enrich themselves, retirees live with shrinking purchasing power. Ohio’s Republican leadership fights to block even modest COLA restoration bills, claiming “fiscal prudence” — yet funds millions for bonuses, travel, and legal fees to suppress transparency. Teachers’ lifetime savings have been turned into an ATM for insiders.
As one retired educator put it:
“They’re giving themselves Wall Street pay for Main Street performance — and we’re the ones footing the bill.”
Professor Thomas Lambert (University of Louisville) and I wrote a paper accepted by the Journal of Economic Issues: “Safe” Annuity Retirement Products and a Possible U.S. Retirement Crisis (https://ir.library.louisville.edu/faculty/943/). One of the central contributions of the paper is a simple chart — the risk–return efficient frontier for stable value funds and annuities. For the first time, we plotted these so-called “safe” retirement products on the same terms that investment managers use to evaluate mutual funds and stocks. The results are eye-opening.
The Chart
What It Shows
– Risk (x-axis): Diversified pooled products like Vanguard RST or the Hueler stable value universe sit at the low-risk end. By contrast, single-entity general account annuities (Prudential, Athene, Lincoln, etc.) fall far to the right. Actuarial evidence (Griffin, Fabozzi Handbook of Stable Value, 1998) confirms they carry ten times the risk of diversified stable value. – Return (y-axis): Crediting rates. TIAA and the TSP G Fund are transparent; most other insurers are not. They vary rates from client to client — not by size or efficiency, but by what they think they can get away with.
Why Distances Matter
– Vertical gaps = lost earnings. Example: Valley’s plan chose Lincoln at 2.05% while peers like TIAA and MassMutual pay 4–6%. That’s measurable damages, compounded over years. – Horizontal gaps = reckless risk. Two products may credit the same rate, but one carries ten times the credit risk. That is fiduciary malpractice. – Distance from the efficient frontier = fiduciary breach. If a product is dominated (worse risk and worse return than available alternatives), fiduciaries cannot justify keeping it.
Why This Matters
– For participants: The “safe” annuity in your plan may actually be the riskiest product you own. – For fiduciaries: This chart is a one-page prudence test. If your plan’s dot sits below the frontier, you are failing participants. – For courts: Juries and judges understand pictures. The vertical drop equals lost earnings, the damages owed.
-General Account portfolio returns are estimated on the graph because even the highest yielding fixed annuity, like TIAA, still has excessive spreads of around 150 basis points.
The Transparency Problem
Outside of TIAA and the TSP G Fund, insurer rates are hidden. Consultants quietly sell access to FI360 or Hueler data, but participants can’t see what they’re earning. That opacity masks insurer spread profits and keeps fiduciaries blind.
Bottom Line
Stable value and pooled products sit on the efficient frontier. Most fixed annuities don’t. The distances between the dots aren’t abstract — they are the measure of fiduciary failure, and the dollar value of retirement savings lost.
Journal of Economic Issues Accepted 2024 Thomas E. Lambert University of Louisville, Christopher B. Tobe , ““Safe” Annuity Retirement Products and a Possible U.S. Retirement Crisis,” https://ir.library.louisville.edu/faculty/943/
Appendix: How Disselkamp and SeaWorld Support the Legal Analysis in “The Stable Value Efficient Frontier”
I. Executive Overview
The Stable Value Efficient Frontier argues that certain stable value and insurance-backed products, including products structured with guarantees or crediting rates set by insurers, lie below the efficient frontier — meaning they offer inferior risk–return tradeoffs compared to diversified alternatives. This economic conclusion has direct legal significance because:
ERISA’s duty of prudence requires fiduciaries to select investments that are not dominated by better alternatives;
Legal precedent recognizes that selecting economically inferior pricing structures can constitute a fiduciary breach;
Both Disselkamp v. Norton Healthcare and the SeaWorld Order confirm that courts view pricing inaccuracies or structural disadvantages as actionable fiduciary issues.
Below is a concise explanation of how Disselkamp and SeaWorld reinforce the legal foundations for the efficient-frontier critique.
II. Disselkamp v. Norton Healthcare — Pricing Decisions as Fiduciary Breaches
Case Core Principle: In Disselkamp, the U.S. District Court for the Western District of Kentucky held that selecting a higher-cost mutual fund share class when identical lower-cost share classes were available can state a claim for breach of fiduciary duty under ERISA §404(a), even without proof of performance lagging an index or peer group. The key issue was the pricing decision itself:
An inferior pricing structure was chosen;
A superior, economically equivalent alternative was available;
The pricing decision locked in a cost differential that persisted and compounded over time.
Legal Logic: The court framed the decision not as a performance dispute but as a pricing/prudence failure — the fiduciaries had a duty to select an option that did not impose unnecessary cost burden on participants.
III. Why Disselkamp Matters to the Efficient Frontier Analysis
The Stable Value Efficient Frontier documents that many stable value and insurer-backed products lie below the efficient frontier of available capital-preservation options (e.g., synthetic stable value funds, diversified high-quality bond portfolios).
Under Disselkamp:
A pricing differential between products is actionable when all other economics are comparable;
A fiduciary’s failure to select the lower-cost option constitutes a breach of prudence;
Losses from inferior pricing are structural and continuing, not merely attributable to market volatility.
Analogy Applied:
Feature
Mutual Fund Share Class (Disselkamp)
Stable Value / Annuity Product
Economic Choice
Lower vs. higher cost share class
Higher vs. lower crediting rate
Pricing Variable
Expense ratio
Crediting rate / insurer spread
Superior Alternative
Available identical share class
Diversified stable value / bond alternative
Fiduciary Duty
Select lower cost
Select higher crediting / efficient product
Legal Harm
Ongoing cost differential
Ongoing lost earnings from rate differential
Thus, when The Stable Value Efficient Frontier shows that a product lies below the efficient frontier, it underscores that fiduciaries have selected an inferior pricing structure, which Disselkamp deems actionable.
IV. SeaWorld Order — Extending Pricing Scrutiny Beyond Mutual Funds
Case Core Principle: In Coppel v. SeaWorld Parks & Entertainment, Inc., a federal court in Maryland denied a motion to dismiss ERISA claims challenging the selection and retention of stable value and annuity-like products. The court held that allegations of:
Low crediting rates,
Undiversified and risky structures,
Failure to consider superior alternatives,
were sufficient to survive dismissal because they plausibly alleged a breach of fiduciary duty under ERISA §404(a) and §406.
Importantly, the SeaWorld Order confirmed that:
Challenging inferior pricing or economic terms is not a “mere performance dispute”;
Low crediting rates and unfavorable contract terms can be the basis for a fiduciary breach claim;
Disclosure and industry custom do not automatically cure pricing/design issues.
V. Why SeaWorld Matters to the Efficient Frontier Analysis
The Stable Value Efficient Frontier does more than identify inferior products. It demonstrates that:
Superior alternatives exist with better risk-adjusted returns;
Certain products’ economic positions are dominated by those alternatives;
The decision to offer or retain these products cannot be justified as prudent when measured against the efficient frontier.
The SeaWorld Order confirms that such economic dominance is legally relevant:
Courts will consider whether fiduciaries compared available alternatives;
A product’s inferior position relative to the efficient frontier can support a finding that fiduciaries failed to exercise due care;
Allegations focusing on the economic substance of the investment — not labels or tradition — satisfy pleading requirements.
Thus, SeaWorld reinforces the idea that economic comparisons like efficient frontier positioning matter legally, not just academically.
VI. Unified Legal Theory: Pricing, Prudence, and Prohibited Transactions
Combined, Disselkamp and SeaWorld support a unified legal theory:
Pricing Decisions Are Fiduciary Decisions
Whether framed as an expense ratio, crediting rate, or spread, pricing decisions are central fiduciary acts.
Inferior Economics = Breach of Duty
Selecting a product that lies below the efficient frontier is analogous to selecting a higher-cost share class.
Continuing Harm Is Actionable
Damages resulting from inferior pricing — whether expressed as lost earnings or unreasonable compensation — are structural and ongoing, not speculative.
Disclosure and Custom Are Not Defenses
Neither disclosure of a product’s features nor industry adoption immunizes fiduciaries from liability for inferior pricing choices.
Prohibited Transactions Are Strengthened
When the inferior pricing benefits a party in interest (e.g., insurer spread revenues), the combination of pricing breach and party-in-interest status supports prohibited transaction claims under ERISA §406.
This unified theory directly supports the conclusions in The Stable Value Efficient Frontier that:
Certain stable value and annuity products are economically dominated;
Fiduciaries have a duty to select superior alternatives;
Failure to do so is actionable under ERISA.
VII. Conclusion
The efficient frontier analysis provides a quantifiable, economic basis for identifying inferior pricing products. Disselkamp and SeaWorld confirm that inferior pricing decisions are not abstract academic critiques — they form a legally cognizable basis for fiduciary breach and prohibited transaction claims under ERISA.
In litigation, plaintiffs can leverage:
Efficient frontier charts to show economic dominance of alternatives;
Share-class analogies under Disselkamp to frame pricing harm;
SeaWorld’s rejection of industry-custom defenses to withstand motions to dismiss.
Together, these authorities transform the efficient frontier from an academic tool into a legal foundation for ERISA claims against stable value and annuity products.
Appendix: Why Evergreen Fixed Annuities Must Be Evaluated Against 7- and 10-Year Rates on the Stable Value Efficient Frontier (2/2/26)
I. The Core Fiduciary Error: Treating Evergreen Products as Short-Term Investments
Most fixed annuities offered inside 401(k) plans—whether labeled “stable value,” “fixed account,” or “guaranteed interest fund”—are evergreen contracts:
They have no stated maturity date at which principal must be returned.
They restrict exits through multi-year withdrawal schedules, market-value adjustments, or employer-level termination rules.
They expose participants to ongoing single-insurer credit risk and insurer discretion over crediting.
Economically, these products do not behave like cash, money-market funds, or even 1- to 5-year instruments. They behave like intermediate- to long-duration credit exposures with limited liquidity.
From an efficient-frontier perspective, this distinction is decisive.
II. Efficient Frontier Analysis Requires Duration and Liquidity Matching
A core principle of modern portfolio theory—and of fiduciary prudence—is that comparisons must control for:
Time horizon / duration
Liquidity and exit rights
Credit concentration risk
Comparing an evergreen annuity to a 1-year or even 5-year instrument systematically understates the return a prudent fiduciary should demand for accepting:
indefinite commitment,
reduced liquidity,
opaque pricing,
and single-entity insurer risk.
Accordingly, the correct benchmark on the stable value efficient frontier is not a short-term rate, but an intermediate- or long-term rate, typically 7 years or 10 years.
III. Market Evidence: What Investors Are Paid for 7- and 10-Year Commitments
Retail markets provide transparent evidence of what insurers themselves must pay when they compete for true long-term commitments.
As of recent periods:
7-year fixed annuities have been offered at approximately 6.90%.
10-year fixed annuities have been offered at approximately 7.65%.
(October 2025 retireguide.com )
These rates reflect retail Multi-Year Guaranteed Annuities (MYGAs)—products where the investor knowingly commits funds for a defined long term and is compensated accordingly.
These rates represent market-clearing prices for long-duration annuity capital, not hypothetical or academic benchmarks.
When a 401(k) plan offers an evergreen annuity crediting 2%–3%, the product lies far below the efficient frontier relative to what the same insurers pay in retail channels for comparable or shorter commitments.
IV. Where 5-Year CDs Fit on the Efficient Frontier
Certificates of Deposit help illustrate the lower bound of the efficient frontier for capital-preservation assets.
Historical data from the Federal Reserve and FDIC show that:
5-year CD rates have typically ranged from roughly 1%–2% in low-rate environments to 4%–5%+ in higher-rate environments.
CDs provide full principal preservation, defined maturity, and FDIC insurance, with none of the credit opacity or lock-in found in annuities.
Because 5-year CDs:
have shorter duration,
offer clear maturity and liquidity,
they should plot returns below 7- and 10-year annuity rates on the efficient frontier—but way lower on risk than low-crediting evergreen annuities that impose longer-term risk without commensurate return.
In other words:
A low-rate evergreen annuity can be inferior even to a 5-year CD rate despite much higher risk,
and is dramatically inferior to market-priced 7- and 10-year annuities.
V. Efficient Frontier Implication: Evergreen Annuities Are Often Dominated Assets
Putting these instruments on the same efficient frontier reveals a clear ordering:
Instrument
Liquidity
Effective Term
Typical Market Rate
Money Market / Short-Term Cash
Daily
<1 year
1-4%
5-Year CD
High (at maturity)
5 years
2-4%
7-Year Retail Annuity
Low
7 years
~6.9%
10-Year Retail Annuity
Very Low
10 years
~7.65%
Evergreen 401(k) Fixed Annuity
Restricted
Indefinite
2%–3% (typical)
An evergreen annuity that:
restricts exits,
concentrates credit risk,
and offers materially lower returns than even shorter-term alternatives,
is economically dominated. On an efficient frontier chart, it plots below and to the right of readily available alternatives—precisely the outcome fiduciary law is designed to prevent.
VI. Fiduciary Consequences
From a fiduciary standpoint:
Accepting short-term yields for long-term risk violates basic prudence.
Duration mismatch is not conservative; it is uncompensated risk.
Disclosure does not cure an investment that lies below the efficient frontier.
When the insurer capturing the spread is a party in interest, the pricing failure also supports prohibited transaction claims.
The efficient frontier analysis thus provides a quantitative, economically grounded framework for evaluating evergreen annuities—one that courts already understand from share-class and pricing cases.
VII. Bottom Line
Since most fixed annuities offered in 401ks have no maturity and cannot be exited freely at par, it must be evaluated against intermediate- and long-term rates—typically 7- and 10-year benchmarks—not short-term cash yields.
Measured correctly, many 401(k) fixed annuities fail this test and sit well below the stable value efficient frontier.
Sources
Retail 7- and 10-Year Fixed Annuity Rates (MYGAs) – RetireGuide
FDIC / Federal Reserve historical CD rate data (5-year CDs)
Background: CDS, spreads and fiduciary/prohibited-transaction relevance
How could you neutralize or hedge the single entity credit risk of an Annuity product and the answer is a Credit Default Swap (CDS). While a high-risk annuity like Athene has a double the default rate of a moderate-risk annuity like Prudential over the next 5 years, the risk differential increases significantly beyond 10 to 20 years, as most annuities have no maturity date.
What is a CDS
A credit default swap is a contractual derivative in which one party (the protection buyer) pays a periodic premium in basis points (bps) to another party (the protection seller) in exchange for a contingent payment if a reference entity suffers a “credit event” (e.g., default, restructuring) on its debt. The “spread” of a CDS (the premium in bps per annum) reflects the market’s assessment of the default-risk (or credit deterioration risk) of the reference entity. Credit default swaps are typically for a certain time, and the market for insurers typically only extends to 5 years for U.S. insurance providers. CDS in general do not exceed 10 years. However, many annuities are evergreen, lasting 20 years or more with no maturity, so these swaps only capture part of the risk.
Why the spread level matters
A higher CDS spread implies higher perceived risk of default (or higher risk of credit deterioration) for the reference entity.
For a fiduciary (e.g., under Employee Retirement Income Security Act of 1974 (ERISA)), when plan assets (or investment vehicles) have exposures to insurers, annuities, or other counterparties whose credit risk is elevated, the fiduciary may have a duty to monitor, disclose, hedge, or avoid those exposures (depending on context), especially if the risk was or should have been known and could materially affect the promised benefits or underlying guarantee.
For prohibited-transaction analysis (e.g., revenue sharing, platform fees, cross-subsidies, insurer compensation layers), evidence that an insurer’s credit risk was materially elevated could support a “should have known” or “imprudent” argument regarding the selection/retention of that insurer, the structure of the product, or the disclosure given to the plan or participants.
In the context of annuity/insurance products offered inside 401(k) plans, the insurer’s relative credit risk may affect the amortization of the “spread” compensation, the insurer’s ability to honor guarantees, and thus potentially the cost/damages metric. If CDS spreads are widening (i.e., compensation increasingly scarce, market‐perceived risk rising), a fiduciary reviewing a product with a “hidden spread” could argue that the risk component should have been captured and disclosed.
CDS rates do fluctuate. Prudential’s 5 year CDs rate went up to 62 bps in October 2025, but it has spiked to 86bps as late as January 2025 and was at 117bps in January of 2023.
The spread is an objective market signal; it reflects trading, not just rating‐agency assessments.
In a higher‐interest‐rate, higher‐spread environment, insurers may pursue riskier assets (e.g., private credit, leveraged finance) to maintain margins (as multiple recent studies show). That, in turn, can increase the tail risk of the insurer.
From a damages perspective, if an insurer’s CDS spread increased materially after the fiduciary decision point (or was elevated at the time), one could argue that the “cost of guarantee” embedded in an annuity product was understated, or that the residual risk was underpriced. This could also have been seen as a failure to monitor the risk.
In Pension Risk Transfers (PRT) it could capture the difference between a Private Equity Insurer, Athene, at 118bps and a more traditional insurer like Prudential at 57bps.
The CDS rate quantifies a portion of the risk damages to participants in a particular annuity product. This applies whether it is a fixed annuity or a lifetime income annuity in a DC 401(k) plan or a Pension Risk Transfer (PRT) annuity in a Defined Benefit Plan and creates a floor for damages.
Appendix: Why 5-Year CDS Understate the True Risk of Long-Dated Annuity Promises
1. The Mismatch Between 5-Year CDS Markets and 20–30-Year Annuity Liabilities
Credit Default Swaps (CDS) — the primary market-based measure of insurance-company credit risk — trade almost exclusively in 5-year maturities. But annuity guarantees are evergreen obligations:
IPG fixed annuities,
Stable-Value general-account annuities, and
Pension Risk Transfer (PRT) annuities
are effectively 20- to 30-year promises (or longer). Most never “mature” at all — they persist until the insurer fails, is downgraded, or closes the block of business.
This creates a structural distortion: we are measuring a multi-decade promise using a 5-year price of risk. No informed investor would price a 30-year bond from a single, BBB+/A- insurer based solely on its 5-year CDS cost — but that is exactly how the annuity industry presents itself to fiduciaries.
2. Why Risk Increases Exponentially With Time, Not Linearly
Credit risk does not accumulate in a straight line.
It increases non-linearly, because:
Probability of adverse events compounds over long horizons.
Insurer balance sheets change — often deteriorate — across cycles.
Regulatory forbearance and accounting games increase in long tails.
A 30-year horizon necessarily crosses multiple recessions, multiple interest-rate regimes, and at least one insurance-industry credit cycle.
This is why life insurers themselves never price long-term mortality risk by extrapolating short-term mortality tables. But the annuity industry encourages fiduciaries to make exactly that mistake for credit risk.
3. Life-Insurance Pricing as an Analog for Annuity Credit Risk
A clean, intuitive analogy exists inside the same companies that issue PRT and IPG annuities: life-insurance pricing.
Consider a 50-year-old male purchasing:
A 5-year term life policy (coverage to age 55), versus
A lifetime policy (whole life or GUL).
The pricing difference is enormous:
The insurer’s risk of the 50-year-old dying in the next 5 years is small.
The insurer’s risk of that same person dying sometime between age 55–95 is essentially 100%.
Thus:
Long-dated promises cost exponentially more, not linearly more.
This mirrors annuity-credit economics:
A 5-year CDS is like a 5-year term life policy: Cheap, because the insurer is unlikely to fail within a short window.
A 20- or 30-year annuity guarantee is like a lifetime mortality promise: The chance the insurer encounters a solvency event approaches certainty, not possibility.
4. The “Smoker Effect”: Why Impaired Insurers’ Long-Horizon Risk Blows Up Even Faster
Now assume the 50-year-old is a smoker.
The cost of the 5-year term policy increases slightly.
The cost of the lifetime policy increases dramatically.
This is the exact analog for insurers with higher CDS spreads (e.g., Lincoln, Athene, Fidelity & Guaranty).
A 50–100 bps 5-year CDS spread today is:
A minor uptick over 5 years, but
A geometric explosion of cumulative default probability over 20–30 years.
This is precisely the dynamic ignored by fiduciaries who use short-dated CDS as if they were long-dated measures of credit risk.
5. From 5-Year CDS to 30-Year Annuity Risk: The Mathematical Intuition
If a 5-year CDS implies a 3–4% cumulative default probability over 5 years (typical for BBB+ / A- insurers like Lincoln or Prudential), then:
Over 20 years, the cumulative probability compounds to 12–16%,
Over 30 years, it can reach 20–25% or higher,
And when you incorporate loss given default, state guaranty cap exposure, and transfer-risk, the participant’s exposure becomes unacceptable for any plan fiduciary who claims prudence.
Thus:
A stable-value annuity or PRT annuity is effectively a long-dated corporate bond without a market exit. No fiduciary would buy a 30-year BBB+ bond as the principal-preservation option in a retirement plan. Yet they buy insurer general-account annuities every day.
6. Why This Matters for ERISA Fiduciaries
ERISA requires fiduciaries to evaluate all material risks, including:
Credit risk,
Single-entity risk,
Liquidity risk, and
Long-horizon solvency risk tied to the structure of the investment product.
But many fiduciaries — especially in health-system 401(k) plans — look only at:
Current credit rating, or
5-year CDS levels.
This is the equivalent of analyzing a 50-year-old smoker’s mortality risk solely by looking at whether he is likely to die by age 55. It ignores where the real risk lies.
7. Conclusion: Fiduciaries Should Treat Long-Dated Annuity Promises Like Long-Dated Mortality Promises
A universal rule applies across insurance and finance:
Short-term guarantees are cheap because the risk is small. Long-term guarantees are expensive because the risk approaches certainty.
The entire annuity industry depends on fiduciaries not understanding this basic fact.
And just as no rational person would conclude that a smoker’s 5-year mortality risk says anything about his risk of dying sometime over the next 30 years, no prudent fiduciary should treat a 5-year CDS spread as a reliable indicator of long-dated annuity-credit stability.
ERISA requires better. Participants deserve better. And the data is clear: long-dated annuity risk is exponentially higher than 5-year CDS markets reveal.
November rate updated Lincoln 105bps Prudential 62bps
The October 2025 Bank for International Settlements (BIS) report, ‘The Transformation of the Life Insurance Industry: Systemic Risks and Policy Challenges,’ provides authoritative evidence that strengthens the arguments made in my recent article on Commonsense401kProject regarding offshore private credit causing increased risk in retirement products backed by Insurance Company General Accounts. The findings demonstrate how structural changes in the life insurance and private equity sectors reinforce ERISA prohibited-transaction concerns. [BIS (2025), pp. 1–3] [Tobe, Commonsense401kProject (2025)]
1. BIS Findings with ERISA Implications
The BIS report documents how life insurers, increasingly owned or partnered with private equity, are reshaping their balance sheets with higher allocations to opaque private credit and structured securities. Key findings include:
Private equity acquisitions of insurers have created conflicts of interest, with affiliated managers steering assets into their own private credit deals.
Offshore reinsurance has surged, with U.S. insurers ceding over $2 trillion of reserves by 2023, 40% to Bermuda and Cayman affiliates subject to lighter regulation.
U.S. insurers now allocate roughly 30% of general account assets to corporate debt and 18% to structured securities, many rated internally or opaquely.
Liquidity stresses are rising from surrender spikes and collateral calls on derivatives, forcing insurers into procyclical asset sales.
The Eurovita case shows how a private-equity-owned insurer collapsed in 2023, requiring a ‘surrender holiday’ and taxpayer-backed resolution. [BIS (2025), Box B, p. 15; Reuters (2023)]
3. Why This Reinforces Prohibited Transaction Risks
The BIS findings strengthen three ERISA prohibited transaction arguments:
Party-in-Interest Conflicts – Affiliated transactions between private equity sponsors, insurers, and offshore reinsurers constitute prohibited self-dealing.
Prudence and Reasonableness – Fiduciaries cannot verify valuations or spreads when private ratings and opaque fee structures dominate.
Offshore Arbitrage – By ceding assets to offshore affiliates, fiduciaries place plan money into regulatory regimes with weaker solvency and disclosure standards.
4. Systemic Risk as Fiduciary Breach
The BIS study shows insurers’ systemic risk contribution (measured by SRISK and ΔCoVaR) has risen relative to banks, particularly in North America. As insurers adopt riskier private credit portfolios, ERISA fiduciaries exposing plan participants to these structures cannot argue they are prudent or diversifiable. The systemic nature of the risk means it is embedded in the financial system, not isolated to one plan or product. [BIS (2025), pp. 18–22]
5. Policy and Litigation Implications
This evidence has three main uses:
Litigation: BIS provides an independent, global authority confirming that PE-linked insurer structures create conflicts, opacity, and systemic risks, supporting claims under ERISA §406.
Policy: BIS recommendations—standardized reporting, capital charges, macroprudential oversight—map directly onto ERISA fiduciary requirements for prudence and exclusive benefit.
Advocacy: Regulators and courts should treat offshore PE-insurer structures as per se prohibited transactions unless they disclose spreads, risks, and conflicts transparently.
Conclusion
The BIS report validates and deepens the concerns outlined in our earlier article. Offshore private equity and private credit structures of life insurers are not just opaque—they are riddled with self-dealing, systemic risk, and regulatory arbitrage. These are exactly the types of arrangements that ERISA’s prohibited transaction rules were designed to prevent. For fiduciaries, the message is clear: reliance on these products is not only imprudent but may be per se unlawful.
UPDATE November 6 2025: Insurers use small ratings agencies to get favorable ratings on Private Credit. The SEC is investigating Egan-Jones for this Practice. Egan Jones has only 20 analysts rating over 5000 different issues. https://www.bloomberg.com/news/articles/2025-11-06/egan-jones-probed-by-sec-over-its-credit-ratings-practices Bloomberg Analysis of NAIC shows that capital charges for AA- rated issues is half of what an A rating is so the incentive in $billions is to inflate ratings.
Private equity has long been marketed to U.S. retirement plans as a source of diversification and “illiquidity premium.” But for ERISA fiduciaries, private equity contracts are not simply another asset class; they are contracts structured to evade transparency, domiciled in offshore havens, and riddled with conflicts. Unlike mutual funds or collective investment trusts (CITs) subject to SEC or OCC oversight, private equity partnerships are bespoke, one-sided agreements with managers and affiliates who extract hidden fees and indemnify themselves against liability.
II. ERISA’s Fiduciary and Prohibited Transaction Framework
ERISA imposes the highest fiduciary standard in U.S. law. Fiduciaries must act solely in participants’ interests, with the prudence of an expert, and for the exclusive benefit of plan participants (29 U.S.C. §1104(a)(1)). The statute also flatly prohibits certain transactions: deals with “parties in interest” (29 U.S.C. §1106(a)) and self-dealing by fiduciaries (29 U.S.C. §1106(b)). Once triggered, they are per se violations unless the fiduciary demonstrates an exemption under §408, and under Cunningham v. Cornell Univ. the burden rests with fiduciaries.
III. Offshore Domiciles and Regulatory Arbitrage
Most private equity funds are domiciled offshore — Cayman Islands, Luxembourg, or Jersey — or structured in Delaware partnerships. These domiciles provide tax and secrecy advantages to managers while obscuring risks and fees from investors. Trustees at Kentucky TRS admitted they could not even disclose which offshore jurisdictions were used for their private equity allocations, illustrating how these structures undermine fiduciary transparency.
IV. The “25% ERISA Exemption” and Its Abuse
Under the DOL’s plan asset regulation, if less than 25% of a fund’s investors are ERISA plans, the fund is exempt from ERISA’s fiduciary standards. This loophole allows private equity managers to deliberately structure investor pools to avoid ERISA oversight, commingling ERISA assets in vehicles designed to evade fiduciary duties. Fiduciaries allocating into these structures are still liable for knowingly participating in prohibited transactions.
V. Hidden Fees, Four Sets of Books, and Conflicts
Private equity funds extract multiple layers of fees: management fees, carried interest, monitoring and transaction fees, and financing spreads on affiliated debt. Managers often maintain multiple sets of records for tax, investors, and regulators. Independent research by Phalippou and others shows that all-in costs exceed 600 basis points annually. This far surpasses index fund costs of 3–10 basis points and violates ERISA’s requirement that expenses be reasonable.
VI. Friends and Family Side Letters
Side letters grant favored investors preferential disclosure, liquidity, or fee terms. ERISA plans are rarely among the favored class. Instead, insiders profit at the expense of plan participants. Offering documents often warn that these selective disclosure practices may violate applicable law. Under ERISA, they are transfers of plan value to other investors without adequate consideration — a prohibited transaction.
VII. Illiquidity and Monitoring Failures
Private equity contracts bind fiduciaries for 7–12 years with little or no exit rights. Valuations are controlled by the GP, preventing fiduciaries from independently monitoring prudence as required by Tibble v. Edison. Secondary sales are restricted and discounted, leaving fiduciaries unable to act if investments become imprudent.
VIII. Why Private Equity is a Prohibited Transaction
Bringing the evidence together: 1. GPs and affiliates are parties in interest, receiving compensation directly and indirectly. 2. Waivers of fiduciary duty and indemnification clauses create textbook self-dealing. 3. Side letters transfer value away from ERISA investors. 4. Offshore domiciles and 25% exemptions are deliberate attempts to evade oversight. 5. Illiquidity and opaque accounting make prudence and monitoring impossible.
Therefore, private equity contracts are per se prohibited transactions unless an exemption applies, and fiduciaries bear the burden of proof. No credible exemption exists.
IX. Policy Implications
Allowing private equity in 401(k)s undermines participant protections, normalizes opaque insider-driven contracts, and invites other high-risk vehicles like crypto and offshore private credit. Courts should recognize that PE in ERISA plans is incompatible with fiduciary duties and prohibited transaction rules.
Appendix Update – Financial Times (Dec. 10, 2025): Retailization of Private Equity Deepens Fiduciary Risk
A new Financial Times analysis, co-authored by Ludovic Phalippou and William Magnuson, documents a significant industry push to extend private equity access to everyday investors, including 401(k) and other retail retirement savers — and explains why this “retailization” of private funds heightens legal and fiduciary risks rather than mitigating them. Financial Times
1. Private Equity Designed for Sophisticated Investors, Not Retail Plans
Historically, private equity funds operated under a light regulatory regime because they were assumed to be accessible only to sophisticated institutional investors with the capacity to evaluate complex fee structures, valuation conventions, illiquidity, and bespoke governance arrangements. In contrast, everyday retirement savers — including 401(k) participants — lack these institutional safeguards and repeat-player advantages. LinkedIn
2. Rising Legal Vulnerabilities When Exposed to Retail Savers
The FT article highlights specific vulnerabilities that are now exposed when private equity products are marketed to non-institutional investors:
Opaque Performance Measures: Common private-equity metrics such as internal rate of return (IRR) can be misleading, particularly when used without context on timing, reinvestment returns, or hurdle structures.
Hidden and Complex Fee Structures: Catch-up clauses, waterfall provisions, and other bespoke compensation mechanics are often poorly understood even by institutional LPs, and are likely to be poorly understood by retirement plan fiduciaries and participants.
Valuation and Liquidity Risks: The infrequent and GP-controlled nature of valuations in private equity obscures true risk and may misstate returns relative to liquidity needs of retirement plans.
Suitability and Disclosure Gaps: Retail investors expect public company-style disclosures and safeguards that private equity by design does not provide. Their lack prompts higher litigation risk when practices are perceived as misleading or unfair. Financial Times
Because retail investors do not fear being cut off from future funds — unlike institutional LPs — the FT commentary underscores that courts, not regulators, may become the primary venue for enforcing accountability in cases of misrepresentation, unfair practices, and lack of transparency. The piece suggests that “tobacco-style” legal challenges could emerge as investors challenge private equity’s opaque practices once retail capital is involved. LinkedIn
3. Implications for ERISA Fiduciaries and Prohibited Transaction Analysis
This Financial Times critique strengthens the view that private equity’s intrinsic structural and disclosure characteristics make it incompatible with the ERISA fiduciary and prohibited-transaction framework:
ERISA’s prudence standard requires fiduciaries to act with the care of a “prudent man” in light of the information available. When basic valuation, fee, and liquidity information is non-standardized and opaque, the prudence standard cannot be meaningfully satisfied.
ERISA’s disclosure requirements and prohibited-transaction rules are premised on transparency and arm’s-length conflict discipline — conditions that private equity’s documented marketing and structuring practices actively undermine when extended to retail retirement assets.
The heightened legal risk of misrepresentation claims — foreshadowed in the FT coverage — underscores that reliance on traditional private equity justification (e.g., institutional sophistication, negotiated side letters, bespoke GP terms) does not extend to 401(k) fiduciaries, whose participants are not repeat sophisticated actors.
The FT commentary thus reinforces that private equity, particularly as it is evolving to include retail investor access (e.g., through 401(k) platforms or retailized vehicles), presents novel and acute ERISA compliance challenges and potential prohibited transaction risks not addressed by current industry guardrails. Financial Times
Appendix: Private Equity Contracts and Prohibited Transactions
Excerpt: “Other sections of limited partnership agreements waive the general partner’s fiduciary duty. One common means of doing that is to provide that the general partner may consider interests other than that of the investors in his fund, including his own interest. Pension funds should never indemnify vendors against criminal liability. Officers and directors who approved such an indemnification would breach their fiduciary duty to the fund. Indeed, pension funds should not indemnify vendors for the vendors’ own negligence.”
Cited examples: Blackstone V, Blackstone VI, Oak Hill III (all held by KRS). Kentucky Retirement Systems (KRS) held Blackstone and Oak Hill contracts where indemnification clauses explicitly covered “criminal” conduct, while other sections allowed the GP to consider its own interests ahead of investors
ERISA impact: This constitutes a transfer of value from plan participants to insiders — a clear §406(a)(1)(D) violation (transfer of plan assets for less than adequate consideration).
Exhibit 2: Offshore Domiciles & 20% Plan Asset Exemption
Excerpt: “Most private equity and private credit funds used by U.S. pension and 401(k) plans are organized in offshore domiciles like the Cayman Islands, Luxembourg, or Jersey. The purpose is tax avoidance and regulatory arbitrage—not participant protection. These structures often shield disclosure of true expenses and valuation practices, and favor affiliates through preferential terms hidden in side letters.”
“KY TRS counsel Beau Barnes replied that members and taxpayers do not have a right to know what offshore tax haven TRS has put his money. The only source of domicile information is within confidential documentation.”
ERISA impact: If a fund claims exemption under the 20% rule, then ERISA fiduciaries cannot rely on statutory protections inside the contract. That makes any allocation itself a prohibited transaction, as plan assets are knowingly commingled into structures designed to evade ERISA
Exhibit 3: Friends and Family Side Letters
Source: Tobe AltsCrypPE11mar25.docx book chapter in upcoming book 401k invesments
Excerpt: “Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information. The fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense. Offering documents warn these nondisclosure policies may violate applicable laws.”
Excerpt: “Private equity and private credit contracts typically lock fiduciaries into long-term, illiquid structures (7–12 years for PE). ERISA requires fiduciaries to monitor and, if necessary, remove imprudent investments. But in these vehicles, no liquidity exists to exit a deteriorating manager. Secondary sales are limited, heavily discounted, and often require GP consent.”
ERISA impact: Lock-in periods and GP-controlled valuations make ongoing prudence impossible.
Excerpt: “Private equity and private credit funds generate fees in layers: management fees, carried interest, transaction, monitoring, and advisory fees paid to affiliates, and financing spreads embedded in affiliated lending. Managers often keep multiple sets of records—one for investors, one for regulators, one for tax, and one for themselves. This opacity mirrors the hidden spread profits problem with annuities.”
ERISA impact: Hidden fee extraction is a prohibited transaction: plan assets are transferred to parties in interest for less than adequate consideration (§406(a)(1)(D)).
Add-On Section: The Trillion-Dollar Carry—Private Equity’s Hidden Fee Machine
Ludovic Phalippou’s latest research (April 2025) quantifies, for the first time, the aggregate “carried-interest” compensation earned by private-equity fund managers—and the findings expose just how massive and opaque this income stream has become. Using fund-level cash-flow data and fee terms from over 12,000 funds representing $8 trillion in deployed capital, Phalippou estimates that aggregate carried interest now exceeds $1 trillion, absorbing roughly 18 percent of all investor profitsLudoNov25.
1. Concentrated and Conflicted
Over 70 percent of all carry flows to U.S.-based managers, and more than half accrues to leveraged-buyout funds, not venture-capital vehicles. Venture capital accounts for less than 10 percent of total carry, undermining the industry’s long-standing political claim that favorable tax treatment is needed to “encourage innovation.” If carry were taxed as ordinary income rather than capital gains, Phalippou estimates that the United States would have collected roughly $250 billion in additional tax revenue over the study periodLudoNov25. In ERISA terms, this represents a massive transfer of plan-asset profits to the general partners (GPs) of private-equity partnerships—exactly the sort of self-dealing compensation Congress sought to prevent through the prohibited-transaction rules.
2. Effective Fees Far Above the Advertised “2 and 20”
Phalippou’s investor-level analysis of 15,900 limited partners (LPs) reveals that a subset of LPs—particularly asset managers and captive insurers—pay effective carry rates exceeding 25 percent of profits, and occasionally above 40 percent. By contrast, endowments and public pensions experience somewhat lower incidence because their portfolios are more diversified and include more funds-of-funds. This means ERISA-plan investors committing to private-equity funds may, in practice, be paying double-digit “spread” compensation above the stated contractual rate—precisely the hidden remuneration that should trigger a §406(a)(1)(C) and (D) prohibited-transaction analysis.
3. Fiduciary Implications for ERISA Plans
The study’s trillion-dollar total underscores that carried interest is not a side bonus—it is a dominant source of profit for private-equity general partners, effectively functioning as a performance-based revenue-sharing scheme. When ERISA plan assets are invested in such funds, the GP becomes a party-in-interest receiving variable compensation from plan assets, violating the core prohibition on self-dealing unless a specific exemption (e.g., PTE 84-14 or PTE 77-4) can be affirmatively proven to apply. Nothing in the LPA structure or disclosure regime ensures that such exemptions are satisfied. In fact, Phalippou’s finding that carry payments track “scale and incidence” rather than actual alpha performance supports the argument that these fees constitute unearned, conflicted compensation.
4. Policy and Enforcement Takeaways
Phalippou’s trillion-dollar estimate transforms the policy debate:
The “carried-interest loophole” is not a minor tax quirk but the largest single unreported compensation pool in global finance.
Because public and ERISA-regulated pensions are among the dominant limited partners, a substantial fraction of that trillion dollars was extracted from retirement trust assets.
The data provide a quantitative foundation for DOL and SEC enforcement: if even a small portion of these payments derive from plan-asset funds without a valid exemption, the entire structure constitutes a systemic prohibited-transaction breach
Appendix 2: Why Even AI Cannot Cure Private Equity’s Structural Problems — Reinforcing the Prohibited-Transaction Thesis
A. Setting the Stage: AI Hype vs. Private Market Reality
Recent commentary by Ludovic Phalippou highlights a growing trend among allocators: the belief that artificial intelligence (AI) and machine-learning (ML) tools can overcome private markets’ opacity and complexity — making them more “manageable,” transparent, or at least assessable. Top1000funds.com+1
Yet according to Phalippou, and echoed by multiple practitioners and academic studies, the core structural problems of private equity remain — and in many respects, AI may even make them worse. Top1000funds.com+2Interactive Brokers+2
B. Key Limitations of AI in Private Equity — Implications for ERISA Fiduciaries
PE Structural Problem
Why AI Fails to Resolve It (per Phalippou & other experts)
Implication for ERISA Plans / Fiduciary Duty
Opacity & strategically framed disclosures (fund documents, LP agreements, side letters, fee structures, recycled fees, exemptions, special clauses)
AI tools often rely on summarizing large text volumes — but in private-market funds, the “meat” is hidden in footnotes, exceptions, complex clauses, and custom contractual terms. What matters (e.g., how “net invested basis” is calculated, how portfolio-company fees are “rebated,” how recycling clauses are triggered) is typically buried in dense legal prose that AI summarizers may gloss over or misinterpret. Top1000funds.com+2Interactive Brokers+2
Using AI-based due-diligence or screening tools gives a false sense of transparency. Fiduciaries relying on AI summaries may miss critical risks, conflicts, or hidden fees. The result: imprudent allocations based on inadequate information — exactly what ERISA’s prudence standard is meant to prevent.
Non-standardized, inconsistent metrics across funds (e.g., different treatments of carry, recycled fees, expense allocations, valuation conventions)
AI algorithms — especially those trained on public markets or “standard” data sets — struggle when each fund uses its own bespoke conventions. The heterogeneity makes apples-to-apples comparisons deceptive or impossible. As Phalippou notes, inconsistent disclosures mean that even “basic elements” such as multiples of money can vary materially across funds. Top1000funds.com+2Top1000funds.com+2
Artificial standardization through AI can mask the true variability and risks across funds. Fiduciaries may be misled into believing they have comparable investments when hidden structural differences make actual risk/return profiles wildly divergent. That undermines the “reasonable and prudent person” analysis required under ERISA.
Long feedback loops and illiquidity — private-equity funds often lock up capital for 7–10+ years; valuations are infrequent, stale, and controlled by GPs
AI thrives on high-frequency data, rapid feedback loops, and standardized metrics. By contrast, private markets deliver delayed, sparse, fragmented, and strategically curated data — the very environment AI is ill-suited for, according to Phalippou. Top1000funds.com+2Interactive Brokers+2
The illusion that AI can “make PE manageable” undercuts the reality of undiversifiable illiquidity and stale, opaque valuations. Fiduciaries cannot rely on AI-generated “model valuations” or “screening outputs” as a substitute for real transparency and periodic, reliable valuation and oversight.
Potential for manipulation, “gaming,” and hidden disclosures — GPs aware of AI screening may adapt their documents to obscure downside, over-emphasize favorable metrics, or bury adverse info in footnotes or hidden clauses
Phalippou warns that as asset owners adopt AI tools, GPs will adapt — inserting more obfuscation in footnotes, complex side-letter terms, and ambiguous language designed to mislead summarization tools. Top1000funds.com+1
This dynamic magnifies the conflict-of-interest risk: AI-powered “transparency” becomes a veneer. Because AI can be fooled, fiduciaries may unwittingly accept flawed assumptions or understates risks — a recipe for imprudence and potential self-dealing under ERISA.
C. Why This Matters: AI Doesn’t Substitute for ERISA Protections — It Reinforces Their Necessity
The described AI-driven efforts to “quantify” or “standardize” private equity obscure how deeply non-standard and bespoke PE funds are. That heterogeneity is exactly why ERISA’s fiduciary and prohibited-transaction framework — requiring transparency, independent valuation, disclosure of conflicts, and prudent monitoring — is critically important. AI doesn’t eliminate the need; it makes poor compliance more plausible.
The use of AI may give fiduciaries — and plan sponsors — a false sense of security, especially if they believe AI screening suffices for due diligence. But given the structural limitations and possibility of AI being “gamed,” that confidence would be misplaced.
In fact, the presence of “AI due diligence” as a selling point or justification for including PE in pension plans may represent a new layer of misrepresentation — akin to “tech-enabled opacity.” If a PE fund pitches itself to a pension with “AI-optimized reporting / analytics,” that may signal not transparency, but an effort to automate obfuscation.
Thus, far from mitigating the risks of PE as a plan asset, the rise of AI-enhanced private-market investing amplifies the prudential and fiduciary risks — buttressing the argument that PE contracts should be treated as per-se prohibited transactions under ERISA (or at least subjected to the strictest scrutiny).
D. Addendum to Original Appendix Exhibits: AI & “Model Risk” as Additional Evidence of Conflicted Compensation and Lack of Prudence
You may insert an additional exhibit — something like:
Exhibit 6: AI-Enabled Private-Equity as New Mode of Obscured Risk Compensation
Summary of Phalippou’s remarks at the 2025 Fiduciary Investors Symposium (footnote-buried clauses, non-standard metrics, risk of GP adaptation to AI screening). Top1000funds.com+1
Reference to academic evidence on AI/LLM bias, confirmation bias, and model risks when applied to complex, non-standard financial contracts. arXiv+1
Correlation to hidden-fees & carried interest issues already documented: AI does not substitute for oversight, but may facilitate deeper concealment.
Conclusion (for the Appendix)
The latest scholarship and industry commentary — especially from Phalippou — confirms an uncomfortable truth: AI does not resolve private equity’s underlying conflict, opacity, and risk structure. If anything, by enabling a new veneer of “data-driven sophistication,” it may exacerbate the very problems that make PE incompatible with ERISA’s fiduciary and prohibited-transaction framework.
Accordingly, the proliferation of AI-driven investment tools and “AI-optimized” PE funds should strengthen — not weaken — the case that PE allocations in retirement plans like 401(k)s, defined-benefit pensions, or other ERISA-regulated vehicles are fundamentally incompatible with the statutory duty of prudence and prohibited-transaction rules.
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The CommonSense 401k Project 