Question: Looks like .NET 4.0 is ignoring the DEVPATH env var for specifying custom directories for locating assemblies. Is support for DEVPATH not available anymore in .NET 4.0? Is there an alternative?

Answer: 
I verified. Works fine in VS2010 and VS2008, targeting .NET 4.0 and 3.5 SP1. Checklist:

* Make sure to restart VS after using Control Panel + System to edit the registry
* Don't forget to provide an app.exe.config file with the `<developmentMode>` element
* Beware that app.vshost.exe.config is used when you debug
* Use fuslogvw.exe to trace the failed bind. Make sure it reports the correct DEVPATH.

Post the trace in your question if this doesn't help.
According to MSDN: <http://msdn.microsoft.com/en-us/library/cskzh7h6.aspx> it is still supported.