The Investor Advisory Committee last week proposed guidelines to safeguard retail investors who dip into private markets.
The Securities and Exchange Commission’s Investor Advisory Committee last weeksignaled its willingness to open private market access to all investors — but with an added set of investor-protection guardrails.
The committee on Thursday voted to adopt a draft recommendation potentially openingprivate markets to all investors, though the committee would prefer that access remains available only through registered funds, rather than direct investments.
The committee in its draft recommendation noted that registered funds provide safeguards such as SEC reviews, audited financial statements, professional fund management, various degrees of liquidity and the protections of the Investment Company Act.
The draft recommendation also includes two subsets of recommendations: a main set for a scenario in which private market access remains limited to registered funds and an additional set to be implemented if the SEC opts to allow access beyond registered funds, amove that the committee does not take a position for or against.
The main set of recommendations includes provisions requiring greater clarity andtransparency regarding a fund’s valuation, enhanced and more prominent disclosures of a fund’s liquidity, the issuance of guidelines regarding when private market assets are in an investor’s best interests, proper disclosure of potential conflicts of interest, changes to rules or interpretations to allow closed-end funds to invest more than 15% of assets inprivately offered funds, and an open request for comments on this issue from the industry in general.
Among the IAC’s recommendations for a scenario in which the SEC would allow direct investor access to private markets is a suggestion to revise the definition of an accredited investor, which is the current threshold for gaining access to private markets. The IAC proposes moving away from using income and wealth levels to identify accredited investors and instead create a set of qualifications based on investor sophistication, including “the notion of creating an accredited investor test … developed by the Commission inconsultation with other federal and state regulators as well as industry and investor stakeholder groups.”
Other proposed measures include limiting the amount a non-accredited retail investor can invest in private markets, excluding retirement savings from the wealth-test portion of theaccredited-investor test and tightening Regulation D disclosure requirements for issuers toprovide greater transparency for investors.
The committee on Thursday voted to pass the draft recommendation, though one member voted against the proposal and one abstained. The SEC commissioners will have the final say. SEC Chair Paul Atkins, in his opening remarks at the committee’s meeting, acknowledgedgrowing investor appetite for private markets but agreed with the IAC’s call for better safeguards.
“We must address the important issues and potential pitfalls inherent to this genre of investments, including liquidity, valuation, diversification, and strategy, terms and conditions of investment, such as investment priority and relative investment seniority in the capital stack,” Atkins said.
“These sorts of questions cannot be left to chance, and fiduciaries who have a long-termretail clientele must understand their duties and investor expectations,” Atkins added.
Democratic SEC Commissioner Caroline Crenshaw adopted largely the same cautious stanceduring the meeting. Crenshaw agreed with most of the IAC’s recommendations but said she”remain[s] skeptical about the overall proposition of stuffing an increased amount of inherently illiquid investments into registered funds” and suggested that the commission”should be careful to avoid an outcome where registered funds effectively become privatefunds disguised in a registered fund wrapper.”
Meanwhile, Republican SEC Commissioner Hester Peirce during Thursday’s meeting seemingly pushed back on some of the IAC’s proposed guardrails, asking, for example, thecommittee to “think through the consequences of increasing Regulation D offering costs by requiring issuers to adhere to more onerous disclosure requirements” and that regulator-issued guidelines regarding the suitability of private market investments could be ditched in favor of investors and their advisors using their own judgment. “My preferred approach remains full access for all investors to the private markets,” Peirce concluded.
Attorney David Harrison, a member of the Public Investors Arbitration Bar Association, told FA-IQ that the IAC’s recommendations “are a step in the right direction, acknowledging the significant growth of private markets and the need for regulatory recalibration” but “do not go far enough to address the fundamental risks that exist.”
Harrison, of Studio City, California–based Bakhtiari & Harrison, said via email that “firms should be legally obligated to take reasonable steps to verify an investor’s accredited status, instead of simply allowing them to check a box. This is a crucial gap in the current system that enables deceit and harms investors.”
“Proper investor protection requires a comprehensive approach that provides for a complete overhaul of the disclosure and due diligence standards for private offerings, and not just the accredited investor definition,” Harrison added. “Any move to ‘democratize’ private marketswithout first establishing these robust guardrails would be a disservice to the public and could lead to significant financial harm.”