The SEC has published a concept release soliciting comment on whether it should expand opportunities for individual investors to access exempt offerings, and whether regulatory changes should be created as part of making these private investments, i.e. investment opportunities in private companies and private funds, more broadly available.
We believe that if the SEC moves forward with broadening private investment opportunities, regulatory change will be required.
Here, we take a look at the current state of exempt offerings and our view on their potential expansion.
Private investment opportunities are not widely accessible today
Currently, investments in exempt vehicles such as private equity funds, hedge funds, and startup companies are typically limited to accredited investors and institutions. Accredited investors are individuals who:
- Have a net worth (excluding their primary residence) exceeding $1 million individually or jointly with a spouse, or
- Surpass an income threshold of $200,000 for the last two years for an individual and $300,000 for a couple.
In practice, most individuals do not seek out these private investment opportunities or even know about them, since their main investments tend to be through their retirement accounts.
While individuals could technically access such opportunities through an IRA, they have generally not been available in defined-contribution plans. This is due to the operational difficulties for recordkeepers in managing valuation, liquidity, and other issues, as well as a lack of clarity around how such investments might satisfy the prudent investor standard of the Employee Retirement Income Security Act.
Operational challenges will accompany broader access to private investment opportunities
In Morningstar’s response to the SEC, we noted the challenges involved with making private investment opportunities more broadly available.
For instance, one way the SEC is considering expanding investments for individuals saving for retirement is by making it easier for target-date funds and robo-advisers to invest in private funds.
While these popular retirement vehicles may be well-suited for some long-term exposure to new asset classes such as private funds, the expansion would come with challenges. We argue that if the SEC takes this route, it needs to consider at least three points:
- The lack of requirements around reporting makes it difficult to compare and verify returns from private funds. That, in turn, makes it difficult for both target-date funds and retirement plan sponsors considering a target-date fund to evaluate whether a private pooled investment is in the best interests of plan participants.
- Infrequent pricing and illiquidity will require operational changes by target-date funds and robo-advisers.
- The private-fund asset class has a high variance, making it challenging to benchmark and fairly assess against other asset classes.
Broader access necessitates better data on private investment opportunities
In addition to these operational challenges, we also believe that existing data on private funds and companies is incomplete and inconsistent due to the low standard of disclosure on Form D filings.
We have seen this inconsistency surface in data collected by our subsidiary, PitchBook, which specializes in tracking private fund and company data. In our experience, not all questions on Form D are answered with completeness, and amendments are not made in a timely way when funds close or other significant changes occur.
In order for retail investors to make informed decisions about private investments, it will be important for information on the size of fund offerings, minimum investment amounts, and the size of private company offerings to be regularly provided and updated in public filings.
Our comment letter includes concrete suggestions about what should require an amendment to Form D, and what information it should include to help investors, if the SEC makes private investments more widely available.
We understand that more disclosure and regulation in this space would diminish the benefits of being private. The SEC has some significant trade-offs to consider as it moves toward a proposed rulemaking.