SEC Chair Jay Clayton is on record as wanting to find ways to expand the ability of retail investors to access private markets – including private equity funds. This Ropes & Gray memo reviews some of the challenges & opportunities associated with expanding retail access to private funds, as well as some of the alternative ways that retail participation might be accomplished. Here’s an excerpt from the intro:
Over the past several years, regulators and market participants increasingly have called for the expansion of investment opportunities for retail investors and retirees. These calls for expanded opportunities have cited market structure changes, the looming retirement crisis and basic fairness to retail investors and retirees who do not meet existing regulatory proxies for investor “sophistication.” SEC Chairman Jay Clayton, for example, observed that, in 2018, more capital was raised in the private markets than in the public markets, and that retail investors should (but currently do not) have access to those opportunities.
From 1996 to 2018, according to the World Bank, the number of exchange-listed U.S. companies decreased by approximately half, from 8,090 to 4,397. Consistent with the declining number of U.S. publicly traded companies, many large investors that had previously invested exclusively in public markets are now investing in private markets as well, seeing them as necessary for diversified exposure to global growth. Because retail investors are generally limited to investments in public companies, these market trends suggest that the investment opportunities available to retail investors have correspondingly decreased.
Calls for expansion of retail investment opportunities have also noted that lack of access to investments in private funds is contributing negatively to the retirement savings of many U.S. workers. In 2018, for example, the largest investors in private funds were government and private “defined benefit” retirement plans. However, most private-sector American workers save for retirement through “defined contribution” plans, such as 401(k) plans. For reasons discussed in Section II below, participants in defined contribution plans, both public and private, historically have had very limited access to private funds. Studies suggest that, over the last 25 to 30 years, access to private market investments is contributing to the relative outperformance of defined benefit plans over defined contribution plans.
Expanding retail access to private equity investments, in particular, has drawn support from academics and other nongovernment commenters in recent months. For example, a November 2018 report published by the Committee on Capital Markets Regulation cited studies demonstrating that private equity buyout funds consistently outperform public market alternatives, and argued that this performance, which appears uncorrelated with the performance of the public securities markets, justifies expanding retail investor access to private equity fund opportunities.
The memo says that while there may be a strong case for expanding retail access to private funds, current provisions of the securities laws and ERISA “essentially foreclose” most retail investors from participating. It discusses the issues associated with alternatives for providing retail access to private funds through direct investment, investment through a “registered fund of private funds,” & investment through a feeder fund advised by a registered investment adviser.
– John Jenkins