Two pieces of news from recent weeks offer an indication of what the next few years could bring:
- The Wall Street Journal reported in early January that the SEC is weighing rules to require more private companies to disclose information related to their finances and operations. Companies that are privately held often get around current reporting rules, which are based on the number of investors. Gensler and the SEC reportedly want to close those loopholes.
- Then, on Jan. 26, the agency proposed a series of rule changes that call for more information disclosures, faster, from a larger pool of private equity and hedge funds. For both classes of investors, the rules would require next-day disclosures of significant events.
Taken alongside prior public comments by commissioners, these developments indicate that Gensler’s SEC has momentous plans for the lightly regulated and highly opaque private market, which has become too big to hide from the SEC’s purview.
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The agency pegs the net assets of US private funds at around $11.5 trillion—$4.7 trillion of which is managed by hedge funds and $4.2 trillion by private equity funds. In the US alone, 340 companies became unicorns in 2021, more than were minted during the previous five years combined, according to PitchBook data. And more deployable capital is accumulating quickly, with PE firms raising over $300 billion and VC firms adding more than $128 billion in 2021.
On top of their size, private markets have attracted scrutiny for a series of market debacles. Last year, an unlikely trio of then-private companies—Citadel Securities, Robinhood and Reddit—were at the center of the weirdest public stock event in recent memory. There was the spectacular collapse of Archegos Capital, a highly leveraged fund that reportedly failed to meet its margin calls. And several high-profile SPAC deals drew charges of fraud from the SEC in their quest to take private companies public.
The agency seems convinced that bringing transparency to the private sector is fundamental to its core mission to protect investors and improve the functioning of the markets.
To start, the SEC is concerned that private funds present a risk to investors. The performance of these funds is notoriously difficult to evaluate, especially after accounting for fee structures. The SEC recently detailed several common deficiencies among private fund managers, including misleading or inaccurate performance disclosures, along with inadequate due diligence of investments. (Our recent Global Fund Performance Report details several challenges of evaluating private strategies.)
And while limited partners are typically savvy investors who know the risks, the SEC is more concerned with the large swaths of Americans represented by those LPs.
“The people behind those funds and endowments often are teachers, firefighters, municipal workers, students and professors,” Gensler said in a November speech to the ILPA, a lobbying group representing LPs.
The SEC also wants more people to have access to private markets, possibly by making additional changes to accredited investor rules. But if private markets open up to more investors, it stands to reason that the agency would want to make them more transparent, and maybe in effect more like public markets.
To be sure, many of the new disclosure requirements would require data to be shared confidentially—with regulators, not the investing public. In its most recent proposals covering hedge funds and PE firms, the SEC is focused on monitoring “systemic risks” posed by private markets.
Gensler is seeking rapid reporting requirements on fund managers as a way to alert the agency to crises-in-motion, thus giving regulators time to intervene. To accomplish that, the agency is proposing changes to Form PF, a quarterly filing that was born out of the 2008 financial crisis.
The thing about risks is that they change all the time, and it’s unclear what exactly is keeping the SEC up at night.
“There is a rotation in the market due to a number of economic conditions such as inflation and supply chain issues,” said Nicholas Tsafos, a partner at accounting firm EisnerAmper. “That rotation is causing a change in the risks that we’re used to. [The SEC] wants to be proactive towards risks rather than reactive.”
Whatever the source of these systemic risks, what they share in common is a threat to the smooth functioning of markets.
SEC Commissioner Allison Lee, who was appointed by then-President Donald Trump, argued in an October speech that today’s opaque private markets pose similar risks to the ones that led the US to create the SEC in the aftermath of the Great Depression.
“We must consider whether the growing lack of transparency in capital markets will lead once again to the misallocation of capital that we saw at the inception of the federal securities laws,” she said.
More transparency, the argument goes, leads to a more efficient market that lowers the cost for companies to raise capital and improves returns for LPs. That’s the sweet spot that the SEC is trying to hit.
The PE and VC lobbyists aren’t buying it. The American Investment Council, which represents the PE industry, contends that private equity “poses no systemic risk.” And Bobby Franklin, head of the National Venture Capital Association, told the WSJ that a transparency push on private companies could result in “unnecessary burdens” and “unintended consequences.”
Among the concerns that have been voiced: The threat of a reporting event could change how fund managers make decisions. New reporting requirements for private companies are a burden with no benefit to those businesses. And disclosures that add time and expense may do little in practice to protect investors or the broader market.
One thing seems clear: The SEC’s push for greater transparency has developed into a core focus. And the political environment—a Democratic-controlled commission in a midterm election year—adds an incentive for further action. The result could be the most significant change to private market regulations since the fallout of the financial crisis.
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