With the Securities and Exchange Commission's report on hedge funds, it's not farfetched to envision a public policy proposal to regulate venture capital and other private equity.
Although the Sept. 29 report is about hedge funds — it recommends, among other things, the commission consider registration of hedge funds as investment advisers — there are brief sections on venture capital and private equity.
Venture capital and private equity funds, the report notes, among other similarities, are "structurally similar to hedge funds … often organized as limited partnerships" and "attract similar types of investors." But the report notes venture capital and private equity funds have features distinguishing them from hedge funds. Both types of funds often play an active role in the companies in which the funds invest.
The SEC report makes no mention of seeking to bring venture capital or private equity under its broad regulatory oversight. We don't think such regulation is a good idea. Nonetheless, pension investors as well as private equity managers have to be prepared to address such a possibility. Just as markets tend to go overboard, government policymakers can overdue oversight.
The SEC has broad regulatory authority over publicly traded securities. But SEC antifraud provisions include many kinds of non-registered investment managers, such as hedge funds and venture capital and private equity funds, investing in non-public securities.
Some of the same reasons for registering hedge funds might apply to venture capital and private equity funds: concerns over potential conflicts of interests and valuation. Registration also would help the SEC get a firmer idea than it now has on the extent of the industry in terms of managers, assets under management and performance. Performance disclosure already is a major issue in private equity, where some public pension funds and public universities are being forced to disclose manager performance, while some managers are deciding to dump those clients over the disclosure.
One thing registration of hedge funds will do is dim the performance mystique. With better data on hedge funds, performance universes will reduce survivor bias favoring better-performing funds. The same effect could occur with venture capital and private equity.
The SEC has a lot on its plate, but in this new era of investment oversight, nothing may be out of reach for long.
It's easy to call for more regulation as a deterrent to prevent harm to investors. But regulation shouldn't be welcomed without compelling advantages. First, the SEC doesn't have the resources. Second, there haven't been the abuses in venture capital and private equity funds as in hedge funds, among other reasons.
Consenting institutional investors and private funds should be able to make contracts on investing without extensive SEC oversight. But private funds should realize investors are more willing than ever to call for oversight if the investment process is perceived as unfair.