SEC looking to open private markets to a wider audience

As SEC Chairman Jay Clayton seeks to address the 2-to-1 imbalance of private fundraising vs. public offerings, one of the more controversial ideas being considered is how to make it easier for retirement savers and other investors to get into private markets.

In June, the Securities and Exchange Commission issued a concept release asking issuers, investors and other market participants to comment on how it could improve the regulatory framework for private offerings to make them accessible to more types of investors while fulfilling its mandate to protect all types of investors, including those with little or no experience with private markets.

That release, with the dry title "Harmonization of securities offering exemptions," noted that in 2018, all types of private offerings accounted for an estimated $2.9 trillion, more than twice the $1.4 trillion of new capital raised through registered offerings, the biggest disparity between the two since 2008.

Between 2009 and 2018, U.S. private equity and venture capital managers made up $761 billion of the $1.3 trillion increase in global private market AUM, with private equity accounting for 80% of those dollars and venture capital accounting for 20%, according to PitchBook Data Inc.

That trend has been a major concern for Mr. Clayton, who is also looking for ways to encourage more companies to enter public markets. To that end, the SEC in September approved a rule change so that companies considering going public can test the waters by communicating with institutional investors. Until now, that was an option only available to emerging growth companies.

Mr. Clayton also wants to do more for retail investors, including figuring out how they can participate in the attractive returns logged by private equity and venture capital.

That is easier said than done. Providing access to private markets in individual retirement accounts "is not a trivial thing to do," said Jasmin Sethi, associate director of policy research for Morningstar Inc. in Chicago. "It's going to take infrastructure changes as well as regulatory changes. There has to be more information if there is going to be access," she said. With the prospect of more disclosure and regulation of private markets, "the SEC has some significant trade-offs to consider," Ms. Sethi said.

One option being considered is offering private funds to retirement savers through target-date funds and robo-advisers, which presents numerous challenges for fund managers and plan sponsors, including how to verify returns, benchmark them and compare them to other asset classes.

Ms. Sethi and others also wonder how to address the question of fiduciary duty of plan sponsors and advisers when it comes to risky assets that do not have daily valuations.

At this point, the SEC effort is just brainstorming, said Ms. Sethi, a former SEC official. "We don't know what the change is going to be."

Major asset managers building up their own private market offerings are hoping the brainstorming leads to change.

"We believe that revisions to the exempt-offering framework are one of the most significant changes that the commission could undertake to expand opportunities for investors who are saving to meet their goals, whether paying for their children's college or for their retirement, to participate in the potential upside performance of exempt offerings," said Barbara Novick, vice chairwoman of BlackRock Inc., and Joanne Medero, managing director at the firm, in their SEC comment letter to the concept release.

Some asset owners are also intrigued. The Washington State Investment Board, Olympia, which oversees $139.6 billion in assets, is now researching the ramifications of embedding private markets into target-date funds offered through its $20 billion defined contribution plans.

"We are researching this because it appears that a prudent measure of private equity exposure in DC retirement plan frameworks makes good sense from the standpoint of risk-adjusted investment performance. However, any such implementation must address the challenges that come with participant education, operational issues and, ultimately, alignment to fiduciary duty," said Chris Phillips, WSIB's director of institutional relations and public affairs.

Other institutional investors are wary, given already fierce competition for new allocations to private equity that has prompted some, including the $381.5 billion California Public Employees' Retirement System, Sacramento, and $242.1 billion California State Teachers' Retirement System, West Sacramento, to cut their return expectations.

More capital from retail investors "will likely result in reduced returns for everyone in the marketplace," the Institutional Limited Partners Association said in its SEC comment letter, which also noted that "given the competitive environment for allocations and the heavily negotiated nature of these contracts, it is often difficult, even for institutional investors, to achieve the needed protections and information access."

With the retail market for private equity expected to grow, "institutional limited partners need to be part of that conversation to ensure that standards remain high and institutional limited partners' interests are protected," said Chris Hayes, ILPA senior policy counsel in Washington.

Adley Bowden, vice president for research and analysis with PitchBook, Seattle, said the overall capacity of the private markets is still a ''question mark." Still, he sees large asset managers working to improve the asset class by dealing with issues like liquidity, pricing and transparency. "It can work; it just will have to change, with new rules and safeguards," said Mr. Bowden.

"I think it is going to happen, but I don't think it is going to happen anytime soon."