It’s worth skimming for the array of eye-catching factoids that Crenshaw presented to the University of Chicago’s Booth School of Business on April 14; such as how private market fundraising has trebled over the past decade to a record of almost $ 1.2tn last year, or how public markets have atrophied to the extent that the Wilshire 5000 index now only has about 3,500 members.
But for the US Securities and Exchange Commission, the big questions are whether this private market boom is really “facilitating capital formation” – to use its favorite phrase – and whether the interests of American investors are truly being served. As Crenshaw said:
My ever-present fear is that the capital formation rules that we put in place pay lip-service to the needs of everyday American entrepreneurs, but really serve another master. And because of the less stringent disclosure requirements in private markets, they do that at the expense of actual, substantive, meaningful disclosure to investors, stakeholders and regulators.
There’s an inescapable conflict between broadening smaller businesses’ access to capital and protecting investors from dodginess. In recent years, regulators have been mostly concerned about the dearth of companies going public, so they have attempted to ease the burden of being listed, while also broadening access to private markets.
In August 2020 the SEC expanded its definition of an “accredited investor”, and three months later passed another rule nattily named “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets.”
The understandable concern was that many of the juicy gains that private companies have made in recent years are primarily accruing to venture capitalists and their well-connected wealthy investors.
But Crenshaw is skeptical whether these efforts have actually done much to improve access to capital OR protect investors in private markets. In particular, she fears that lighter disclosure and compliance enjoyed by private companies is just shifting costs and risks on to investors and markets. Two excerpts from her April 14 speech:
. . . The influx of capital to the private side of the industry, coupled with the severity and frequency of misconduct that our agency is uncovering (even with the limited information we are able to collect) suggests to me that our recent rulemaking may not have been the right approach to serve our goals. The incomplete visibility that we have into the private markets tells me that we need more information to regulate and to ensure every American can adequately save for their children’s education and their own retirement. Quite simply, we need more insight, more education, indeed more data, to be able to effectively protect investors, before the big frauds occur.
. . . Unicorns may prefer not to provide the kind of insights into their businesses that publicly traded companies have to disclose, but the result is less public data about what is actually working and what is, instead, just shifting burdens to those less able to bear them. So I am concerned that not only are we not advancing access to capital for the businesses that could most benefit, but also that the present system does not provide standardized disclosure that all investors can rely on for decision-making, reporting frameworks that form the basis of corporate accountability, and the industry data we need as regulators to inform our decisions.
The private capital boom is clearly a big topic at the SEC. Fellow commissioner Alison Herren Lee last year raised some pertinent issues in a big speech on the subject. Earlier this year the SEC’s Division of Examinations put out a “Risk Alert ” highlighting worries around private fund managers, such as misleading track records. Dodgy valuations and outright frauds are another worry. Chair Gary Gensler also has private markets in his sights.
Here are, for reference, the questions that Crenshaw posed to the academics at Chicago:
Where are retail investors putting their funds and are there adequate protections in place?
What are the full, systematic implications of the increasing size of our private markets, and of having so many so-called Unicorns? Are there unforeseen implications when Unicorns do go public, including how they might utilize their privately accumulated capital to influence the IPO process and their governance structure?
What are the barriers to accessing public markets today, and how can we alleviate such barriers without eroding investor protections and increasing the already large information asymmetry?
Should we be taking immediate steps to better protect employee-investors of private companies, who are particularly vulnerable to liquidity and valuation challenges accompanying private companies?
Are there minimum corporate governance and code of ethics standards that should apply to all companies, public and private?
Are there other areas of our exempt offering framework that could be improved or better calibrated? For example, Regulation D and the Accredited Investor definition?
Should we revisit the rules under Section 12 (g) of the Exchange Act?
Like Crenshaw, Alphaville has more questions than answers. But we know this is going to be a wildly important debate to follow in the coming years. If you have any good responses to the above then leave them in the comments below.