The SEC should protect investors, not private funds

The U.S. Securities and Exchange Commission (SEC) has proposed a rule change that would make it easier for private equity, venture capital, and private capital fund managers to attract retail investors' money. This move would effectively open up previously closed-off strategies and high-performing managers to average investors. While the intention behind the proposal is noble, there are several reasons why private funds have remained off-limits to ordinary investors, and these issues persist even with the new proposal.

For one, these investments typically require a significant time commitment, often several years, which would be a new experience for most retail investors. Moreover, private funds come with performance fees and "backdoor costs" like administration, legal, and IT expenses. Academic studies suggest that these fees may not be justified, as they can significantly reduce the returns for investors.

Another concern is the potential for abuse within private funds. The SEC's proposal permits fund managers to create multiple share classes without prior regulatory approval. This could lead to situations where retail investors are charged higher fees while institutional investors enjoy lower fees. Such conflicts of interest could be challenging to detect, especially given the already significant conflicts of interest in private funds' valuation methods.

Furthermore, retail investors lack the robust oversight that institutional investors benefit from. They don't have a team of professionals closely monitoring the funds' assets, performance, and valuation methods. This lack of oversight could expose retail investors to significant risks, as fund managers could potentially mask poor performance by citing the higher cash-on-hand requirements of running a public-access fund.

The SEC's proposal does not address these issues of liquidity, transparency, governance, or valuations. It essentially treats retail investors as if they were on the same playing field as institutional investors, which is an unfair comparison. In reality, the SEC's proposal could expose retail investors to even greater risks and potentially harm the overall industry.

A more sensible approach would be to require tighter oversight and discipline from private fund managers in return for the anticipated cash bonanza. This would ensure that both the industry and retail investors benefit from any potential growth without compromising their security.