Everyday Investor Participation in Private Strategies: What Role for Investor Advocate in SEC Drama?

Carlton Fields
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Carlton Fields

The SEC is under pressure to increase direct or indirect participation by everyday “retail” investors (consisting primarily of those who do not qualify as “accredited investors” under SEC Regulation D) in certain investment strategies that have largely been foreclosed to them. These “private strategies” can include, for example, a focus on private equity or private credit investments. The pressure is coming from many sources, such as the investment company industry (including both SEC-registered and unregistered funds), insurers that issue certain investment products, other elements within the retirement fund industry, and Trump administration executive orders.

Since the departure of former SEC Chair Gary Gensler, the SEC itself has shown an increased inclination to facilitate greater retail participation in private strategies. But private strategies present a variety of investment risks that can be very difficult even for highly knowledgeable institutional investors to fully assess or mitigate, regardless of the quantity or quality of information and disclosures to
which they have access. Such risks commonly include:

  • High leverage and limited liquidity.
  • Complex and sometimes subtle arrangements for imposing (directly or indirectly) substantial fees and expenses on the investors.
  • Asset valuations that often are necessarily subjective and potentially subject to manipulation.
  • Other significant potential conflicts of interest between the retail investors and the promoters or managers of the private strategies.
  • Complex contractual provisions that may significantly limit any liabilities that such persons might have to the investors.

Office of the Investor Advocate

Although the SEC’s Office of the Investor Advocate (OIAD) is located within the SEC, the Dodd-Frank Act mandates that the OIAD report directly to Congress and in other ways bestows on the OIAD substantial freedom from control or undue influence by other parts of the SEC or its commissioners. The OIAD’s key functions include:

  • Identifying problems with financial products and other areas in which investors would benefit from regulatory changes.
  • Analyzing the potential impact of proposed rules and regulations on investors.
  • Proposing appropriate changes to the SEC and Congress.

Accordingly, it would seem appropriate and potentially useful for the OIAD to play a substantive role in the unfolding drama at the SEC over retail investments in private strategies.

However, the OIAD’s most recent annual report to Congress specifically describes only a somewhat limited agenda in this regard for the coming year. The report states that the investor advocate will “explore some of the issues surrounding the inclusion of alternative investments, such as private equity and private credit, in retirement savings plans and their implications for retail investors” and “consider, among other things, the interplay between the investor protection issues in this area and the often-complex issues that arise under the Employee Retirement Income Security Act of 1974 … when defined contribution plans offer these investment products.”

The fact that this language speaks only of employee participation in private funds via retirement plans, and gives particular emphasis to investor protection issues under ERISA, could indicate that the OIAD will play only a bit role — or even merely be part of the scenery — in the SEC’s deliberations. After all, ERISA issues are primarily within the purview of the Department of Labor rather than the SEC.

Nevertheless, securities law investor protection issues quite similar to such ERISA issues also commonly arise in various non-ERISA plan forms of retail investor participation in private strategies. This would include, for example, direct retail investment in closed-end investment companies that, in turn, invest in private strategies. So it would be natural and appropriate for the OIAD also to consider investor protection issues in those other contexts.

Moreover, the OIAD’s report describes its plans for the coming year as being a “continuation” of the work described in its report to Congress a year ago. That report described plans relating to private markets that were considerably broader than those specified in this year’s report. So, although the curtain has already risen, much suspense remains about whether this year’s report sets out the OIAD’s whole script for its performance on private markets.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Attorney Advertising.

© Carlton Fields

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