Markets or Casinos? SEC Pushes Private Equity for Retirement While Hedging Its Bets

Welcome to the June 2020 edition of our newsletter!  In this issue, we’ll examine the tension between the Securities and Exchange Commission’s push to involve private equity in retirement accounts, and its policing of conflicts of interest within the private equity industry.

Efforts to Add Private Retirement Options May Add Risks and Conflicts

The retirement landscape is changing, as mass unemployment and already ballooning deficits have strained Social Security.  In the midst of this environment, the SEC and Labor Department recently recommended that private equity vehicles be allowed as part of ordinary investors’ retirement portfolio.

Setting aside the vastly different risk profile an index fund has from that of a hedge fund — something every investor would have to consider in any event – the SEC must also contend with an investment adviser industry that, by its own admission, is rife with conflicts of interest and questionable practices.  For example, its own research recently found that fees were not evenly divided among investors, leaving some to pay less while others paid more.  In addition, the SEC found that policies at many private equity firms regarding insider trading were poorly defined and loosely enforced.

Although the SEC’s enforcement division continues to be an aggressive watchdog when offenses are found, opening more opaque asset classes up to everyday investors will ultimately put the responsibility of risk management on to that investor.  Even family offices, whose resources typically dwarf those of average Americans, will have difficulty closely analyzing many private equity vehicles, which are designed to have units across many jurisdictions, often with favorable taxation and even more favorable business disclosure regulations.  If considering a private equity investment in this new era, all investors would be advised to seek to peel back the veil of secrecy as much as possible, and learn about the background of the fund manager or their individual point of contact at the firm.  Have they been cited for conflicts of interest or improper trading in the past?  Have other investors taken action against them?

One effect of the SEC’s reforms is to allow a broader swath of the public to access markets that were previously available only to “sophisticated investors” – a somewhat narrowly defined term that excludes many individuals.  Democratizing markets further also broadens the exposure to greater and more complicated risk factors, and investors will need in-depth insights to proceed properly.  Proper due diligence will likely involve not just assessment of the asset risk, but also any risks posed by the asset manager as well.