The Securities and Exchange Commission is proposing rules that would make certain private investment funds, now available only to very sophisticated investors, the equivalent of public mutual funds. This is an exercise in government overreach, contrary to law and common sense. If the SEC adopts this rule, it will spend years in litigation and breed judicial mistrust of this and subsequent regulations.
Historically, the commission has refrained from intervening in markets absent a perceived significant market failure or insufficiency. This is especially the case where, as here, very sophisticated investors (or their advisers) can understand and protect their own interests and the market is made up of many players operating competitively.
The investors whose interests the SEC apparently wishes to protect are participants in so-called 3(c)(7) funds, specifically exempt from the requirements of the Investment Company Act of 1940 and related SEC regulations. The terms of this exemption apply to “qualified buyers,” which are generally individuals with at least $5 million in investments or businesses with at least $25 million in investments.
As the legislative language reflects, Congress has decided that these investors can “manage on their own” and do not need or warrant government protection at taxpayer expense. The protections afforded to such investors by the current anti-fraud provisions are sufficient, as the committee has previously acknowledged. Worse, creating a regulatory regime governing these funds would increase the operating expenses of a fund, and those expenses would ultimately be borne by those who invest in it, the same people the SEC claims to help.
To compound these difficulties, adopting these rules would result in a substantial and ongoing expenditure of public money to ensure compliance and pursue prosecution. Public money should not be used to protect investors who can protect themselves. The nature of the asset management market, which is massive and highly competitive, also contradicts the need for these rules. No vendor in the market has monopoly power and entry barriers are extremely low.
Sophisticated investors who are the targets of the SEC’s proposals have no shortage of options for managing their money. As the commission itself notes, there are some 44,378 private funds managed by registered investment advisers in the United States and thousands of other exempt reporting advisers. All of these asset managers essentially offer one product: asset management services. It is one of the most purely competitive markets in the world, which singularly reflects the fact that market forces must be able to operate naturally.
Congress has expressly decreed that 3(c)(7) funds should not be subject to SEC regulation. The proposed substantive rules are not accompanied by any demonstration of market failure or inefficiency that justifies the extraordinary step of regulating them. But even setting aside the statutory injunction against commission regulation, the proposed rules would actively mandate or prohibit specific agreements and activities. Because the SEC cannot demonstrate market failure or insufficiency, the proposed rules are arbitrary and capricious. Indeed, all the commission offers as justification is an unsubstantiated assertion that the activities it proposes to prohibit could be contrary to the public interest and the protection of investors.
Finally, as a group, the proposed rules would create serious barriers to entry into the private fund management industry. Too often, regulatory requirements make it difficult or impossible for new entrants to gain traction in an industry, to the detriment of those who might otherwise have been customers or customers of the new entrants. There are often no voices at the table to represent the interests of this segment of the industry. For this reason alone, it would be in the public interest for regulators generally, including the SEC, to refrain from adopting rules that impede competition in the absence of a real and unambiguously demonstrable compelling need. No such need is reflected in the commission’s proposed release.
Mr. Pitt is CEO of Kalorama Partners LLC. He was Chairman of the SEC, 2001-03.
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Appeared in the April 29, 2022 print edition.