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SEC develops fund-like plan to give retail investors access to pre-IPO shares

Charles Gasparino

The Securities and Exchange Commission is looking to clear a path for small investors to access the burgeoning market for private company stocks. The effort could involve new rulemaking that would allow for the creation of a hedge fund-like instrument that invests in pre-IPO shares structured for the average retail investor, the Fox Business Network has learned.

The SEC initiative is still in the discussion stages and timing of the implementation is unclear. But the talks follow recent remarks made by SEC Chairman Jay Clayton, who said small investors should have access to buying pre-IPO shares – a market that is open only to large institutional investors and accredited individual investors who either have a net worth of $1 million or make $200,000 annually.

The market for buying and selling pre-IPO shares is indeed booming, which is why Clayton and SEC commissioners have taken up the matter. They are trying to determine if a vehicle could be created to open such securities to small investors. Last year, companies in the private market raised roughly $3 trillion while public companies raised $1.8 trillion.

Market participants point out the gains are often greater in the trading of pre-IPOs shares than some recent prominent initial public offerings, such as ride-share provider Uber, which has floundered in its public debut after racking up huge gains when Uber private shares traded in the pre-IPO market.

"The SEC is seriously considering approving a new investment vehicle for private shares," John Coffee, a Columbia law school professor who specializes in financial issues, said.

“The mechanics are unclear but the SEC can either ask Congress for legislation or adopt a rule that exempts its new vehicle from the Investment Company Act of 1940,” Coffee added.

An SEC spokesman declined comment.

The SEC’s talks center on passing a rule that would create a new investment vehicle that mirrors a hedge fund. But unlike hedge funds, it would be open to non-accredited investors, according to people with knowledge of the discussions. Small investors would gain access to the private market by going through this fund-like vehicle, which would be comprised of a diversified portfolio of pre-IPO companies in order to reduce investment risk.

But not all market participants believe the effort is a good idea. The SEC would demand additional disclosures from the companies themselves, thus making the companies less likely to issue private shares, much less public shares. The reason many companies are opting to remain in the private market for years is the less stringent disclosure requirement mandated by the SEC because investors are considered more sophisticated than so-called mom-and-pop retail purchasers of stock.

“Part of why private companies can enjoy accelerated growth is that they are free from the regulatory burden public companies face. In addition, they are more efficient because their management teams are not beholden to quarterly earnings and compensated based on a public share price,” said Omeed Malik, the founder and CEO of Farvahar Partners, a broker-dealer specializing in the private stock market.

“Allowing Main Street to invest in privately traded companies sounds nice but the road to hell is paved with good intentions,” Malik said in an interview on FBN’s Cavuto Coast to Coast. “Allowing retailer investors to participate in private placement is a noble sentiment … but there are significant ramifications,” he said in a subsequent interview.

Because the private markets have fewer regulations than public markets, some analysts fear retail investors could be putting themselves at greater risk without fully understanding the volatility of pre-IPO companies. While there may be opportunities in private markets, investors are not insulated from losses just because they get in on a company’s stock earlier. 

Clayton has made serving the needs of small investors a centerpiece of his agenda as SEC chairman, and people close to the commission say he’s intent on opening the private market to small investors as part of that effort.

In a Sept. 9 speech at the Economic Club of New York meeting, Clayton said, “Twenty-five years ago, the public markets dominated the private markets in virtually every measure.  Today, in many measures, the private markets outpace the public markets, including in aggregate size.”

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