Caroline Crenshaw, a designated Democratic commissioner with the Securities and Exchange Commission (SEC) recently was sharply critical of private markets.
“Investor protection and systemic risk are interconnected,” Crenshaw said at an Oct. 11 event put on by the progressive Center for American Progress (CAP) think tank. “Markets in which securities protections are not present mean investors have less information, less confidence in the integrity of the information they do have, and fewer assurances that market participants will not abuse the trust they place in them.”
She also blamed the 2008 global financial crisis on a lack of regulation.
“In the years leading up to that crisis, financial institutions had successfully convinced regulators that the laws and the regulations enacted in the wake of the Great Depression could be loosened,” Crenshaw said in her closing remarks. “They were able to point to decades without a crisis to argue that strict regulations were unnecessary and the business of banking had become safer.”
The event, called “Accessing Public Capital Without Public Disclosure,” was dedicated to addressing a host of transparency concerns among progressives regarding private capital markets.
Given that the focus of the event was on private lending and private investment, the title gave the game away. This is not “public capital” in any sense, but many progressives would intend for it to be.
Although subject to federal statutes against securities fraud, companies with investors who trade in private markets are largely insulated from disclosure mandates from laws such as the Sarbanes-Oxley (SOX) and Dodd-Frank Acts, and this is making a huge difference in where the money is going.
Private markets outpace public markets when generating capital growth, overseeing an estimated $22.6 trillion in assets. Much of this market growth is attributed to a steady flow of capital from high net worth investors.
Public markets also suffer record low entries for initial public offerings (IPOs). As a result, many private companies are opting to remain private as the rate of public entry recently hit a 30-year low in 2022.
The CAP event failed to highlight how the annual rate of publicly listed companies suffered a 58 percent drop since 2021, while the capital generated from these firms plummeted by 72 percent. Many high-growth companies rely on public capital to introduce innovative products in the market. Slow IPO growth will only stifle new innovations, while depriving much needed funding for tech-startups and emerging technologies such as AI, cloud computing, and predictive analytics.
According to research from Marshall Lux and Jack Pead with Harvard Kennedy School, since 2000, “the number of IPOs has averaged 135 annually, less than a third of the average in the 1990s. That decline has long been viewed as a problem that threatens American technological innovation, job creation and competitiveness.”
One of the reasons for public market decline is regulatory in nature – the costly auditing requirements associated with SOX. In the 20 years since its passing, SOX has made it particularly expensive for small and mid-sized firms to enter the market, as noted in a Wall Street Journal op-ed by CEI Director of Finance Policy John Berlau and former CEI research associate Josh Rutzick to mark the law’s 20th anniversary last year. This stems from the stringent auditing standards that firms must now satisfy in order to go public with an IPO and remain a public company.
A report issued by then-President Obama’s Council on Jobs and Competitiveness found that in the 1990s, 80 percent of IPOs were smaller than $50 million, compared to 2010 where the inverse was true; 80 percent of IPOs exceeded $50 million by the time of entry.
Neither of the speakers at CAP referenced the regulatory burdens of SOX as a contributing factor for continual growth in the private markets and steady decline in the public markets. With this omission, audience members were left with an unclear picture of what exactly is happening.
Public market decline impacts everyday investors as well. Investment choices are constrained by a reduction in publicly listed alternatives. This hurts families searching for vital investment options when saving for future retirement, childhood education, and life insurance.
Lack of regulation in the private markets is not the real issue. Decline in public capital is. One of the SEC’s primary objectives is to ensure steady capital formation in the public markets. Crenshaw’s remarks skirted around this dire picture six months after members of the House Financial Services Committee issued a letter urging SEC Chair Gary Gensler to take this matter more seriously.
Thankfully, there are some small, yet visible signs of recovery. Note that 37 IPOs raised $8.5 billion in Q3 2023. However, the initial market performance of these public offerings appears underwhelming, which should caution us against planning on a rebound in 2024.
Rather than encouraging growth or providing incentives for new public entry, Crenshaw focused her concern squarely on regulating private actors. She proposed new disclosure and reporting requirements for unregulated private banks. Punishing the private markets with the very cause of decline in the public sphere is not a promising proposal.
Rather than highlight the competitive advantages that private markets enjoy when accumulating capital relative to the public markets, Crenshaw was incensed with how little investors know about the “opaque” nature of privately held companies. The speech appeared to endorse the SEC’s aggressive intervention in the private markets in recent years, the most notable breach being the Commission’s private fund rules.
The rule imposes a set of anti-competitive restraints that undermine the professional courtesy of private fund advisers, as the SEC now monitors every aspect of adviser-client engagement. By barring advisers from issuing certain fund information to investors over concerns that it may disadvantage others, the SEC upended a once autonomous practice. As a result of the rule, the SEC exerts much greater control over the management of private funds in a manner that is unorthodox and ahistorical, given the agency’s traditional mission focus on public market activity. The rule will also impose hefty regulatory burdens to the tune of 3.7 million compliance hours and $5.4 billion in additional compliance expenses each year, according to SEC estimates.
If the massive financial regulation achieved under the New Deal and subsequent periods was insufficient to prevent the 2007-2008 financial crisis, what reassurance do modern investors have that further regulation of the markets will prevent future crises? Crenshaw’s preemptive approach — an offer to regulate industries before a crisis transpires – does not engender confidence.
If the SEC is really worried about ordinary investors losing out on public capital, it should put a stop to its costly regulations on climate disclosure and other public company mandates that are sending entrepreneurs into a beeline exiting the US public markets.