SEC's proposal on private placements isn't backed by data

One of the more curious initiatives of the Securities and Exchange Commission has been its push to expand access to offerings of private, unregistered securities. It seems to be a pet project of SEC Chairman Jay Clayton, who professes to have the interests of mom-and-pop investors at heart, but is willing to put their hard-earned money on the line in risky ventures that provide far less disclosure and far fewer safeguards than found in the public markets.

And for what? One of the arguments is that initial public offerings are costly and cumbersome, and companies would rather raise money in the private markets. Expanding the universe of potential investors would give such companies greater access to capital. But is there really a dearth of capital out there? Interest rates are at historically low levels, and there doesn't seem to be a shortage of venture capital, angel investors or any number of other sources from which to raise money — at least for honest, legitimate companies. Indeed, in 2018, companies raised $2.9 trillion in private offerings, far more than the $1.4 trillion from public offerings.

On the other side of the equation are the investors Mr. Clayton says he wants to help. The way the law and regulations are written now, one generally must have a net worth of $1 million or more, excluding home value, or an income of $200,000 ($300,000 for couples) to qualify to invest in a private placement. The underlying reason for such requirements in the past was the recognition that private placements carry more risk than more regulated investments and anyone investing in them should be able to withstand the loss of their investment without going bankrupt.

Some critics would prefer to scrap the guidelines altogether and open private placements up to all investors. Others would impose some type of litmus test to determine whether an investor has the knowledge and sophistication to make an informed decision on a private placement. Either way, calls for reform presume there is a hue and cry among investors for access to private placements. Yet there is scant evidence to support that presumption. In response to the SEC's concept release, which asks for comment on whether private placement rules should be relaxed, SEC commissioner Robert Jackson has raised important questions about fraud.

Although the majority of private offerings operate legally, others do not. Recently, the SEC closed down Castleberry Financial Services Group after it raised $3.8 million through fraud and chicanery. Earlier, and on a grander scale, the SEC shut down Woodbridge Securities, but only after it fraudulently raised $1.2 billion over a five-year period. Mr. Jackson points to an acknowledgment in the concept release that the SEC lacks data on investor harm caused by private placements. It is hard to believe that an agency tasked with protecting investors doesn't have such data, but before it moves further on any kind of proposal, it should gather it. "Without that evidence," Mr. Jackson wrote in a statement, "it's hard to see how the commission can strike the basic balance any rules in this area would require."

Apart from fraudulent private placements, the SEC should conduct a comprehensive study to see how well legitimate private placements have performed overall. Are investors who currently qualify for private placements actually making money? If so, how much? Enough to justify the added risk that such securities often entail? If Mr. Clayton believes some investors are missing out, let's see the proof. It is clear that more work needs to be done before the chairman's efforts on behalf of private placements can move forward.

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