News

Professor of Law Gina-Gail S. Fletcher argued Wednesday for more disclosure by private companies seeking capital from retail investors, telling the House Financial Services Committee that given the lack of transparency and consumer protections in the private markets, expanding access would come with heightened risk to those investors – and the economy itself.

Fletcher was one of five witnesses, and the only law professor, to testify at the February 8 hearing titled “Sophistication or Discrimination? How the Accredited Investor Definition Unfairly Limits Investment Access for the Non-Wealthy and the Need for Reform.”

The hearing was convened to consider arguments for lowering the qualifications for who gets to invest in companies seeking capital on the private market. Currently, those opportunities are limited to “accredited investors,” a definition that includes such financial criteria as having individual or joint net worth of at least $1 million, or individual annual income of over $200,000 per year. Half a dozen proposals in the House of Representatives seek to expand that definition.

But Fletcher said to do so without also requiring adequate financial disclosures would increase investor risk, not investor choice. Unlike in the public markets, private offerings are not regulated by federal securities laws, and issuers are not required to provide information like audited financial statements.

“I do question the premise of this hearing,” said Fletcher, an expert on complex financial instruments and market regulation. “The expansion of the private markets puts investors and our economy at risk. No amount of wealth or sophistication is a substitute for robust securities laws that ensure that all investors, not just the wealthy or connected, get the information they need to make informed investment decisions.”

Fletcher also called claims that it is discriminatory to limit who can invest in private companies “perverse logic at best.”

“The public markets are where all investors are generally treated fairly and equally, regardless of wealth, sophistication, or connections. The private markets are the very opposite of that,” Fletcher said.

“Expanding the definition of accredited investor is not going to result in more investors becoming millionaires. Rather, it would expand the opportunities for wealth extraction and amplify wealth inequality.”

Witnesses at the hearing included heads of several minority-owned angel investor groups who said restricting the investor pool starves startups of capital they need to grow. And some legislators say the qualifications exclude people of lower means from opportunities to build wealth.

But Fletcher argued that the lack of disclosure deprives would-be investors of basic financial governance and operational information they need to make an informed decision on often-risky private offerings, which also carry significantly weaker fraud protections than publicly-traded securities.

Private markets are an insiders’ game, she testified, where even well-educated investors would be betting their money on “unproven, opaque investments.”

“Allowing retail investors [to invest in] private offerings will simply expose them to a market that is inherently uneven in the distribution of information and increase the likelihood that they are victims of fraud. These characteristics are a feature, not a bug, of the private markets and will certainly result in retail investors being exploited by low-value private offerings and losing their hard-earned investments.”

Even the most sophisticated investors in the capital markets were duped by the founder of FTX, the now-bankrupt cryptocurrency exchange once valued at $32 billion, Fletcher noted.

In her written and oral testimony, Fletcher, a board member of the Healthy Markets Association and a member of the SEC’s Investor Advisory Committee, detailed other disadvantages retail investors face in the private markets, including lack of liquidity. Unlike publicly-traded securities, private investments cannot be instantly liquidated if an investor needs their money in an emergency. And because audited financial statements are not required, many private companies have unsupported valuations that make them more difficult to sell.

After a legislator accused Fletcher of wanting to “ban private markets,” she replied that that was “furthest from the truth."

“What I want is information in the private markets,” Fletcher said. “The private markets currently lack all information. We are dependent on private funds, on private companies, to provide information when they deem it, when they feel like it, and to whomever they feel like it.”

 Read Fletcher’s written testimony here.

Watch video of the hearing here (proceedings begin at 0:10:11, Fletcher’s testimony begins at 0:44:35.)