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The SEC has proposed a wider door to private markets. Before you buy in, count the boxes the shares are packed in

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On September 30 the SEC proposed ways to bring private-market strategies to everyday investors through regulated funds. The same day, in a separate action, it sued an adviser it says sold nearly 100 investors interests in funds meant to hold SpaceX and other pre-IPO shares and, in one case, told investors a deal had closed after the transfer was refused. The documents in the two actions do not mention each other. Read together, they show what to ask before buying any piece of a private company: what you own, whether the transfer happened, how you get out, and how the manager is paid.

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In February and March 2021, according to a complaint the Securities and Exchange Commission filed on Wednesday, thirteen people put about $1.1 million into a fund called Starship VI. The fund's purpose was to give them a piece of SpaceX, a company that was not then publicly traded. Starship VI was not going to buy SpaceX shares. It was going to buy another company's interest in a second fund, which in turn held SpaceX shares, and that second fund's rules said its own representative had to approve any transfer.

According to the complaint, the approval never came. On April 2, 2021, a representative of the second fund wrote that it was "unable to arrange a transfer here." On June 29, investors got an email with the subject line "Starship VI - Closed!" Account statements covering January 1 to February 16, 2023, showed them unrealized gains, with a line saying the statement reflected "the latest tender offer round for SpaceX at $770/share (pre-split 10-1)." The SEC alleges that most of the money the seller later returned was misappropriated.

Those are allegations against Meyer Global Management and its chief executive, not findings, and the case has only just been filed. But the shape of what the complaint describes is worth knowing now. On the same day, in a separate action, the same agency voted to propose ways to bring more ordinary investors into private markets.

Two documents about one market

The SEC's proposals, released Wednesday, would let advisers to regulated funds be paid a share of gains, as private-fund managers commonly are, and would revise the rules for interval funds, which let investors cash out only at set times. Separately, the agency asked whether more people should be able to qualify as accredited investors, the category allowed into many private offerings, by passing a new exam or by holding certain additional professional credentials, such as a CPA license: routes that do not turn on income or net worth.

The agency describes the aim as "expanding retail investor choice" while preserving appropriate investor protections. The proposals open for comment once they are published, and nothing about them is settled.

The documents in the two actions do not mention each other. Read side by side, though, they describe the same market from opposite ends: one is about widening the door, the other about what an investor found on the other side of one.

What "access" usually means

FINRA, the self-regulatory body that oversees brokerage firms, published a plain-language warning about pre-IPO investing in August. Its first point is the one the Starship VI investors ran into. Many offers to buy into a well-known private company are not purchases of its stock at all. You buy into a fund that is trying to acquire shares, or interests in shares, and that fund may itself own them through another layer.

FINRA also explains why a layer can turn into nothing. Many private companies must approve any transfer of their shares, and without that approval the transaction "might be void." On paper, an investor can hold a statement showing gains on a stake that never arrived.

The SEC's own proposals are candid about their trade-offs, too. On performance fees, the proposing release says investors in funds that pay them on gains that exist only on paper "may be at risk of paying performance fees that do not correspond to future realized gains." On interval funds, which could wait up to two years before their first repurchase offer under the proposal, it says investors who unexpectedly need their money before then could bear costs.

None of that is an argument against the proposals. It is the agency telling readers, in its own documents, where to look.

Five questions to ask about any piece of a private company

  1. What exactly will I own? A company's shares, or an interest in a fund that holds an interest in a fund? Count the layers.
  2. Has the transfer actually happened? If the company had to approve it, ask for evidence that it did.
  3. How do I get my money out, and when? Private shares often cannot be sold freely. An interval fund buys back shares only on its schedule, and only up to a limit.
  4. How is the manager paid, and on what? A fee on gains that exist only on paper is different from a fee on money actually made.
  5. Who is this person? FINRA says to check the registrations of both the professional and the firm directly, in its BrokerCheck and the SEC's Investment Adviser Public Disclosure database. It also lists unsolicited offers and "exclusive" access among the signs of a scam.

The door to private markets may well get wider. It does not change what is on the other side of it: a company that may or may not go public, a price that is hard to check, and as many boxes between you and the share as somebody decided to build.

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