My Crypto Lawyer Sec Speeches Cryptocurrency Remarks at the Stanford University Private Capital Roundtable

Thank you, Scott [James], for that kind introduction.

Before I begin, I must – as always – inform you that my remarks today are provided in my official capacity as the Securities and Exchange Commission’s Director of the Division of Investment Management, but do not necessarily reflect the views of the Commission, the Commissioners, or other members of the staff.

It’s a great privilege to be back at Stanford. On my way over here, I walked through the Huang Engineering Center and stood inside the replica of the garage in which William Hewlett and David Packard founded an electronics company. The lore is that they started with a drill press and $500 of working capital, and they ended up helping change the world.

Now, I never met Bill or Dave — or Jerry or David, or Sergey or Larry — but like so many Americans I feel connected to all of them through the companies they started on this campus, companies financed by venture and growth capital providers.

Sadly, I – like so many Americans – was never able to invest in any of those startups before they went public. Nor could I invest in hedge fund strategies, private equity and buyout funds, or other “alternative” assets and exposures. Those options were as a practical matter the exclusive purview of “institutional” investors.

As you may have read in the papers, the Administration, and more specifically the Commission, is trying to change that. And, with your indulgence, I’d like to briefly outline that plan and how it seeks to provide more retail access to alternatives without sacrificing the protections that retail investors have relied upon for over eight decades.

Under our securities laws, institutional investors and high net worth individuals can:

• obtain exposure to a myriad of alpha and beta opportunities,
• negotiate compensation arrangements designed to align the incentives of an investment adviser with a desired portfolio outcome, and
• invest in, and profit from, the innovative, cutting edge companies that drive the nation’s economy.

It might not be overstating the matter to describe the desire to provide retail investors, in a thoughtful and intentional manner, access to these same markets as an historical imperative.President Trump, by Executive Order, has instructed that retirement account participants have more private market options in their 401(k) accounts.[1] Chairman Atkins (also known as “my boss”) has directed us in the SEC’s Division of Investment Management to propose “responsible retailization” measures that would allow retail investors more freedom to direct their “post-tax, pre-retirement” dollars to alternative assets and strategies.[2]

So-called “alternative” investments — like all investments — are not without risk and uncertainty.Some of these risks are familiar to retail investors, like the possibility of poor performance. Others are less familiar or even novel, like suspension gates and binary payouts. This is why the Chairman has insisted, from day one, that any retail access proposal have fiduciary protections and other “guardrails” to address these kinds of risks. This is the basis of our “Responsible Retailization” initiative.

The Responsible Retailization initiative relies on three essential components (which we refer to as a “three-legged stool”):

1. Access
2. Transparency; and
3. Incentives.

Access means utilizing, and modernizing, the existing regulated fund regime to provide retail access to alternatives in structures that still provide for fiduciary oversight.

Millions of Americans invest in regulated funds, and this has allowed many ordinary investors to build wealth and provide for their families.While our retail regulatory regime can be paternalistic and limiting, its durability and penetration is undeniable.In other words, by and large, it works pretty well.

But, like any 86-year old, the structure could use some updating.Over the past year and a half, my colleagues in the Division have provided guidance and no-action letters and issued orders pursuant to delegated authority addressing tools and techniques traditionally exclusive to private funds.We have, for example, addressed the ability of:

• Fund sponsors to “seed” newly-formed registered funds;[3]
• Regulated funds to co-invest alongside other advised funds and accounts;[4]
• Registered funds and business development companies to issue multiple share classes with different distribution economics and operational structures;[5]
• Fund sponsors to schedule and to size registered fund redemptions.[6]

And I would like to be clear on one important point: All of these actions were done with a focus on investor protection. While these efforts may have been inspired by common practices in the private fund space, they occur under regulated fund safeguards, including independent board approval and oversight (in addition to the requirement that the investment adviser running the fund adhere to a strict fiduciary duty).

These various staff efforts over the past year-and-a-half have, we believe, laid much of the groundwork for regulated funds as they consider their ability to offer alternative asset exposures. But work continues: the Commission proposed additional modernization measures for interval funds two weeks ago,[7] and we have more things up our sleeve in the exemptive world.

Transparency is the second leg of our stool. We believe that true retailization requires that retail investors and the broader market both see the underlying exposures in these funds and that the market be able to assess their values.

To be clear, solid fair value processes by fund managers are and will continue to be an expectation and an examination focus, as those fair values drive internal fund management and performance fee calculations. But, by facilitating retail funds listing on exchanges (we – most unoriginally – call this “ticker-izaton”) we are actively encouraging sponsors of regulated alts funds to provide position-level transparency. We are also hopeful that analysts and other traders will be enabled and incentivized to form independent views on a fund’s value. If this happens, it could result in a price discovery feedback loop that could instill confidence in the retail investor, inject liquidity into these new retail funds, and create a “virtuous cycle” of independent pricing data flowing back into the private market. Again, there are no guarantees on how any investment will perform, but letting the market have a say on what an investment is worth seems like a good idea.

Every system requires incentives. It is very, very hard for fund sponsors to make money in the retail space; fees are comparatively low, distribution can be expensive, margins can be razor-thin, and competition is fierce. It is no surprise that very, very few successful alternatives managers have dared to swim in the retail waters.

The Commission has proposed a solution to this situation: make it worth your while. Expanding the ability for advisers to charge performance fees could incentivize advisers currently operating in the private markets to bring diverse strategies to a wider group of clients and investors, including investors in regulated funds, subject to numerous protective conditions.[8] To be clear, we do not expect that these will have exactly the same terms as the private funds currently offered, but today we don’t even have apples and oranges.We have nothing and oranges. The Commission’s proposals, if adopted, could incent some alts managers to consider offering retail tangerines alongside institutional oranges.

I simply could not come to Stanford and not mention Super Intelligence.[9] SI offers a unique opportunity for regular folks to gain access to vast expertise, including investment expertise. I say over and over again – because it is true – that I work for the most pro-innovation SEC ever, and we want to encourage investment advisers and fund sponsors to utilize this technology responsibly for the benefit of the American investor.

My colleagues and I have been having many productive discussions with investment advisers and their counsels about operationalizing SI. However, there is still far more trepidation about SI deployment than I think is warranted, so – continuing with the theme of risk and reward – I hope that I can ask this audience to help financial sector participants see that SI adoption, done thoughtfully, is worth the discomfort of leaving the status quo.

SI is a tremendous innovation, but it doesn’t render everything we have done in the past obsolete. Our principles-based, fiduciary duty regime adapted to the invention of television, email, the internet, and smartphones; it will adapt to SI.

Fiduciaries have duties of care and loyalty, and progress can be consistent with both of them. I will be the first to admit that innovation – by definition – involves some risk, but so does investing. My recommendation to advisers and sponsors is to enthusiastically innovate in a responsible and thoughtful manner. And don’t wait for regulators to hold your hands through this shift, because you may receive guidance that is both too limited and too late.

However, if there are specific laws, regulations, or SEC staff positions that are actually preventing investment advisers from deploying SI tools, we want to hear about them. Call us or visit us and we can assess these roadblocks. We are easy to find: take the train to DC’s Union Station, walk towards the McDonalds, make a left, and we are at the end of the hallway.

*  * *

Risk and reward are interlinked. Everyone – not just the people in this room – should be able to make informed decisions on how much risk to accept. But the regulators must try to ensure those decisions are made within a system of intelligent safeguards.

Great things can happen when people take calculated risks — just ask Hewlett and Packard.

With that, I would like to once again thank all of you for having me, and open the floor for discussion.