Jay Clayton's effort to allow broker-dealers to sell more private and alternative investments to retirees is clearly misguided and the wrong move in the rollercoaster market of 2020.
Managers of alternative investments love to preach to advisers that adding illiquid real estate or oil and gas partnerships to a client's portfolio adds growth and stability over the long term. That may be true in some cases, but the investment product market certainly continues to give birth to plenty of examples that show the opposite.
The chairman of the Securities and Exchange Commission, Clayton wants retirement investors to have greater access to private funds.
As my colleague Mark Schoeff Jr. has reported, under Clayton’s leadership, the SEC has expanded the pool of sophisticated investors who are eligible to buy unregistered securities and has advanced a proposal to simplify the process for start-up firms to raise capital with unregistered securities.
The argument behind the changes is that the private marketplace is outpacing the public market in terms of size and potential for growth. Retirees are missing out on investment opportunities currently found in the private market.
That may be, but not the SEC is not giving enough serious consideration to how brokers sell alternative investments and the potential for harm.
Indeed, Chairman Clayton doesn't have to look further than a current edition of InvestmentNews to know he's pitching a bad idea. The SEC should put the brakes on these changes.
It's obvious that many brokers and financial advisers are not clearly communicating the risks of such products to the client. The result is broker-dealers blowing up, clients being harmed and the reputation of the alternative asset industry suffering.
For example, a small but worrying number of broker-dealers that sold GPB Capital Holdings private placements are going out of business. That's a bad sign for an industry that wants to broaden the marketplace sell more high-risk alternative investments to retirees.
Remember, GPB raised $1.8 billion from investors starting in 2013 through sales of private partnerships, but it has not paid investors steady returns, called distributions, since 2018.
Last year, the company, which has invested primarily in auto dealerships and trash hauling businesses, delivered a blow to investors when it reported significant declines in the values of its funds. And GPB has a host of other problems, including being investigated by a number of regulators.
We want to create a market that is fully transparent so investors know what they are investing in, what it costs and then reasonably understand probable outcomes.
Tony Chereso, president and CEO, Institute for Portfolio Alternatives
According to a tally by InvestmentNews based on a filing with the SEC, 10.9% of the firms – 7 of 64 – that sold one of GPB's biggest deals, called Holdings II, has closed over the past few years.
Over the summer, InvestmentNews reported that one of those firms, Capital Financial Services Inc., was in the process of closing and leaving close to a dozen clients with lawsuits against the firm almost zero chance of getting money back from failed or unsuitable investments.
It wasn't clear if those investments were GPB private placements, but Capital Financial Services was a small broker-dealer with a history of selling problematic alternative investments. Chairman Clayton should think about Capital Financial investors as he loosens restrictions for sales of high-risk private funds and alternative investments.
An SEC spokesperson declined to comment.
In an average year, 5% to 6% of broker-dealers close, according to statistics by the Financial Industry Regulatory Authority Inc. It's a shrinking industry, and many of the broker-dealers that sold GPB have little cash in the bank and thin insurance to pay for damages if investors bring claims and then win them.
And it's not only GPB. Chairman Clayton has to look to farther than the recent performance of New York City REIT Inc. to give himself pause when it comes to his push to sell such alternatives. Formerly a nontraded real estate investment trust, the REIT listed in August. Investors who bought the REIT in its offering in 2014 saw shares decline in value in the neighborhood of 80%.
Alternatives like GPB private placements and New York City REIT were expensive for clients but lucrative for the brokers who sell them, although the nontraded REIT industry has recently adapted to offering a variety of share classes that are a better deal for clients.
When it comes to nontraded REITs and other alternative investments, "the fees, transparency and pricing have all improved for a variety of reasons," said Tony Chereso, president and CEO of the Institute for Portfolio Alternatives. "We want to create a market that is fully transparent so investors know what they are investing in, what it costs and then reasonably understand probable outcomes."
Good intentions often fall short. I've been covering private placements and alternative investments for 20 years and have reported on numerous failures and blowups. The SEC and Chairman Clayton, as they push to broaden that market, should not ignore the harm that such investments can do to investors and the advisers who sell them.
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