Can Private Funds Go Public? Rethinking the Future of Funds

Abstract

Most households’ investments are now managed by funds. Yet the law that governs investment funds was not built for today’s world. For nearly a century, the regulation of funds has rested on a simple division. Regulated funds, like mutual funds, are sold to the public and are heavily regulated under the Investment Company Act of 1940. Private funds, in contrast, limit their investors to institutions and the ultra-rich and are entirely exempt from these rules. Each half has functioned on its own terms. No more. The largest asset managers today are looking to repackage every private market strategy, from venture capital to private equity to private credit, in a fund sold to the general public and thus governed by the Company Act. The result is a collision between private equity and fund regulation that lets us see how the statute actually operates in practice. Using new data and analysis of these funds, I show that much of fund regulation matters far less than we thought. However, one provision, Section 17, does impose a binding constraint on the emerging industry. Section 17 embodies a pre-modern approach to regulating conflicts of interest: a flat-out ban. Yet regulated funds investing in private markets routinely seek to engage in conflicted transactions. Over the last five years, the SEC has sometimes granted expansive exemptive relief, but without any ultimate philosophy guiding what conflicts should be allowed. Meanwhile, the private equity industry’s proposed alternative to Section 17 – approval by nominally independent directors – is a mirage, given the limited information and authority of fund directors. I argue for a third path. Rather than extending Section 17’s prohibition or abandoning it, fund regulation should import the economic mechanisms already used by sophisticated actors to curb opportunism in private funds. More generally, my account helps clarify the fundamentals of fund regulation and retail investors’ access to private markets.