The SEC's private funds rule and its effect on crypto investing

This week, True Ventures submitted a comment letter in response to the SEC's proposed rule seeking to impose new obligations and restrictions on private investment funds.  Give it a read here.

One part of the rule would prevent venture capital firms from seeking indemnification from the funds they manage for any losses related to a governmental investigation or a lawsuit.

We think this is a bad idea.

Why? For one, these arrangements are negotiated by sophisticated investors with superior information and market power.  They've determined that indemnification incentivizes the behavior they want from their venture capital funds: taking smart risks and helping portfolio companies to succeed.  (Who would serve on a board of directors without it?) These investors are nowhere near the top of the list of those in need of the SEC's protection.

So why is the SEC pursuing this change?  Hard to say, but I wanted to underscore one observation from our letter that's directly relevant to crypto—which wasn’t mentioned in the rulemaking, but could be affected nonetheless.  

We wrote:

For venture capital funds that invest in digital assets, it is difficult to decouple these proposed prohibitions from the SEC’s review of the industry. . . .

[T]he combination of evolving regulatory guidance, increased SEC enforcement, and this proposed ban on adviser indemnification for government investigations, might have the foreseeable consequence of dampening venture capital investment in crypto (as well as in other areas where regulation is uncertain).

This would not be a positive development.

We believe that having experienced venture capital investors involved in the crypto industry and other nascent fields is a constructive force—tending to increase companies’ focus on consumer protection, risk mitigation, legal compliance, and other important public policy goals.

To spell this out a bit more: the rule, if enacted, would cause venture capitalists to think twice about investing in crypto projects—or any project in an area of regulatory uncertainty—because the VC would no longer have the indemnification safety net in case of a government investigation or a private lawsuit (at the same time the SEC has promised greater enforcement in crypto). Some investments might not happen at all.

This would hurt companies working in this area, not just because they'd miss out on U.S. investment dollars, but on the experience of VCs who have seen a lot of the issues they're facing over many years.

And it'll certainly hurt VC investors—the very people the SEC is purporting to protect—because they won't have exposure to a wide swath of potentially successful companies.

We urged the SEC to pull these provisions from the proposed rule. Let's hope they do.

This post was originally published on Mirror at https://mirror.xyz/coldebella.eth