Regulation, Bubbles and Systemic Risk - The Blue Owl Conundrum and Liquidity
Sarbanes Oxley Helped Create the Conditions for Another 1999
Fourteen years ago, as CIO of the Kauffman Foundation, I drove the writing and strategic framing of our 2012 report “We Have Met the Enemy... And He Is Us,” along with my colleagues Diane Mulcahy and Bill Weeks. Based on nearly 100 venture funds and two decades of real LP data, we delivered a blunt self-critique: LPs, including sophisticated institutions like ourselves, were complicit in a broken system. The core problem was not bad GPs — it was misaligned incentives, weak benchmarking, and acceptance of structures that rewarded fundraising and paper marks over real cash returns to investors.
John Cowan’s outstanding June 8, 2026 essay “Liquidity, Stupid” nails the enduring diagnosis: “The venture instrument was built without programmed liquidity. Everything wrong with it is what you get when allocators with no exit path collide with managers paid for activity rather than outcomes.” He correctly traces the persistence of these failures directly back to our Kauffman analysis. I appreciate his clear-eyed update.
IRR: The Original Sin We Exposed in 2012
In the Kauffman portfolio, IRR created dangerous optical illusions. Early paper markups from later-round financings or manager fair-value adjustments produced high interim IRRs exactly when GPs were out raising the next (usually bigger) fund. We showed that the classic J-curve was “empirically elusive.” Many funds exhibited early peaks followed by stagnation or declines — what I now call an N-shaped (or worse) curve: initial dip from fees, mid-hype inflation, markdown reality check, and uncertain harvest.
Of the 88 funds we analyzed in detail, 69 (78%) failed to return enough after fees, carry, and illiquidity to justify the risk. Only about 20 funds beat a small-cap public PME by more than 3% annually. Larger funds (> $400 million) performed especially poorly.
We recommended Public Market Equivalent (PME) benchmarking after extensive consultation with industry experts such as Harvard VC experts Josh Lerner and Felda Hardymon. Such public market benchmarking relies on relevant indexes such as the Russell 2000 because it matches actual cash flows to transparent public market performance and eliminates subjective valuation gaming.
Cowan updates the numbers from our paper and the outcome after 14 years brutally reinforces our warning and shines a bright line on failure in many pension and investment board rooms. In Q1 2026, AI/machine learning accounted for 88.8% of $267 billion in U.S. venture deal value. Exit value hit $347 billion, but stripping out the five largest exits reduced that figure by 86.6%. Recent North American vintages show single-digit median IRRs and sub-1x median distributions to paid in capital (DPI). The 2019 vintage has the weakest five-year DPI since 2006. Fewer than 40% of 2019 and 2020 funds have returned any capital. Private-market secondaries topped $225 billion in 2025 (up >40% YoY), but much of this is GP-led continuation vehicles that extend fee streams while LPs take haircuts. Value on the books is still not value in the bank.
Private Credit and the BDC Liquidity Prison
The same incentive structure has now migrated aggressively into private credit — a market that ballooned as public equity access for smaller companies was throttled. Hybrid Business Development Companies (BDCs) are the most visible example of the manufactured liquidity illusion.
BDC Mechanics (1940 Act Structure):
Must invest at least 70% in qualifying assets (primarily private or small public U.S. middle-market companies).
Required to distribute ~90% of income as a Regulated Investment Company (RIC) for tax pass-through.
Two retail-access versions dominate:
Publicly traded BDCs (e.g., Blue Owl Capital Corporation — OBDC): Shares trade daily on exchanges. Continuous price discovery is often harsh. As of mid-2026, many trade at 20–25%+ discounts to stated NAV, reflecting market skepticism on underlying valuations (especially tech/software exposure).
Non-traded / perpetual-life (semi-liquid) BDCs (e.g., Blue Owl’s OBDC II / OCIC ~$36B flagship, OTIC tech-focused ~$6B): Continuously offered at NAV through broker-dealers to retail and IRA investors. They promise quarterly redemption windows capped at 5% of NAV (fully discretionary — boards can suspend or pro-rate). No daily market price; redemptions happen at the manager’s latest fair-value NAV.
Q1 2026 Stress in Action:
Blue Owl saw redemption requests of 21.9% for OCIC and 40.7% for OTIC — among the highest quarterly levels ever recorded. The firm capped redemptions at 5%, pro-rated payouts, sold ~$1.4 billion in assets in one case, halted regular redemptions in some vehicles, and shifted to opportunistic return-of-capital distributions.
In the context of publicly traded BDCs (e.g., Blue Owl’s OBDC) and their related non-traded/semi-liquid BDCs, the same Level 3 assets are often held across vehicles with high portfolio overlap (~98% in some Blue Owl cases). A markdown in one vehicle (signaled by the public BDC trading at a steep discount to NAV) creates contagion pressure on the others, even though the non-traded versions redeem at the manager’s latest internal Level 3 NAV. This subjectivity fuels the very IRR/markup and valuation gaming issues highlighted in the 2012 Kauffman paper - and regulators allowed high net worth retail the ability to jump in this very dirty pond, assuming qualified investors smart enough to understand the accounting rules and the daisy-chain problem with changing internal mark to market prices on assets.
Optimistic Level 3 fair-value marks boost interim internal rates of return (IRRs) and support fundraising/fees until redemption pressure or reality forces adjustments. Level 3 fair value (under ASC 820 / IFRS 13) refers to assets valued using unobservable inputs — essentially management’s own assumptions, models, and estimates — because there are no active market quotes or observable data available. These are the most subjective valuations in the fair value hierarchy (lowest reliability), typically relying on discounted cash flows, adjusted multiples, or internal projections for illiquid private loans, equity stakes, or other non-traded assets.
Berkshire Hathaway: The Right Way to Do Permanent Capital
Warren Buffett solved this decades ago. Berkshire has true permanent capital — no redemption facility whatsoever. The stock can trade at a discount to intrinsic value for extended periods; patient buyers step in, and the business operates on its own timeline without forced sales. Discounts become opportunities, not crises.
Non-traded BDCs invert this: they offer redemption at stale NAV until they cannot, then force asset sales or gates that hurt remaining holders. The structure primarily gathers retail AUM for fee income while regulators pretend the 1940 Act wrapper suffices.
The Sarbanes-Oxley / PCAOB Root Cause: High Costs of Going Public Force New Companies into Massive Funds Run by Big Investors
This private credit/BDC boom is not happening in a vacuum. It is the predictable downstream consequence of regulatory barriers that have strangled public equity access for smaller growth companies.SOX 404(b) external auditor attestation requirements, escalating PCAOB inspection and compliance costs, and dramatic auditor consolidation (registered firms roughly halved since ~2010) have raised the IPO bar dramatically.
Exchanges demand full PCAOB-compliant audits with little tiering. The result: median IPO size and revenue thresholds have soared, while nimble “fast boats” — innovative small and growth companies that once accessed public markets early — are largely excluded. In effect, regulation by government agencies and exchanges eliminate competition for big Wall Street firms and prevent small companies from accessing public markets for more flexible financing needed to build and scale operations.
The U.S. public company count has fallen roughly 40–50% since the late 1990s peak (from ~8,000+ to ~3,500–4,000 today). Capital that once funded public small- and mid-cap growth now floods into private credit vehicles, including these high-fee BDC hybrids. Investors (including retail) get locked into bulky, opaque “cruise ships” with valuation games, cross-holding contagion, and gated liquidity — while the small boats that could drive broader innovation and economic growth can’t find the fuel to put in their very fast motors.
The irony is grotesque: Sarbanes-Oxley was sold as investor protection after Enron. Today it contributes to new forms of opacity and liquidity traps in private markets that the same regulators bless with expanded retail access.
The Persistent Enemy
We concluded in 2012 that LPs and the system itself were often our own worst enemy through complicity in misaligned incentives and weak benchmarking. Cowan is right — that truth now extends to retail investors, policymakers, and the broader economy. When public markets are throttled, private structures inflate and create exactly these mismatches. Practical next steps remain consistent with our original recommendations, Cowan’s liquidity focus, and targeted regulatory relief:
Rigorous PME-style cash-flow transparency and independent (not manager-friendly) valuation audits with full cross-holding disclosure.
Honest liquidity matching: true permanent capital structures (Berkshire-style) or genuinely daily-priced vehicles — not hybrids that conceal illiquidity until stress hits.
Tiered SOX/PCAOB relief, small-auditor registration incentives, and a dedicated venture/small-cap exchange to revive nimble public listings.
The private credit experiment, enabled by public market failure, is re-testing these lessons in real time. Hope over experience continues. We should not be surprised by the next reckoning.
Footnotes / Sources
Kauffman Foundation (2012): https://www.kauffman.org/wp-content/uploads/2019/12/venturecapital.pdf
John Cowan, “Liquidity, Stupid” (June 8, 2026): https://www.johncowan.io/liquidity-stupid/
Blue Owl redemption data: Reuters, PitchBook, Bloomberg (April 2026 reports)
Public company count & SOX impact: Various analyses including Columbia Business School, Tuck Dartmouth, World Bank/CRSP data
Private credit/BDC market stats: PitchBook-NVCA, Cliffwater, company filings