A US Securities and Exchange Commission (SEC) staff report has issued recommendations which could tighten up the qualifying criteria for accredited investors and their ability to invest in private fund vehicles such as hedge funds or structured products.
At present, any individual with an annual income in excess of $200,000 or a total net worth of over $1 million can qualify as an accredited investor making them eligible to allocate capital into private fund vehicles. However, Section 413(b)(2)(A) of the Dodd-Frank Act obliges the SEC to re-evaluate the definition of accredited investor every four years. In 2010, the SEC elected to exclude the value of an investor’s primary residence from the net worth calculation.
Recommendations in the staff report include leaving the existing income and net-worth thresholds in place although subjecting individuals to investment restrictions, or creating a new, inflation adjusted income and net worth threshold which are not subject to investment restrictions. Aligning accredited investor thresholds with inflationary trends would reassure regulators given the thresholds have failed to take account of inflation in nearly a quarter of a century.
However, this could make it harder for smaller, start-up hedge funds. Many of these managers often rely on seed capital from family and friends prior to institutionalizing their businesses. A dry up of this seed capital through more restrictive net-worth and income thresholds could hinder these managers’ ability to raise money.
The passage of the JOBS (Jump-start Our Business Start-ups) Act, which allowed hedge funds and other private funds to publicly market and advertise their businesses is another regulatory driver behind toughening up the eligibility criteria for accredited investors.
A number of policymakers and consumer groups had warned some investors could be susceptible to fraud following the JOBS Act. In reality – however – very few hedge funds have taken advantage of the JOBS Act. A hedge fund survey conducted by international law firm Seward & Kissel found that not a single manager had taken advantage of the eased marketing and advertising rules under the JOBS Act.
Many hedge funds have been reluctant to embrace the JOBS Act due to the strict bad actor rules and additional reporting obligations. There is also a risk of regulatory arbitrage between the JOBS Act and the European Union’s (EU) Alternative Investment Fund Managers Directive (AIFMD), which prohibits firms from marketing into EU member states unless they comply with local national private placement regimes (NPPRs) or become fully compliant alternative investment fund managers (AIFMs).
Other recommendations by SEC staff include permitting individuals with certain professional credentials to qualify as accredited investors. This may include bankers, lawyers or auditors, for example. The staff report also said “knowledgeable employees of private funds” could qualify as accredited investors too. The report added that individuals who pass an “accredited investor examination” could be eligible.
The SEC is now inviting public comment on whether the definition of accredited investor ought to be changed. No comment deadline has been provided.