A debate brews between the U.S. Security and Exchange Commission (SEC) and the hedge fund industry about proposed changes to the current definition of accredited investor. The Dodd–Frank Wall Street Reform and Consumer Protection Act requires this definition be reviewed every four years. The definition of an accredited investor has not changed since 1982, except for the 2010 exclusion of a potential investor’s primary residence from net worth calculation, which actually flows from passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act, not an SEC review.
Fears are that smaller hedge funds, those with under $100 million in assets under management, will experience a disproportionately negative impact as compared to larger hedge funds. This fear is based on the fact that institutional investors tend to favor large hedge funds, while smaller funds are dependent on individual high net worth investors. As a result, any change that shrinks the pool of individual investors operates to the detriment of smaller funds.
What’s on the Table?
One of the more innovative changes being considered revolves around the concept of evaluating the potential investor’s level of financial sophistication. How this would be accomplished is not entirely clear. However, it has been suggested that holding a Chartered Financial Analyst’s credential or a FINRA Series 7 license could be a starting point for accreditation. This would shift the emphasis from income and net worth to a standard that relies on the investor’s financial sophistication.
Another approach having merit consists of establishing a percentage of assets or income that may be invested. In theory, this would not shrink the pool of investors, whereas raising the income and/or net worth thresholds would certainly have that effect.
The Poor Get Poorer and the Rich Get Richer
The current definition of an accredited investor slams the door of opportunity in the faces of all but the wealthiest among us. Existing policy smacks of elitism and is not fundamentally different from Jim Crow laws precluding those not owning land from voting.
To put this in perspective, less than 5 percent of U.S. households meet the current definition of an accredited investor, leaving more than 95 percent of potential investors unable to benefit from investing in hedge or private equity funds.
The SEC is presented with a unique opportunity to expand and invigorate the economy and widen economic participation in the broader investment community by making prudent changes to the crucially important definition of the accredited investor.
With American individual net worth having dropped below that of Switzerland, Australia, Norway and Luxembourg, the time may be right for the SEC to remove its boot from the throat of the nation’s economy. Shouldn’t economic freedom be on a par with the freedom to exercise one’s right to vote, to enjoy equal employment opportunity, to receive equal pay for equal work, and to be free from discrimination because of physical disability, sexual orientation, race or creed? Is there a rational argument for discriminating against someone based on net worth or gross annual income? This act of discrimination affects a greater percentage of Americans than any of the aforementioned. Where is the ACLU on this point?