New proposed accredited investor definition specifically for hedge funds

Bill Sjostrom —  12 February 2007

A post on DealBook pointed me to a recent SEC release I missed over the holidays. The proposed rules contained in the release “are designed to provide additional investor protections” with respect to hedge funds. The proposed rules include amendments to Regulation D that change the definition of accredited investor to be applied to a natural person with respect to an investment in a “private investment vehicle,” i.e., hedge fund. Under the proposal, for a natural person hedge fund investor to be considered accredited (what the release refers to as an “accredited natural person”), he or she would need to meet the existing definition of accredited investor under Rule 501(a)(5) or (6) (i.e., net worth of at least $1,000,000, annual income of at least $200,000, or joint annual income of at least $300,000) and own at least $2.5 million in investments. Note that it appears a hedge fund would still be able to take money from up to 35 non-accredited investors as allowed under Rule 506 provided it furnishes them the requisite disclosure and believes the investors are sophisticated (although, it seems highly unlikely that a hedge fund would bother with non-accredited investors (many funds have seven-figure minimum investment requirements), and I would view it as a red flag if it did (it can’t attract the smart money)).

I have not studied the release in depth, but one interesting thing of note is that the proposal provides that the $2.5 million threshold will be adjusted every five years for inflation, which is not the case for the $1,000,000/$200,000/$300,000 thresholds referenced above. These thresholds, as the release notes, have remained unchanged since the SEC established them in 1982. Putting aside “nanny state” criticisms referenced in the DealBook post, it strikes me as curious that the SEC would include an inflation adjuster in this new threshold yet say nothing about adding one for the old thresholds. Maybe it has something in the works.

[Have you noticed that this is the most action we’ve had in a single day on this blog in a long time? Perhaps Frank has emboldened us TOTMers.]

3 responses to New proposed accredited investor definition specifically for hedge funds

  1. 

    I think it is important to note that the “accredited natural person” definition applies only to hedge fund investments, it does not alter the definition of accredited investor for Reg D purposes.

    I believe we will see that this is much ado about nothing. The large hedge funds that everyone reads about in the newspaper are not taking investments from “accredited natural persons.” With investment minimums in the millions of dollars, those who meet that definition on the low end do not have sufficient funds to meet the minimums.

    Perhaps the Commission will keep Mom and Pop from investing in the smaller hedge funds, but that is nothing new. There has always been a definition of accredited investor that keeps Mom and Pop out of hedge funds (and most private placements for that matter).

    So, while the objections to the government’s paternal approach are well taken, nothing much is going to change…nor should it, IMHO.

  2. 

    At the SEC Speaks Conference last week, the staff said that most of the 200 comments they’ve received regarding this proposal have been negative.

  3. 

    This will do more than hurt hedge funds, it will kill small private business investment. Small business offerings don’t make sense as registered offerings because of the minimum $50-100k in legal and consulting fees to do one. Raising the minimum net worth requirement means most unregistered offerings will now have to be registered. In other words, they won’t happen at all. Not that the SEC cares; their constituency consists mostly of large and small brokerage houses, who don’t earn commissions on unregistered private offerings. Registered offerings are almost always sold through brokerage houses. It’s also bad for both investors and businesses, since brokerages usually want as much as 10-15% of capital as their fee, leaving that much less money available for actual business use.