SEC could introduce financial competency exams to determine accredited investors
The Securities and Exchange Commission (SEC) is likely to change the definition of accredited investor either by increasing the income or net worth threshold, or by introducing financial competency examinations in what could make it harder for smaller fund managers to raise capital.
At present, individuals with an annual income of $200,000 and a net worth in excess of $1 million qualify as accredited investors and are therefore permitted to invest in private fund vehicles. Section 413(b)(2)(A) of the Dodd-Frank Act requires the SEC to re-examine the definition of “accredited investor” every four years. The last time the SEC reviewed the definition was back in 2010 when it decided to exclude the value of a person’s primary residence from the calculation of their net worth. The SEC is unlikely to give its recommendations until early 2015.
“There are going to be changes to the definition of what constitutes an accredited investor, although I doubt it will happen anytime soon. I suspect the threshold will increase in some areas – maybe not around net income or total net worth – but we could see sophistication tests being introduced for prospective buyers of funds,” said Fred Bryant, chief executive officer at WealthForge, a Virginia-based broker-dealer that specialises in processing private placement transactions online.
Introducing financial competency examinations is beset with difficulties and operational complexities. “A financial competency examination would be a challenge. There is uncertainty as to how it would be administered. Who would carry out the tests? How would they do it?” said Bryant.
This would bring the US in line with the stance taken by the UK’s Financial Conduct Authority. Some have advised investors with a background in law, audit or banking be automatically deemed as accredited.
The SEC has made it no secret it wants to tighten up on what constitutes an accredited investor, particularly given the definition was first promulgated more than a quarter of a century ago and has since failed to take into account for inflation. Furthermore, the passage of the JOBS Act has added a further impetus to the SEC’s resolve. The SEC is reportedly nervous that unscrupulous or fraudulent managers could target unsophisticated investors through the relaxed marketing and advertising measures contained in the JOBS Act.
“Any changes to what constitutes an accredited investor would certainly be tied up in the SEC’s frustration with the passage of the JOBS Act and its desire to improve investor protections,” commented Bryant.
Despite the SEC’s fears, hedge fund and private equity enthusiasm for the JOBS Act has been remarkably muted despite some initial fanfare. Many managers are put off by the stringent ‘bad actor’ rules and additional reporting requirements the JOBS Act entails while others are concerned about the risk of arbitrage with the EU’s Alternative Investment Fund Managers Directive, which prohibits any form of marketing by a non-EU firm into Europe if it does not comply with the national private placement regimes being adopted by member states.