The SEC recently proposed a new hurdle to qualify individuals seeking to invest in hedge funds and other privately offered investment pools. Not only would these individuals have to be accredited investors (for which a million in net worth qualifies), but they’d also have to have $2.5 MM in investments, a figure that would be adjusted for inflation every 5 years.
The million-dollar net worth threshold for accredited investor status was set in 1982 and has not been adjusted since. It doesn’t seem so far fetched to think that a million bucks ain’t what it used to be, and if the idea is that being rich proxies for investor sophistication, a million in net worth doesn’t really mean you’re rich these days, especially if the lion’s share of that is in home equity. So why not include an adjusted, higher net worth threshold for investors in private investment pools? Admittedly, the new $2.5MM hurdle might be a little high. It would not include home equity, and it overadjusts for inflation if the target is $1MM in 1982 dollars. The comment period for this SEC rule change recently expired, and the comments appear to be overwhelmingly negative, to my initial surprise.
Raising the bar, of course, would reduce the pool of investors eligible for private offerings. So of course, one would expect hedge fund interests to object. What initially surprised me—and in retrospect, probably should not have—was the vehemence of the objections by individual investors who saw themselves being cut out of possibly lucrative hedge fund investments. Some saw the new hurdle as elitist:
I have no need to have the SEC save me from myself. This is elitist and completely unnecessary. Please reconsider.
Others questioned the use of net worth as a proxy for brains generally:
You have to be rich to be smart?
If I gave you $2.5 Million would it make you any smarter?
This latter criticism of course challenges the whole notion of individual accredited investor status built into Reg D. Very few comments favor the new rule.
In retrospect, I probably should not have been surprised. There is an enormous selection effect going on here. The millionaires who have no interest in investing in hedge funds are indifferent as to the new rule. It won’t affect them. So even if in the abstract they favor more investor protection, they’re not chomping at the bit to make a public comment. Only investors on the cusp—accredited investors who would not meet the additional $2.5MM hurdle—and who are interested in hedge fund investments care enough about the issue to comment. Mystery solved.
But it led me to wonder more generally just how valuable the public comment process is if there are not concentrated interests on both sides of any proposed rule change. Viewed through a conventional public choice lens, this sort of unbalanced issue must arise all the time.
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1. Posted by Archer on March 22, 2007 @ 0:29 | Permalink
Remember. back in 1982, stockholding was limited to more affluent people. Commissions were sufficiently high so as to deter most middle class people from owning stocks directly, and mutual funds were fairly new. We still had usury laws and deposit regulations in those days. Wealth really wasn't a bad proxy for sophistication.
Now, the better argument for a higher threshold might be "you are rich enough to afford third party advice...." Another argument for higher income requirements is ability to sustain losses (and to have enough one's hedge fund holdings not represent more than, say, 25% of one's financial assets. For small fry to meet hedge fund minimums, they would wind up having unduly large proportion of their wealth in a risky asset class)
2. Posted by Fred Tung on March 22, 2007 @ 9:22 | Permalink
All good points. The democratization of capital markets changes everything!