The Securities and Exchange Commission recently changed its official definition for what an accredited investor is, has been in discussion for years. On paper, that means more investors have access to hedge funds and other private funds and startups. However, that may not necessarily be a good thing for investors, and smaller hedge funds may not benefit either.
The new definition of an “accredited investor”
Traditionally, to be an accredited investor, one had to have a net worth of at least $1 million, excluding whatever their principal resident is worth, or at least $200,000 in annual income for individuals or $300,000 for couples. These amounts haven’t changed, but what has changed is that there will be another way people can qualify as accredited investors to invest in private funds.
The new rule allows people with specific certifications to qualify as an accredited investor even if they don’t have those levels of wealth. For now, they are limited to those who hold Series 7, 65 and 82 licenses.
They include certifications as a Financial Regulatory Authority (
FINRA) Licensed General Securities Representative and a Licensed Investment Adviser Representative. Employees of private fund managers may also invest in their firms’ funds.
The SEC may expand the provision and add more certifications at a later time. After the new definition is published in the Federal Register, it will go into effect in 60 days. The SEC originally announced the rule on Aug. 26.
Why investors may not benefit from the new definition
The SEC aims to provide more investors with the opportunity to invest in hedge funds, startups and other private assets. Still, the new definition may not have the desired effect, at least not where hedge funds are concerned.
The idea behind the change was that investors with a certain level of sophistication and knowledge in investing would be able to invest in a broader range of assets. Specifically, it allows them to invest in private investments, which includes not only hedge funds but also private equity and startups.
The SEC argued that the internet has made information more accessible to more people. Still, the problem with this argument is that there is less information available about private assets than public ones. More investors will be able to place their money at greater risk with less available data.
Since these individuals won’t have the same level of wealth as traditional accredited investors, they will be hurt more if they lose the money they invest than those who are wealthier and can stomach greater risks.
Why less wealthy investors still won’t have access to hedge funds
In the case of hedge funds and private equity funds, investors may not even have as many opportunities as what the SEC assumes. Many such funds are organized as 3(c)(1) funds, which means they are limited to no more than 100 investors.
Since funds that are structured this way tend to be smaller, they may be unwilling to take on investors who don’t have a lot of money to invest. They want to target investors with millions of dollars so they can raise more money from the 100 investors they are allowed to have.
Most hedge funds and private equity funds have minimum investment amounts. For many funds, these amounts may be more than what a less wealthy investor can afford, especially if they are going to diversify their investment portfolio properly.
Thus, even if they could get into hedge funds, they would have a less diversified portfolio because of how much money it would take for them to get into those funds.