Advisers wary of becoming private-offering gatekeepers

SEC floating idea to expand pool of people qualified to put money into hedge funds, private equity and other high-risk investments

Nov 22, 2013 @ 10:01 am

By Mark Schoeff Jr.

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An idea being floated by the Securities and Exchange Commission that would make financial advisers gatekeepers for private placements is getting a cold reception.

In a letter to lawmakers last week, Securities and Exchange Commission Chairman Mary Jo White said that the SEC is considering expanding the pool of people qualified to purchase hedge funds, private-equity funds and other private placements.

Only “accredited” investors — those with $1 million in net worth excluding home value or an annual income of more than $200,000 — can participate in private investments. But among the ideas being vetted is to allow people to invest who don't meet the financial criteria but display sufficient industry knowledge or financial acumen.

One idea is allowing investors who work with a registered investment adviser or broker to participate in such offerings.

Having the added responsibility of vetting the often risky, illiquid and opaque products for investors who fall below the accredited-investor standard doesn't sit well with Harold Anderson, president of Parkshore Wealth Management.

He has seen too many private placements go bust and doesn't want to be on the hook for giving a green light to a client to get into one.

“My stress level would go way up,” Mr. Anderson said.

“I would not want to be the gatekeeper for this kind of investment," he said. "At this stage of my career, I don't want to take the risk.”

An adviser should tread carefully in this new territory, if it becomes a reality, said Sharon Appelman, director of financial planning and investment management at Francis Financial.

“Any adviser who does this might want to consider increasing their professional liability insurance,” she said.

The SEC has asked for comment on revising the accredited investor definition as part of a proposal to amend the rule that permits the sale of private-placement securities. The Dodd-Frank financial reform law also requires the SEC to review the standard for sophisticated investors.

In a Nov. 15 letter to Rep. Scott Garrett, R-N.J., and Rep. Patrick McHenry, R-N.C., Ms. White said that obtaining the advice of an investment professional could provide added protections for investors who buy private offerings.

But she cautioned that the use of an adviser wouldn't necessarily mean that an investor fully understands the risks.

“As part of its review, the commission staff may determine that it is feasible to analyze the extent to which investors file claims against professional advisers arising from investments in unregistered offerings,” Ms. White wrote. “Such an analysis may assist in evaluating the level of protection afforded to investors when relying on professional advisers.”

The lawmakers, who have leadership roles on the House Financial Services Committee, are pushing the SEC to expand the accredited investor definition so that more sources of capital are available to fledgling companies and more investors can participate in private offerings.

Having investment advisers sign off on complex offers for real estate, oil and gas and other ventures doesn't sound like a good idea to Neal Solomon, managing director of WealthPro.

“That would be really frightening to me,” he said.

“Some RIAs may be capable of doing the due diligence and research. Most are not," Mr. Solomon said. "I rely on my broker-dealer," he said. "They have people doing this all day.”

One adviser said that her firm would be able to take an accredited-investor rule change in stride because it has experience in reviewing private-offering memos.

“There have been many times we've said 'no.' There have been a few we've recommended [them],” said Diane Pearson, an adviser at Legend Financial Advisors Inc.

“We assume responsibility in how that fits into the makeup of [a client's] overall portfolio," she said.

Ms. Pearson emphasized that it is important that advisers who become portals for private offerings operate under a fiduciary duty.

One difference between SEC-registered offerings and many of the private offerings on the market is the fact that the latter are often illiquid.

“Most people aren't used to tying up their assets for an extended period, other than taking out a mortgage on their house,” Ms. Pearson said.

Allowing a wider range of investors to participate in private offerings would be good for the market, according to Brian Lockhart, chief investment officer at Peak Capital Management.

It wouldn't be a shock to the system because many mutual funds and exchange-traded funds already available to all investors utilize complex derivatives, commodities and leveraged strategies.

“It's not like we're opening Pandora's box,” Mr. Lockhart said. “Pandora's box opened a long time ago.”

Rules surrounding alternative investments should focus on preventing fraud rather than limiting who can participate based on their wealth or earnings, Mr. Lockhart said.

Recently, the SEC approved public advertising for private placements, helping to whet the appetite in the market.

“Most investment advisers would say there's been a definite uptick in clients who have asked our opinion of the different types of investment vehicles,” Mr. Lockhart said. “Frankly, I think that's a good thing.”

Even if the accredited investor definition changes, advisers still can make their own decisions about whether to help clients enter the private-placement realm, Mr. Solomon said.

“It's not a responsibility unless the adviser accepts it as a responsibility,” he said. “When we get into trouble is when advisers try to be everything to everyone.”


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