Consumer group cautious about expanding definition of accredited investor

SEC looking at alternative criteria beyond wealth to determine who can invest in private offerings.

An investor advocate is warning that expanding the pool of people who can invest in private offerings without appropriate safeguards will harm the investing public.

In a Nov. 15 letter to Rep. Scott Garrett, R-N.J., and Rep. Patrick McHenry, R-N.C., Securities and Exchange Commission Chairman Mary Jo White said that the SEC is considering modifying the definition of an accredited investor, possibly increasing the number of people who would qualify. Currently, only investors who have a net worth of $1 million, excluding the value of their homes or an income greater than $200,000 can buy unregistered securities or buy into private-equity and hedge funds

Barbara Roper, director of investor protection at the Consumer Federation of America, said that the definition should be changed but not simply as a way to open the private-placement gates to more investors. She is wary of putting all the focus on capital formation rather than protecting the people providing the capital.

“It just does not work,” Ms. Roper said. “We have been down that road before. It led to the Great Depression.”

In her letter to the congressmen, Ms. White said that the SEC may consider alternative criteria in defining an accredited investor.

“Professional certifications, such as a [certified public account] or a [chartered financial analyst], are among the possible supplemental or alternative criteria for qualifying as an accredited investor that commission staff will consider as part of its review,” she wrote. “Such a certification may position an individual to be able to analyze more comprehensively a company’s financial condition and results of operations.”

The SEC also will mull whether an investor who uses a financial adviser could qualify as accredited.

“Obtaining the advice of a professional adviser may enhance an investor’s ability to make an informed investment decision and therefore strengthen investor protection in [private] offerings,” Ms. White wrote. “An investor’s use of such an adviser, however, may not necessarily measure the investor’s understanding of the risks of the investment.”

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.

Although his clients may qualify under a rule change as accredited investors, Kenneth Klabunde will steer them away from private placements, which he says are too risky.

“Products that fall under the accredited investor requirements — hedge funds, private equity, private placements — across the board, with rare exceptions, lack three requirements for a prudent investment: transparency, liquidity and low cost,” said Mr. Klabunde, founding principal of Precedent Asset Management.

Another adviser questions whether a financial analysis credential is enough.

“You can be a CPA and not know anything about investments or be a CFA and not be clear on how that knowledge applies to your personal finances,” said Erin Baehr, president of Baehr Family Financial. “If you’re practicing in the personal financial world, that’s a different story.”

The Investment Adviser Association backs the idea of making the use of a registered investment adviser as one of the accreditation criteria.

“If you’ve hired an adviser, the adviser is standing in your shoes and doing what’s in your best interest,” said Karen Barr, IAA general counsel. “They’re serving as your proxy in this transaction.”

The Investment Company Institute called for strengthening the accredited investor standard, saying that the income and net worth tests are not as relevant today as they were 30 years ago.

“They have substantially eroded since they were established in 1982, to the point where they no longer identify a universe of individual investors who can fend for themselves and do not need the protections of securities laws,” wrote ICC President and chief executive Paul Schott Stevens in a Sept. 23 comment letter.

The lawmakers want the SEC to expand the definition of accredited investor so that there are more sources of capital available to fledgling companies and so that more investors can avail themselves of private offerings.

About $903 billion was raised by private placements with about 234,000 investors participating last year, according to an SEC study.

“A wealth test, to the exclusion of other methods of evaluation of accredited investors, is tantamount to the government sanctioning a special club — those who have already reached a certain level of wealth and are therefore deemed eligible for membership,” Mr. Garrett and Mr. McHenry wrote to Ms. White in an Oct. 30 letter.