Don’t rush to open private equity floodgates

Change is in the air over what constitutes an accredited investor but how far should the industry go?

According to baseball legend Yogi Berra, “You don’t have to swing hard to hit a home run. If you got the timing, it’ll go.” When it comes to private equity, proponents not only think they’ve got the timing right, but they’re swinging hard.

As mentioned elsewhere in this alternatives-themed issue, financial author Tony Robbins has released a new book that explores the pillars of private equity and why he believes investors should take a closer look at areas previously accessible only to ultra-high-net-worth investors and institutions.

It’s an appealing narrative after the COVID-19 crash gave the 60/40 portfolio model a beating; investors want diversification and less correlation to public markets, while forecasts of future returns for stocks are muted (although they said that last year, too).

There’s something else whirring away in plain sight – what constitutes an accredited investor. Private equity firms clearly sense a sea change here and, pun intended, there is something in the water.

Only investors who meet income and wealth thresholds – $200,000 or more in annual income or $1 million in net worth excluding the value of a home – are deemed accredited and allowed to purchase unregistered securities. The definition was amended in 2020 to include people with certain licenses and job experience.

In theory at least, meeting these standards qualifies someone as a sophisticated investor capable of handling more complex and risky securities. But private equity firms and, generally speaking, Republicans argue this deprives many people of golden investment opportunities. Opponents, often Democrats, believe expanding the number of accredited investors exposes too many to products that offer less protection and fewer disclosure requirements.

Of course, the expansion is already underway. Inflation over the 42 years since the thresholds were set by the SEC means the number of accredited investors has grown substantially.

Last year, the House passed two bills that would increase further the number of investors who can buy private securities. The Fair Investment Opportunities for Professional Experts Act would give accredited status to people who have certain licenses or educational or professional backgrounds, similar to the aforementioned SEC amendment back in 2020. The Accredited Investor Definition Review Act gives the SEC discretion to determine what certifications, designations, or credentials investors must possess to be accredited. Elements subsequently discussed include introducing an exam to become accredited.

But the floodgates may not be about to burst open in the way some private equity firms want. For one, Senate approval appears unlikely in this congressional session given the Democratic majority, albeit slim. Will Sherrod Brown, D-Ohio, chair of the Senate Banking Committee, really be that keen to have the panel take up an accredited-investor bill and advance it to the Senate floor? There’s a small chance it gets attached to a must-pass bill later this year, such as a measure to fund the government, but that effort would be resisted.

Of course, if the Republicans hold the House and capture the Senate and White House in November, the bill could be reintroduced next year with improved prospects. But regardless of political maneuverings, private equity has set a narrative and senses a chance to widen its pool of investors.

As ever, the answer might lie somewhere in the middle. Investors are arguably more sophisticated than ever, with more information at their fingertips, and democratization of opportunity should not be dismissed in any walk of life. But those thresholds were set for a reason – to protect the average investor from overly risky, opaque, and illiquid investments that can lock in money for years.

Returns can be high on private securities, but so can the risk. They’re not for the faint-hearted and not immune to economic downturns. The rules may be outdated and overly protective, but the industry should think long and hard before throwing open the doors to more ordinary investors.