Advisors express caution, enthusiasm about being gatekeepers to private markets

Investment advisors expressed both caution and enthusiasm about the idea of serving as gatekeepers who can usher their retail clients into the world of private investments.

They would find themselves in that role under legislation the House Financial Services Committee advanced to the House floor April 26 by a party-line vote, 28-21. The bill — the Expanding Access to Capital Act — contains a provision that would broaden the definition of an accredited investor to include retail clients of investment advisors.

The legislation would allow investors to bypass the income and net worth thresholds required to qualify as a sophisticated investor who can purchase unregistered securities, or private placements. They would do so if they receive individualized investment advice as defined by the Investment Advisers Act of 1940.

The Securities and Exchange Commission promulgated a rule in 2020 that expanded the definition of accredited investors to include financial professionals who hold Series 7, Series 65 and Series 82 licenses.

The bill the House panel approved would essentially make accreditation transitive. It’s something that ordinary investors can achieve if they receive a recommendation to buy a private offering “from a professional who qualifies as an accredited investor,” a bill summary says.

Chris Chen, a wealth strategist at insight Financial Strategists, doesn’t think it’s a good idea. He doubts most advisors would have the time to adequately parse private investments, which often are risky and opaque.

“I don’t have a lot of bandwidth to do a lot of due diligence and I suspect my colleagues in the space don’t either,” Chen said. “What is best for the client is not to get into a private investment that I don’t know anything about.”

Charles Sachs, chief investment officer at Kaufman Rossin Wealth, takes the opposite view. He recommends private placements for a large percentage of clients as a way to diversify portfolios so that they have a “sleeve” that “doesn’t jump around with the stock or bond markets.”

Under current rules, Sachs can only use private investments for clients who are accredited. But they could be helpful to the full range of his clients.

“We are that knowledgeable advisor,” he said. “Let the advisor make the decision whether or not [private investments] make sense for the individual [investor]. This is what we’re paid to do."  

Not all financial advisors have the same grasp of private-market alternative investments that are only available to accredited investors, said Pamela Chen, founder and chief investment officer at Refresh Investments. Such investments can include private equity and hedge funds, nontraded real estate investment trusts, and oil and gas limited partnerships.

Many advisors outsource the investment strategy part of their practice, and certain advisors, such as those who are chartered financial analysts, are better suited for navigating the private markets, said Pamela Chen, who holds a CFA and is not related to Chris Chen.

“It is risky to automatically give clients of all advisors access to alternative strategies because not all advisors are specifically trained on the risks and returns associated with individual investment strategies,” she said.

The criteria for being a sophisticated investor — an annual income of $200,000 or more, or net worth of $1 million or more, not including a home — miss the point, said Joe Endoso, chief operating officer at Linqto, a platform for investing in private technology companies.

The attributes of a sophisticated investor are a certain level of financial literacy and the wherewithal to withstand losses, and Endoso said advisors can assist in both areas.

Investment advice “provides a level of financial literacy and sophistication,” he said. The advisor also can assess whether the investor's risk profile is a good fit for a private investment.

“I love the idea of a financial advisor stepping in and helping them,” Endoso said.

That’s also the position of the Investment Adviser Association, which backs the bill, which was written by House Financial Services Committee Chair Patrick McHenry, R-N.C.

The IAA has long advocated reforming the accredited investor parameters to give retail investors greater opportunities to invest in private offerings, said Neil Simon, IAA vice president for government relations.

"We believe this would be best accomplished and provide an appropriate level of investor protection by deeming as accredited a retail investor whose assets are managed by a fiduciary investment advisor," Simon said in a statement.

He added in an interview: “It expands investor choice."

In his opening statement at the markup last Wednesday, McHenry said that one of the goals of the bill, which includes about 20 provisions focused on capital formation, is to widen the definition of an accredited investor “to help more Americans build wealth.”

But unlike other bills the committee approved last Wednesday that gained strong bipartisan support, McHenry’s bill drew only Republican backing. It may still be approved by the GOP majority in the House, but Democrats control the Senate.    

“Its prospects in the Senate are less certain than the other bills,” Simon said.