March 9, 2007

The Definition of Accredited Investor in Certain Private Investment Vehicles

Key materials
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Highlights 

The Regulation

  • The Securities and Exchange Commission (SEC) seeks public comment on proposed rules raising the level of personal wealth required for individuals to qualify to purchase securities offered by certain private investment funds commonly referred to as "hedge funds."

  • The SEC's new requirement for individuals would limit hedge funds only to those investors who already have $2.5 million in investments, reducing those able to invest by 85 percent.

Our Findings

  • The SEC's proposed rules harm investors by reducing their ability to decrease overall portfolio risk through purchasing hedge fund securities.

  • Hedge funds are primarily a tool for risk management and risk reduction, not beating general market returns.

  • Even though hedge funds are private investment vehicles not subject to the SEC's system of registration and disclosure, there is enough public information about them for a substantial portion of investors to make informed decisions.

  • Hedge funds have become more complicated over the last decade. Yet increased complexity allows hedge funds to better manage risk, and hedge funds are in some important ways less risky than prior years.

  • Numerous other investments with the same types of risks and complexity as hedge funds are not subject to any qualifications based upon personal wealth.

By the Numbers

  • During the 2000 to 2002 bear market, the S&P 500 had an average annual loss of 15.5 percent and the NASDAQ Composite Index likewise lost 10.6 percent annually. The average annual return for hedge funds during the same period was a gain of approximately 2.5 percent.

  • The S&P 500 lost 2 percent of its value in February 2007, but by most measures hedge funds gained one-half to nearly one percent.

  • The size of the hedge fund industry doubled over the past several years. Today, hedge funds manage about $1.5 trillion in assets globally spread across over 13,000 funds.

  • Approximately 40 percent of hedge fund capital comes from individual investors, and institutions such as pension plans are projected to account for over half of total flows into the funds through the end of the decade.

Recommendations

The SEC can better promote the goals of investor protection, efficiency and capital formation by:

  • revising the proposed rules to substantially reduce any net worth, income and/or value of investments required to purchase the securities of hedge funds;

  • amending applicable rules to permit all investors to purchase the securities of hedge funds registered with the Commission or some other regulatory body; and

  • studying how the policies of other countries that allow investors greater access to hedge funds affect investor protection, competition, efficiency, and capital formation.