Fortune's Bethany McLean (pictured left) takes a look through the public comments on the SEC's proposal to raise the bar on the wealth requirements for investing in hedge funds. And what she finds isn't pretty. Despite lots of cries for greater restrictions from politicians and scare stories in the press, those offering comments to the SEC are up in arms against the proposal.
Of course higher 'net worth' requirements strike many as discriminatory and lots of folks aren't happy that the SEC seems to be attempting to reserve hedge funds for the very, very wealthy (as opposed to just wealthy). Others have pointed out that the new requirements might well have disparate impacts on various populations groups in the US, perhaps making the world of hedge fund investors even whiter and more male than it is today.
But one of the most trenchant criticisms is that the new rules would bar many individuals from participating in various alternative investment strategies despite the fact that they are permitted to invest in one of the riskiest strategies in the world—putting their savings into an individual stock or commodity.
Of course, much of this line of criticism ignores the very real danger that without minimum wealth requirements—and perhaps wealth requirements even higher than those currently in place—the marketing departments of hedge funds might push the funds on investors for whom they are entirely inappropriate. Stock brokerages at major financial institutions are highly regulated and brokers operate under obligations to consider the appropriateness of an investment for each investor. Hedge fund sales operate under far less regulatory scrutiny—in part because the wealth requirement is a kind of stand-in for an "investing sophistication" requirement. Do away with this—or allow it to be diluted by inflation or illiquid net-worth gains from real estate gains—and there is a real risk of growing the now nascent hedge fund boiler room industry.
One solution that gets trotted out now and then is to impose some sort of actual test of investment sophistication. Something like a Series 7 for accrediting investors. This strikes us as a simply terrible idea for the quite obvious reason that we already have enough tests and records governing our lives. What's more, we're skeptical that any sort of computer based or written test can really measure something like "investor sophistication" anyway.
SEC slammed over hedge fund 'wealth' test [Fortune via CNNMoney.com]
Posted by joe , Feb 13, 2007 2:06PM
Anyone who's ever taken the Series 7 can attest to the fact that the correlation between those who pass the test and those who are "sophisticated investors" is 0.
It's insane that grandma jones can buy pets.com in her IRA with no problems, but god forbid she be allowed to put her money with a hedge fund manager.
Posted by InIT4the$ , Feb 13, 2007 2:39PM
Bethany McLean looks like Heather Graham...definitely business magazine hot.
Posted by Robert C. Banjo ("Mr. Banjo") , Feb 13, 2007 2:48PM
I agree with Joe. The Srs. 7 measures nothing.
"Others have pointed out that the new requirements might well have disparate impacts on various populations groups in the US, perhaps making the world of hedge fund investors even whiter and more male than it is today."
Holy shit, we can't have that, can we?! Seriously, what is wrong with being white and male? Enough with the self-flagellation. White males are among the wealthiest demographic segment, so it makes sense that they are heavily represented among hedge fund investors (aside from the fact the US is overwhelmingly white). Having said that, there's nothing preventing Asians, a very small proportion of the population, from investing in hedge funds.
Posted by E. Vye , Feb 13, 2007 9:31PM
There actually is a proviso in many unregistered funds at the discretion of the manager for "knowledgeable investors" who do not meet the accredited/qualified investor wealth requirements...the definition is broad...like any employee who is an AVP or above of an investment firm could in some cases be considered "knowledgeable", therefore the fund could potentially be offered to employees of their firm who have the minimum $250k or so to pony but aren't worth a mil in non-real estate assets.
meah.
Posted by guest , Jul 09, 2008 3:00PM
The carve-out for "knowledgeable investors" is not all that great, either. As I recall our lawyer explained to us when we launched a $100+ mm hedge fund a couple of years ago, the SEC takes the position that eligible employees must head a department or have a similar role ("Chief ____ Officer", etc.) ... so perversely the head of marketing or chief administrative officer (which was and is basically a glorified office manager) were able to participate in the fund, whether or not they knew anything about investments, while the analysts were not generally eligible under this exception.