By Michael Loo
During the Practicing Law Institute’s SEC Speaks in 2016 conference, SEC acting chairman Michael Piwowar shared his thoughts on how the SEC should remove the distinction between accredited and non-accredited investors. Accredited investors can invest in private securities not registered with financial authorities. Under SEC Rule 401 of Regulation D, some of the requirements to be an accredited investor include having an income of $200,000 or having a net worth of $1 million (excluding the primary residence). This naturally targets the alternative investment space, such as hedge funds and private equity funds. Should the distinction between accredited and non-accredited cease to exist, alternative investment managers could have a larger pool of viable investors to tap into.
Piwowar argues that by distinguishing between accredited and non-accredited investors, you divide the “world of private offering investors into two categories: those persons accorded the privileged status of “accredited investor” and those who are not.” As accredited investors have many more investment opportunities available to them than non-accredited investors. Piwowar supports this claim with two key financial economic concepts—the first being the risk-return tradeoff. Investors are risk averse, so riskier securities should offer higher returns than less risky securities. By restricting non-accredited investors from investing in high-risk securities, the SEC is denying them the opportunity to earn higher-returns. The second concept Piwowar applies is the modern portfolio theory. The risk of the portfolio as a whole is lower than the risk of any individual assets that portfolio holds. Even if investors add high-risk securities to their portfolios, portfolio diversification will kick in to help mitigate some of that risk. As long as these high-risk securities are proportional to the portfolio, investors may be able to increase their expected return with little to no change in the portfolio risk profile and can possibly decrease the risk profile. By preventing certain investors from investing in private securities, the SEC may be inadvertently limiting the tools available to diversify their portfolios.
Alternative investments managers should watch how this argument develops over the coming months. With the current administration stance on deregulation, if the SEC does remove the restrictions on who can invest in private securities, there may be an entire new group of investors for managers to contact.
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