But it has broader implications. Should the United States government be deciding what people can do with their money? And how do you define who is wealthy enough — and smart enough — to invest in these offerings?
We’re talking about private placements — a term the financial industry uses for anything from real estate deals to hedge funds to last year’s much-talked-about offering in Facebook shares. What all these investments have in common is that they can be sold with fewer disclosures than public offerings.
They also often carry cachet, and those who get into them can end up with large returns. That may seem unfair to anyone excluded because of a lack of wealth. But these private investments can go to zerojust as easily as they can climb into the stratosphere, which is why investors who cannot afford to lose a lot of money are barred.
Since 1982, specific dollar amounts have been used to define who is an “accredited investor,” the S.E.C.’s term for someone deemed sophisticated enough to invest in these nonpublic deals.
The two most commonly used measures are annual income — over $200,000 for an individual or $300,000 for a couple — and net worth, which was $1 million. In late December, the S.E.C. redefined how people should calculate their net worth. Per the requirements of Dodd-Frank, the commission removed the equity in a person’s primary residence from consideration. (But if the value of that house is less than the mortgage, that liability needs to be included.)
“It’s an interesting question as to why this qualifies someone as sophisticated,” said Robert E. Buckholz Jr., a partner at Sullivan & Cromwell. “The income and the net worth requirements are a proxy for the ability to fend for yourself.”
But also in compliance with Dodd-Frank, the S.E.C. will spend the next three years determining whether to make further changes in the accredited investor requirements. While it is hard to say what the review will produce, it is worthwhile to look at how wealth and financial expertise have been confused.
WHAT THE RULE DOES In a 2009 article in The Washington University Law Review, Wallis K. Finger, now an associate at Schulte Roth & Zabel, used humor to lay out the problem of using money as a proxy for sophistication.
“Paris Hilton almost certainly can purchase unregulated securities issued by hedge funds or other private investment vehicles,” Ms. Finger wrote. “Although her training and sophistication in the field of high-stakes financial transactions may be limited, the Securities and Exchange Commission would leave her to her own devices if she chose to invest in private offerings.”
For comparison, she created a woman named Sheryl who has a master’s degree in business from Harvard and a doctorate in financial systems analysis. “After all of this schooling, Sheryl is long on debt and short on assets,” Ms. Finger wrote. “She has several offers to work at the nation’s most prestigious investment brokerages. But if Sheryl wants to invest in a private offering, the S.E.C. regulations will not allow it.”
In other words, using money as a stand-in for financial sophistication is a fairly unsophisticated solution.
When news leaked out last year that Goldman Sachs was planning to offer private shares in Facebook to its wealthiest clients, there was outrage from people who were excluded. After much media attention, the firm limited the private offering to overseas clients to be sure it complied with S.E.C. regulations. (Anyone will be able to buy shares in the initial public offering of Facebook.)
In reality, most private offerings are far less glamorous and carry significant risks.
Barbara Black, a professor and director of the corporate law center at the University of Cincinnati College of Law, said she was more concerned about small offerings, like a local real estate partnership, where an entrepreneur tries to raise money by promising outsize returns to investors in the community.
“It may be perfectly fine, but the nature of things is that these are risky,” Ms. Black said. “You see litigation involving people who are wealthy, but you don’t think of them as super-rich — doctors, dentists, lawyers, some accountants. Are these really sophisticated investors?”
DOES IT WORK? The accredited investor regulation is by design paternalistic, but its arbitrariness is what bothers people.
Originally, the Securities Act of 1933 aimed to provide more information on securities to prevent investors from being manipulated. Those who were exempted from these requirements were believed to possess enough knowledge to make informed choices.
Using the example of doctors and lawyers investing in a local real estate deal, Yasho Lahiri, a partner at law firm Baker Botts in New York, said investors would be better protected with more disclosures, not by their degree of wealth.
“What these rules do is limit that amount of information,” he said. “If all these real estate documents were out there, you could assess the deals and compare them to others.”
He added that really sophisticated investments were not marketed to accredited investors anyway. They go to qualified purchasers who have at least $5 million in assets that can be invested and qualified institutional buyers with over $100 million.
If the goal, though, is to protect people from losing all of their money in an illiquid investment, the current standard fails on that count, too. Andrew Abramowitz, a lawyer in Manhattan who has worked with both buyers and sellers of private placements, said a better standard might be to limit how much of their net worth people can invest.
“There could also be a prohibition on participation in a new private placement if the investor’s previous investments in illiquid securities constitute a specified share of investor’s liquid assets,” he said.
At the very least, the dollar amounts have not been changed since they were put in place in 1982, and people who qualify today would not have qualified then. After all, $1 million from 1982 would be worth $2.34 million today. Indexing for inflation had been proposed for Dodd-Frank but was removed in Congressional negotiations.
OTHER OPTIONS There are all sorts of alternatives to the accredited investor standard. The tough part is turning recommendations into regulations, especially since the S.E.C. faces opposition from groups that depend on a big pool of investors for private placements.
Walter J. Woerheide, the vice president of academic affairs at the American College, which focuses on training financial service professionals, suggested a simple test to determine a person’s level of financial knowledge, akin to the test for a driver’s license.
John C. Coffee Jr., a professor at Columbia University School of Law, said the rule should be changed to require a minimum net worth of $5 million and to set a standard for diversification so that no more than 15 to 20 percent of someone’s net worth could be in unregulated investments.
He said he was particularly concerned about legislation being considered by the Senate that would eliminate the current requirement that brokers need to have an existing relationship with clients before they can try to sell them private placements.
“Upper-middle-class Americans who qualify as accredited investors will soon begin receiving streams of unsolicited offers from brokers they do not know for unregistered offerings,” Mr. Coffee said. “From a consumer protection standpoint, this combination of little sophistication and even less disclosure seems troubling.”
And if that happens, investors may have to become more honest in assessing what they know.
Fuente: The New York Times
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