From the January 2007 issue of Investment Advisor • Subscribe!

January 1, 2007

Raising the Bar for Getting Into Hedge Funds

The SEC voted December 13 to raise the accredited investor limit for investors in vehicles such as hedge funds, private equity, and venture capital from $1 million to $2.5 million--a move that some hedge fund officials say is long overdue. SEC Chairman Christopher Cox told reporters the day before the December 13 meeting that the $2.5 million amount is an inflation adjustment, as the accredited investor standard had been stuck at $1 million since 1982. Cox also said the increase will address concerns the SEC has about the "retailization" of hedge funds.

Jim Hedges, president and chief investment officer of LJH Global Investments, a hedge fund advisory firm based in Naples, Florida, agrees that the accredited investor increase is long overdue, stating that "$1 million in the early 1980s is certainly not $1 million today." The $2.5 million standard, he says, will also limit the number of participants in a hedge fund, he says, "which is good," adding that the amount is "in keeping with the notion of offering privately placed securities exclusively to high-net-worth or sophisticated investors." Hedges also believes the new minimum will not "change capital flows into the hedge fund industry a lot because most people that invest in hedge funds probably have that net worth anyway."

John Berlau, director of the Competitive Enterprise Institute's recently formed Center for Entrepreneurship, disagrees. He put out a statement saying that the $2.5 million threshold "will sharply limit the pool of investors that entrepreneurs can count on to finance their ventures." He added that "The idea that 'poor millionaires'--who 'only' have less than $2.5 million--can't protect themselves is simply absurd."

Under the proposed rule, investors are also not allowed to count real estate, such as their homes, toward the $2.5 million. Berlau disagrees with this aspect of the proposed rule as well, stating, "If people are allowed to take out new mortgages that bear risk, they certainly should be allowed to be 'angel investors' to new firms."

The SEC also voted for an antifraud provision under the Investment Advisers Act of 1940, which would make it "fraudulent, deceptive, or manipulative...for an advisor in a pooled investment vehicle to make false or misleading statements or to otherwise defraud investors or prospective investors in that pool."

Both the antifraud and accredited investor proposals are out for a 60-day comment period that ends in February.

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