Would you advise a client to sit for an exam that would enable them to invest in alternative investments that are currently off-limits to most nonwealthy investors?
That’s the idea behind a bill that just sailed through the U.S. House of Representatives with strong bipartisan support.
The Equal Opportunity for All Investors Act, wrote by Nebraska Republican Mike Flood, aims to expand the availability of private investments like hedge funds, private equity, and venture capital. Currently, the SEC limits access to those with accredited investor status—individuals with a net worth of over $1 million or those who earn upward of $200,000 a year ($300,000 for married couples filing jointly).
The bill would direct the Securities and Exchange Commission to develop an exam for evaluating whether an investor is sophisticated enough to qualify as an accredited investor, granting them access to unregistered funds and private placements.
Critics of the current system argue that it screens out sophisticated investors who might understand the risks of private investments but aren’t allowed to participate because they don’t meet the financial criteria.
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“It is my firm belief that the accredited investor definition should not be tied exclusively to wealth,” Flood says in a statement. “Instead, we should unlock opportunities for knowledgeable investors that may not come from means.”
The bill cleared the House by a vote of 383 to 18. All the negative votes were cast by Democrats.
In the event the measure makes its way through the Senate and becomes law, don’t expect advisors to start rushing lower-net-worth clients into private placements.
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“First I thought this was a solution in search of a problem, but on second thought I think it’s actually a problem masquerading as a solution,” says Michael Delgass, a managing director at Wealthspire Advisors, who calls the bill a “horrendously bad idea.”
Evelyn Zohlen, founder and president of Inspired Financial, doesn’t take a much more positive view of the bill. “This is an issue that impacts 1% of the 1%,” she says.
Like Delgass, Zohlen has many clients who currently meet the criteria to qualify as an accredited investor, but she says direct investment in private vehicles isn’t a major part of her practice.
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“Among our clients, there is little demand or interest in investing in private funds,” she says. “We have a handful of clients that do own them but the structure of the investment did not require investor accreditation.”
Clients can gain exposure to alternative investment strategies through ETFs, many interval funds, and other registered products that don’t require accreditation, so direct investments that require accreditation only makes sense for ultrawealthy clients who can put a portion of their assets in illiquid instruments, Delgass says.
Consider venture capital. The bill would allow investors who pass the test to buy securities in illiquid private companies, similar to what venture capitalists do. Delgass points out that a venture capitalist is considered successful when one or two investments work out, paying off big, while their other portfolio companies routinely fail.
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“These are people that do this for a living 24/7, and they still can’t make it work on better than one-in-20 kind of odds,” he says. “If you’re thinking about someone who’s not an accredited investor, they cannot possibly afford to build a portfolio of direct investments.”
Delgass argues it would be a form of advisor malpractice to recommend illiquid private investments to clients with investible assets below the $1 million mark that currently unlocks accredited investor status.
“It’s insane to try to build huge pieces of illiquidity into such a small portfolio,” he says. “We wouldn’t even think of creating illiquidity in a portfolio that’s less than a million.”
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The examination that the bill would establish would be administered by brokerage industry self-regulator Finra. It’s hard to imagine an advisor working with a client to help them prepare for the test, according to Zohlen.
“Advisors want to make the investing process as easy as possible for their clients, and asking clients to take an exam to be allowed to invest in a product is a ‘hard pass,’” she says. “Clients expect their advisors to be the experts and if the client has to pass an exam to make an investment, what does that suggest about the advisor?”
Backers of the measure see it as a way to level the playing field for investors to ensure that certain opportunities aren’t only available to the wealthy. There’s an appealing logic to that—after all, the bill cleared the House with overwhelming bipartisan support. However, Delgass argues that the current accredited investor definition is a helpful safeguard to prevent less affluent clients from plunging into investments that are inherently risky.
“It’s totally right that just having money doesn’t mean that you’re financially savvy,” he says. “The accredited investor rule doesn’t imply knowledge, but it does imply that you’re not staking your life savings on one particular idea. If you’re got a million dollars you have a few bucks to spread around.”
