Much Ado About Nothing: An Analysis of the “Accredited Natural Person” Standard

Abstract

Hedge funds are private investment vehicles that avoid a large degree of securities regulation through exemptions in the major Congressional acts that created securities law. Because hedge funds are largely unregulated, they are able to engage in trading strategies not available to other investment vehicles, such as mutual funds. Due to the growth of the hedge fund industry and the collapse of some large hedge funds, the Securities and Exchange Commission (“SEC”) in reexamining many of the securities law provisions that deal with hedge funds, including those that exempt hedge funds from regulation. Currently, hedge funds are able to avoid regulation under the Securities Act of 1933 by limiting the sale of their securities to “accredited investors.” For a natural person to qualify as an “accredited investor,” he or she must either have a new worth of $1 million or a minimum annual income. The SEC recently released Proposed Rules 509 and 216, which would reduce the number of natural persons able to invest directly in hedge funds by creating an “accredited natural person” test that would require an individual to own $2.5 million in investments before he or she can invest directly in a hedge fund. This Not evaluates the impact that the “accredited natural person” standard would have on both the market and individual investors, ultimately concluding that the SEC should not adopt the proposed rules. While the SEC believes that the Proposed Rules provide necessary investor protection, they will actually harm the individuals who would be excluded from investing directly in hedge funds. The Proposed Rules will hinder capital formation and reduce hedge fund competition.