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Securities and Exchange Commission proposes new
anti-fraud provisions and
changes to the definition of “accredited investors”
At an open meeting held on December 13, 2006, the five commissioners of
the
Securities & Exchange Commission voted unanimously to
propose
two new rules which would impact investors in hedge funds and other
pooled
investment vehicles.
The following rules have been proposed:
• New antifraud provisions under Section 206 of the Investment Advisers
Act of
1940 which prohibit fraud by Investment Advisers to Certain Pooled
Investment Vehicles
• New revisions under the Securities Act of 1933 to revise the criteria
for
natural persons to be considered “accredited investors” for purposes of
investing in certain privately offered investment vehicles
Antifraud Rule |
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Chairman Cox indicated that the antifraud
proposal arose from a need to address
issues and clarify ambiguities that developed as a result of the
decision of the United
States Court of Appeals for the District of Columbia Circuit in
Goldstein v. SEC
While certain passages from a vacated “hedge
fund rule”
remain "effective" through the no-action letter issued August 10, 2006,
the
definition of what constituted a client, the key provision of the SEC's
rule, is no
longer in place. The current rules under Section 206(1) and 206(2) of
the
Investment Advisers Act have antifraud provisions encompassed, but they
are
limited to clients and prospective clients. The Goldstein decision was
largely based
on the court’s focus on the SEC interpretation of the term “client”,
which is not
defined in the Investment Advisers Act and was not intended to include
the fund’s
investors. As a result, the Commission acted swiftly to draft the
proposed antifraud
rule which would extend beyond clients (the funds) to the investors.
These
considerations demonstrate the Commission’s continued focus on
protecting
The Commission also proposed a new rules under the 1933 Securities Act
to define a
new category of “accredited investor” to determine a natural persons
ability to invest
in securities issued by hedge funds and other private investment pools
under the
1940 Act Section 3(c)(1) exemption.
The current rules defining an “accredited investor” make a natural person
eligible if
he/she meets the net worth test or income test specified in rule 501(a),
which is that
he/she must have an individual net worth, or joint net worth with the
person’s
spouse, that exceeds $1 million at the time of the investment and an
annual income
exceeding $200,000 within each of the two most recent years or joint
income with a
spouse exceeding $300,000 for those years and a reasonable expectation
of the
same income level in the current year. These dollar limits were
established under
the Securities Act of 1933, Regulation D in 1982.
Due to inflation as well as a large housing boom which has occurred since
1982,
there are many more individuals who now meet the existing accredited
investor
requirements. Under the new rule, a natural person would be an
accredited investor
and be able to invest in a hedge fund and other private investment pools
only if he
or she meets the existing requirements and additionally owns $2,500,000
of
“investable assets”, solely or jointly with a spouse. “Investable
assets” specifically
exclude a personal residence. Personal residence was excluded as it was
determined
to not be a good measurement of the sophistication level of an investor
with respect to financial instruments.
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