Responses to Proposed SEC Rules Revising the Definition of "Accredited Investor"

Proposed Rules 509 and 216

Turn Key Hedge Funds Inc. has compiled a collection of specific responses to the SEC’s proposed rules of December 27, 2006 which, if effected, will revise the definition of "accredited investor." Such a change will significantly alter the hedge fund landscape.

Fund managers, fund investors, other market participants, and, indeed, any and all interested parties are encouraged to use what follows, in whole or in part, to respond to the SEC’s call for the public’s comment on this matter. Use these comments as a basis for your own discussion of the proposed rules’ merits or failings, or simply as a standard, brief response. Remember: the greater the public’s response to these proposals, the more likely the SEC will take those views into account when effecting final rule.

There are various methods whereby individuals can submit their comments to the SEC. These are enumerated at the bottom of this page.

• The proposed standard is arbitrary and its proposed application is arbitrary. The proposed "second step" of the accreditation test for natural persons– $2.5 million in "certain investments"– has no basis in any objective measure; it surpasses the current "qualified client" measure outlined in the Advisers Act and does not correlate with the 1982 accreditation standards adjusted for inflation. Further, the Commission intends to apply the new accreditation standards to market participants in one sector, only: hedge funds. Venture capital funds, which in many instances carry the same risks, complex investment strategies, etc. as the typical hedge fund, are curiously given reprieve from the new standards by being placed under the umbrella of "business development companies." What about the dozens of hedge funds who invest a sizable portion of their assets in private equity in a similar fashion?

• The Commission, in effecting this proposed rule, will deprive a great number of currently accredited and sophisticated investors of the ability to invest in a sector of the market that oftentimes outperforms standard indexes. Hedge funds provide many investors with the ability to diversify their portfolios while hedging against downside risk, as they have the propensity to succeed while the market fall. The Commission is effectively stunting the individual investor’s ability to build a strong portfolio by limiting the investments he/she can make.

• The Commission argues that the large decrease in eligible investors proposed is acceptable because the percentage of US households which met the current accreditation standards in 2003 was 8.47% versus 1.87% in 1982, when the standards were first established. It further notes the cause for this increase is "inflation, along with sustained growth in wealth and income of the 1990s." However, it does not account for the overall growth of the US’s population, nor does it mention that investor sophistication may have proportionately grown with income levels. Access to information of all kinds, including that regarding investments and securities, has skyrocketed over the past two decades with the proliferation of the internet and other media outlets. The public domain, which the Commission asserts does not provide access to information about certain risks, etc. is gigantic– the potential to obtain data is incalculable.

• Using a specific amount of investments as a test for sophistication is misguided. Many abundantly wealthy people entrust the care of their assets to investment advisers and brokers while remaining completely ignorant of the merits or risks of the investment vehicles or choices their money is being used in or for. Yet, under the new standards, they would be admitted to newly restricted private investment vehicles. Simultaneously, many individuals who do not have that same level of discretionary assets but possess a true depth of knowledge in the realm of finance and investment (i.e., brokers, CPAs, investment advisers, some attorneys, and many other professionals) would be barred entry. There is an inherent inequality present in this paradigm.

• The Commission hopes "thinning the herd" of hedge funds by diminishing their eligible client base will promote competition, perhaps giving way to reduced fees imposed. This assertion is flawed as it does not take into account the primary reason investors join certain funds: performance. The more participants (both investors and investment sponsors) in the hedge fund marketplace, the better the chance for more high performers and, consequently, more choice for eligible investors. Increased choice and a comfortably-sized pool of investors will give way to competition of the type the Commission claims to desire, whilst the only end to the currently proposed rules is a major loss of opportunity for fund managers and investors, with the latter bearing the brunt.

• The proposed rule promotes inequality. Its key failing is not taking into account the true elements which comprise "sophistication." Exorbitant amounts of discretionary assets does not a sophisticated person make. The current income and net worth standards are sufficient; the Commission should focus on better defining sophistication if its aim is to better protect investors. Protection does not equal exclusion.

Submitting Comments

By Internet:

Navigate to http://www.sec.gov/rules/proposed/proposedarchive/proposed2006.shtml, and click on the link, Submit comments on S7-25-06 (for the December 27, 2006 proposal);

By e-mail:

Send an e-mail to rule-comments@sec.gov; Please include File Number S7-25-06 on the subject line;

By mail:

All submissions should refer to File Number S7-25-06.

Send paper comments in triplicate to:

Nancy M. Morris, Secretary

Securities and Exchange Commission

100 F Street, NE, Washington, DC 20549-1090.

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