To consider three important items pertaining to investment adviser compensation, registered closed-end investment companies and business development companies, plus, more generally, accredited investor designations, the SEC will host a public meeting September 30.
Accredited investors
Let’s start with this one, because the agency and its commissioners have been talking about whether to designate certain certifications, designations, or credentials as qualifying for accredited investor status.
Under SEC Chair Paul Atkins, the agency has signaled an intention to expand retail investor access to private markets and move beyond strict wealth- and income-based definitions for “accredited investor” status. Atkins has criticized traditional income and net-worth thresholds as arbitrary, noting that financial sophistication cannot be measured by wealth alone.
Atkins has also directed SEC staff to collaborate with FINRA to explore developing a qualification exam or knowledge-based certification. This test would allow retail investors to demonstrate financial sophistication and qualify as accredited without necessarily meeting the historical net worth benchmark.
Certain restrictions have already been alleviated in this arena, as the SEC has lifted historical policy barriers, such as the 15% private fund limit on registered closed-end funds, allowing retail investors wider exposure to alternative asset classes like private equity and hedge funds.
Critics of the expansion of this definition (like Better Markets and the Consumer Federation of America) fear that exposing less-protected retail investors to high-risk private markets will be damaging for them. They point out that private market investments involve limited public disclosure and more opaque financials, and that those qualified solely via professional credentials rather than wealth could face deep financial losses.
They further note that passing a general test does not automatically mean an individual understands the complex and often illiquid nature of venture capital or private equity funds.
RIAs and performance-based compensation
The SEC will also deliberate whether to put forward amendments to the rule under the Investment Advisers Act of 1940 that gives an exemption to the prohibition on registered investment advisers (RIAs) to collect compensation based on a portion of capital gains in or capital appreciation of client accounts.
The proposed amendments would also incorporate enhanced disclosure requirements relating to performance-based compensation arrangements.
Currently, Rule 205-3 provides an exemption from the prohibition on registered investment advisers receiving performance-based compensation or a share of capital gains. The 1998 exemption to the rule states: “The amendments provide investment advisers greater flexibility in structuring performance fee arrangements with clients who are financially sophisticated or have the resources to obtain sophisticated financial advice regarding the terms of these arrangements.”
The meeting agenda obviously showcases a desire to add some enhanced disclosure requirements to these performance-based RIA comp arrangements.
Investment Fund modernization
The SEC will also consider whether to propose amendments to the Investment Company Act of 1940 rule (Rule 23c-3) that permits regulated closed-end funds to make repurchase offers to shareholders at net asset value at periodic intervals. The proposed amendments would thus expand the ability of regulated closed-end funds (and business development companies) to issue multiple share classes. And it follows recent instances in which certain private credit interval funds faced challenges meeting higher redemption requests due to loan valuation concerns.