SEC slammed over hedge fund 'wealth' test

It seemed reasonable enough: Protect the little guy from big risks in hedge funds. But the public comments suggest little guys don't want any help.

By Bethany McLean, Fortune editor-at-large

NEW YORK (Fortune) -- You almost have to pity the poor SEC. Recently, the commission was all but accused of a cover-up by Senators Grassley and Specter in the matter of Gary Aguirre.

(You may recall that Aguirre, a former SEC lawyer, complained that he was fired by the commission for complaining that an insider trading investigation of hedge fund giant Pequot Capital was squashed for political reasons.)

Before that, Phillip Goldstein, a hedge fund manager few had heard of, had the temerity to sue the SEC over its controversial 2004 rule that forced managers to register with the commission. And Goldstein won!

The latest is the furor over the SEC proposal, made in December, to lift the minimum wealth required to invest in hedge funds. In 1982, the bar was set at $1 million in net worth; the SEC proposed adding to that a requirement that a would-be investor also have $2.5 million in investments.

"We are therefore proposing to define a new category of accredited investor, which is called an 'accredited natural person,' which is designed to help ensure that investors in these types of funds are capable of evaluating and bearing the risks of their investments," wrote the SEC.

Who could quibble with the SEC on this one? After all, everyone, from politicians to the press, both here and abroad, has been shrieking in increasing apocalyptic terms about the myriad dangers that big, bad hedge funds pose to poor, small investors. Why not protect those poor, small non-accredited and presumably unnatural people from themselves?

Oh boy. If you want to hear quibbles - and then some - just check out the comments the SEC got. Here is a sample:

"You have to be rich to be smart?"

"I find the idea that the definition of an accredited investor is based solely on a net worth requirement to be repugnant to the principles of equality of all people. Why should the "rich" be allowed a wider array of investment options just because they are rich? This is often just as much an accident of birth as race or sex....I take this proposed change as a direct affront on my ability to take care of my and my family's future. The approach that you appear to be taking is short-sighted, mean-spirited and represents the easy way out."

"The proposed rule changes are discriminatory and anti-Constitutional. We have long since done away with property qualifications for voting, and with other forms of discrimination throughout our society."

"If I gave you $2.5 Million would it make you any smarter?"

"Please don't protect me from myself! I am quite capable of protecting myself! It's you that scares me."

"If I am smart enough to buy/sell stocks, bonds, options, futures, etc. I am smart enough to buy/sell hedge fund managers."

As readers noted, the "little guy" can - and often does - lose 100 percent of his investment in a single company that goes bankrupt.

One commenter wrote, "Earlier this decade I had the opportunity to buy any number of dot-com stocks that eventually and quickly evaporated. I enjoyed this luxury without any oversight from federal regulators."

Some argued that the SEC should spend its time policing small cap stock frauds instead. "If it is truly the SEC's wish to protect unsophisticated investors, then why don't you clean up the glaringly illegal and grossly unfair practices which take place daily in the stock market and cost retail investors countless thousands of dollars (the very same dollars you're trying to keep them from losing in "risky" investments."

And readers suggested alternatives. The one letter I found that agreed with the SEC's proposal also had this to offer: "There should also be a option for investors who do not reach the requirement to pass an intermediate level financial exam...An investor who could pass the exam would qualify to invest in these private funds."

Actually, why not require all investors - rich or otherwise - to pass an exam? After all, you have to pass a test to drive a car.

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