SEC RULE CARRIES NEW RISKS

​I doubt many of my readers spend a lot of time studying, or caring about, Rule 144A from the Securities Act of 1933, but let me point out how a recently proposed change to that rule might affect them.* The rule requires investors in the private capital markets to qualify as “Accredited Investors.” This means they must meet minimum thresholds for net worth and/or income levels. The theory is that private offerings may have higher risks and therefore are only suitable for individuals with enough financial resources to bear those risks.
 
The SEC is proposing changing the definition of “Accredited Investor” and in one area of change it relates to financial advisors who hold certain licensing. For these advisors the income and asset minimums would be waived. The SEC believes that a financial advisor who can legally give advice to others on these products should be knowledgeable enough to decide whether they should personally own them.
 
I understand the logic the SEC is using in reaching this conclusion, but in my opinion, they are overlooking a key element that may have unintended negative side effects for investors. I believe that good financial advisors must first be financially sound in their own lives. They become sound by demonstrating, over time, an ability to save and invest in a manner that will naturally lead them to becoming accredited investors themselves. Let them go through the same process they teach to their clients. Along the way they will not only strengthen their own finances, but increase their ability to give advice to others.
 
Private offerings carry unique risks and if advisors are permitted to invest in them before they are “financially” prepared, they risk getting themselves into financial difficulty. You would never want to get financial advice from an advisor who was in financial trouble. Such a situation could lead to the advice being biased by the advisors need for income. While counseling another financial advisor some years ago who I could see was giving advice based on his personal need for a commission, I asked him the question, “Are you planning your clients’ retirement or your own with this advice?”
 
It is my opinion that if advisors are allowed under this new rule to take more risks in their own investments than would otherwise be appropriate, the potential exists for those advisors to get themselves into financial trouble.  I do not believe the SEC should change the accredited investor rules to allow certain financial advisors to bypass the income and asset requirements. I believe doing so may put them and their clients at risk. Let them save their money, invest wisely, build a solid portfolio, and demonstrate by a lifetime of sound investing that they are ready to move on to potentially higher risks in the private capital markets. If they are unable to do so, then maybe it’s an indication that they shouldn’t be giving financial advice in the first place.