The rule would expand the definition of an “accredited investor” based on certain professional designations or certifications, one’s status as a “knowledgeable employee” of a private fund, as well as family offices with more than $5 million in assets under management and their family clients.
Initially, the SEC opened the proposed rule up to a 60 day public comment period, but due to COVID-10, the comment period has extended through June 1st.
Expanding the definition of an “accredited investor” would create opportunities for a significant amount of smaller investors who previously didn’t meet the SEC’s wealth thresholds. Not only can these smaller investors now offer capital, they can also diversity their portfolio. However, potential risks may come with this. As SEC Commissioner Allison Herren Lee says, “The release wholly ignores the flip side of the problem with the wealth thresholds—they are indisputably over-inclusive, capturing investors with little to no ability to assess or bear the risks of private offerings.” For compliance professionals, it will be more critical than ever to have a robust and reliable compliance program in place to ensure that SEC guidelines are not being violated in the process of this expansion.
3 Components of a Strong Compliance Program for Alternative Investments
Firms offering alternative investments should re-evaluate their compliance program so that it’s tailored to address the risks associated with the specific products, services, and distribution models used. The following list highlights 3 components of a strong compliance program that can help guide firms in the right direction.
- Training: The most important thing firms can do is ensure salespeople and compliance staffers understand the products the firm offers, inside and out. Product-specific training should include the potential compliance risks inherent in the product, which will help personnel make the connection between disclosure requirements and risk.
- Due Diligence: It is important for firms to conduct adequate due diligence on any new product, service provider, or third-party relationship. Firms should make sure due diligence also covers third parties’ use of technology and their controls related to cybersecurity risks.
- Technology: As is also true with other areas in financial services, the alternatives space is changing rapidly in large part due to technological innovations. According to AIMA, the alternatives industry is expected to spend a staggering $1.7 billion on alternative data and are increasingly leveraging machine learning and AI. Compliance personnel need tools that will allow them to monitor transactions and spot potential issues.
Expect Continued Growth in the Alternatives
While past performance is never a reliable indicator of future results, hedge funds reported attractive returns in 2019, with an average 9% net of fees according to AIMA’s survey. The industry is also expected to expand and grow in more emerging markets.
If your firm operates in the alternatives space, it’s imperative you are ready to handle the opportunities and challenges that could come with the proposed rule changes that would redefine “accredited investor” as soon as June.