From: Robert J. Klosterman
From: Robert J. Klosterman, President and CEO of White Oaks Wealth Advisors Inc.
Re: SEC proposal 33-8766
Thank you for the opportunity to comment on the proposal put forth by the commission to change rules regarding funds operating under 3(c)(1) and 3(c)(7) exemptions. White Oaks Wealth Advisors is a registered investment advisory firm that operates pools under the 3(c)(1) exemptions and as such we have some views on the various proposals and implications within. One cannot argue that fraud and misrepresentation should not happen in any business and particularly in a firm investing capital for the public and we wholeheartedly support that provision of the proposal. We do have several concerns however, about the fairness of the proposals regarding the changes of the accredited investor status.
It would seem that it is a very slippery slope indeed to use a monetary number to assess investor sophistication. While one can point to instances of sudden wealth and the combination of a lack of sophistication about financial matters, it would seem that most that have accumulated $1 million are indeed a fairly sophisticated bunch. They have worked hard, saved, invested and made mistakes to accumulate the sum. This combined with the plethora of financial media resources that we have today that were simply not available in 1982. This includes numerous 24-hour financial news channels, numerous financial media magazines, and financial newspapers and whole sections of daily newspapers that did not exist at that time designed specifically to increase knowledge and sophistication.
The proposal further reduces the types of assets that would be included in determining accredited investor status. Exclusion of business real state interest is puzzling. The very ownership of business real estate in and of itself would suggest some experience/sophistication as an investor. There seems to be very little reason to exclude business real estate for that reason alone, in fact, it probably should be a reason to count an investor has been sophisticated.
The proposal does nothing to delineate between types of pools or the types of firms offering pools. Should not a firm whose managing member is registered by the SEC as a registered investment advisory firm (RIA) be held to different standard than those who are not registered? Would it not make sense to maintain the accredited investor standards for registered investment advisory firms and raise them for firms who are not registered with the SEC? This would assure regulatory oversight for firms operating under the existing standard and provide incentives for other firms do the same.
The proposal seems to treat all funds organized under the exemptions of 3(c)(1) and 3(c)(7) the same with the exception of (viewed by some as the riskiest) venture capital funds using the notion that this serves as a greater social interest. There is no distinction between pools that are made up of liquid tradable securities and those not using sophisticated trading techniques to those that are made up largely of options contracts or are using highly leveraged strategies. There is no distinction for pools using “qualified custodians” and those that do not. There is no distinction between firms who use a third-party qualified firms to do valuations and those who do not. It is hard for us to recognize why pools, made up of long only liquid securities using qualified custodians should be painted with the same brush as other non-liquid funds using highly leveraged strategies that do not use qualified custodians. Our pools were organized to combining buying power for clients to reduce costs. To suggest that an investor need to be more sophisticated to participate in our long only liquid securities pool than to purchase a venture capital pool is hard for us to understand. How is this materially different than the same investor owning a brokerage account and giving a broker discretion? The fact that a RIA firm also has a responsibility to its clients further distinguishes them from other pool sponsors. Would not the public be better served to make distinctions between types of pools and adjust the accredited investor standards between them including whether or not they have RIA status?
The new proposal would restrain a large number of smart and intelligent, market savvy investors from investment pools that can reduce their costs and improve investor returns. It seems unlikely that this proposal would increase competition or very importantly reduce costs but rather would decrease competition, increased secrecy, move more funds offshore and result in increased costs.
Finally, we would hope that there would be a grandfathering of all existing investors for the accredited investor standard if indeed the rules changed. This would be true for maintaining their status as an investor in existing pools and the ability to contribute future capital sums based on their prior status as an accredited investor. They were sophisticated enough to make the original purchase, they should be allowed to continue in their existing fund without impairment. These investors chose to become part of these pools based on the ability to add additional capital over a span of time and should be allowed to do so going forward.
Pools that are managed by SEC RIA firms, where clients receive statements no less than quarterly from a qualified custodian, and are valued by an independent third party firm should continue to with an accredited investor status of $1 million subject to annual audit by an independent, third-party accounting firm. This $1 million would be made up of investment assets and would exclude the equity value of their primary residence. Pools that do not meet these standards would be held to a higher level of accredited investor status. Investment real estate (not used as a residence) would continue to be eligible as part of investment portfolio. The $1 million investment only portfolio should be consistent with the intent of the proposal and with pools created under 3(c)(7). Employees of an RIA firm sponsoring a pool investment would be eligible to participate in the pools as knowledgeable investors. That current investors be grandfathered with continued rights to add additional capital to existing pools. That the commission give some thought and gather further comment on how to further differentiate among the types of pools and investment strategies used within them prior to implementation of this or future proposals.
The investing public is well served when full disclosure of the risks and a variety of opportunities are available from which they can choose. Any action the commission chooses should serve to increase the amount of disclosure and choice the consumer has their disposal.