Wealth and Knowledge: Strengthening the Economy by Expanding the Qualified Purchaser 'Sophisticated' Standard Under the Investment Company Act of 1940

Author:Eveyln S. Anderson
Position:J.D. Candidate, The University of Iowa College of Law, 2017; B.A., Grinnell College, 2012
Pages:735-760
SUMMARY

This Note traces the government's effort to balance the need for investments with the need for regulating the economy. Regulations of the financial industry, largely in response to economic crises such as the Great Depression and the 2008 recession, have focused on limiting investments deemed too risky for the general public to "sophisticated" investors. Struggling to define "sophisticated,"... (see full summary)

 
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735
Wealth and Knowledge: Strengthening
the Economy by Expanding the Qualified
Purchaser “Sophisticated” Standard
Under the Investment Company Act of
1940
Evelyn S. Anderson*
ABSTRACT: This Note traces the government’s effort to balance the need for
investments with the need for regulating the economy. Regulations of the
financial industry, largely in response to economic crises such as the Great
Depression and the 2008 recession, have focused on limiting investments
deemed too risky for the general public to “sophisticated” investors. Struggling
to define “sophisticated,” Congress and the SEC opted for criteria based on the
investor’s net worth with narrow exceptions for highly knowledgeable but
lower-net-worth individuals. Recent legislation and interpretation of that
legislation have expanded these narrow exceptions, suggesting the trend is
moving towards investor eligibility criteria based on sophistication measures
beyond net-worth. This change is a positive one for investors, businesses, and
the economy as a whole. However, the benefits of the current efforts to expand
the definition of “sophisticated” cannot be realized because legislative
incentives for investment managers continue to limit investment
opportunities to only the very rich without regard for knowledge or expertise.
This Note proposes that Congress should expand the Qualified Purchaser
standard under the Investment Company Act of 1940 to allow sophisticated
but lower-net-worth individuals to invest in hedge funds.
I. INTRODUCTION ............................................................................. 736
II. HEDGE FUNDS: A REGULATORY FRAMEWORK ............................... 739
A. ECONOMIC DOWNTURNS AND SUBSEQUENT REGULATIONS ......... 741
* J.D. Candidate, The University of Iowa College of Law, 2017; B.A., Grinnell College,
2012. Thank you to Julie Coleman, Zack Shankman, Brett Rogers, and Mike Hankin at Brown
Advisory for sparking my interest in this topic and giving me the opportunity to develop my
understanding of finance and corporate law. Thank you also to my friends and editors on the
Iowa Law Review for their help with this Note.
_ANDERSON
736 IOWA LAW REVIEW [Vol. 102:735
B. INVESTOR ELIGIBILITY: DEFINING “SOPHISTICATED ................. 742
1. Accredited Investor Standard ....................................... 743
2. Qualified Purchaser Standard ...................................... 744
C. EXPANDING “SOPHISTICATED ................................................. 746
1. The Knowledgeable Employee Rule and Qualified
Purchasers ...................................................................... 747
2. The JOBS Act and Accredited Investors ...................... 748
III. FAILING TO DEFINE AND IMPLEMENT A WORKABLE DEFINITION OF
“SOPHISTICATED” .......................................................................... 750
A. “SOPHISTICATED”: THEORY VERSUS REALITY............................ 751
B. IGNORING INCENTIVES IN EXISTING REGULATORY FRAMEWORK
AND PROPOSALS ...................................................................... 753
1. Inadequacy of the JOBS Act and the Knowledgeable
Employee Rule .............................................................. 753
2. Inadequacy of Current Proposals ................................. 754
C. HOW MISALIGNED INCENTIVES HURT THE ECONOMY ................ 755
IV. EXPANDING “SOPHISTICATED UNDER THE QUALIFIED PURCHASER
STANDARD ..................................................................................... 756
A. LONG- AND SHORT-TERM SOLUTIONS ....................................... 756
B. CONSIDERING COUNTERARGUMENTS ........................................ 758
V. CONCLUSION ................................................................................ 759
I. INTRODUCTION
Fear surrounding economic downturns is not a recent phenomenon.
After the stock market crash, or “Black Tuesday,” that propelled the United
States into the Great Depression in 1929, The New York Times reported,
“[s]tock prices virtually collapsed yesterday,” and called the crash “the most
disastrous in Wall Street’s history.”1 Almost 79 years later, in 2008, a headline
in The New York Times proclaimed, “For Stocks, Worst Single-Day Drop in Two
Decades.”2 As is typical in moments of fear and panic, the American public
searched for answers that might explain the losses that left many without jobs
or opportunities. The American government, seeking to alleviate such fears,
1. Stocks Collapse in 16,410,030-Share Day, but Rally at Close Cheers Brokers; Bankers Optimistic,
to Continue Aid, N.Y. TIMES: ON THIS DAY (Oct. 29, 1999), http://www.nytimes.com/learning/
general/onthisday/991029onthisday_big.html (last visited Oct. 12, 2016).
2. Vikas Bajaj & Michael M. Grynbaum, For Stocks, Worst Single-Day Drop in Two Decades, N.Y.
TIMES (Sept. 29, 2008), http://www.nytimes.com/2008/09/30/business/30markets.html.

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