A Securities and Exchange Commission probe of hedge fund practices could affect other private investment partnerships such as venture-capital and buyout funds.
The year-old investigation was prompted by concerns about the incidence of fraud at hedge funds and their growing availability to smaller investors. Many people think the SEC will eventually require managers to submit to more oversight by registering as investment advisers. It may also impose tighter restrictions on who can invest.
Since venture capitalists rely on the same exemptions from securities laws, they risk losing their loosely regulated status, too.
“We would certainly have to work very hard to make sure we were protected,” said Mark Heesen, president of the National Venture Capital Association.
Heesen said venture capitalists are particularly concerned about possible changes in the qualifications for investing in hedge funds and other investment vehicles that are sold through a private offering. Currently they are only available to individuals with a net worth of $1 million or an annual income of $200,000.
Most venture capitalists cater to investors who have no trouble meeting the standards. But Heesen said venture funds frequently waive their minimums for smaller investors who might have expertise in a particular industry or other qualifications. Raising the net-worth or income test for accredited investors might make it difficult to bring these kinds of investors on board.
“We’re meeting with the SEC and making it very clear … that any changes to the accredited investor rule should be exclusive to hedge funds,” he said.
Venture capital funds are already having trouble raising money, taking in less than $1 billion in the first quarter, down from $1.7 billion in the previous quarter, according to figures compiled by Thomson Venture Economics and the NVCA. Industry experts expect fund-raising activity to remain low for the foreseeable future as the venture capital industry steadily depletes its current reserves.
Venture capitalists say they have legitimate reasons for tapping investors who may only be moderately wealthy as limited partners.
Richard Ginsberg, an attorney with Katten Muchin Zavis Rosenman in New York, says many venture fund clients like to have retired or semiretired executives in the industry in which they invest and these investors might not meet higher net-worth tests.
“Almost all VC funds have people that barely meet this test, and so will fall out” if that standard is raised, he said.
Not everyone is concerned about the SEC raising the accredited investor standard, however. Steven P. Bird, the general partner at Focus Ventures, of Palo Alto, Calif., says there are between 40 and 50 limited partners at the firm’s various venture capital funds who are wealthy individuals.
They are all so wealthy that they would have no trouble meeting the accredited investors standard even if it were doubled to $2 million, Bird said.
“As much as we try to be prudent, venture capital is high-risk,” he said. “If they weren’t able to pass by a wide margin, I’m not sure I’d be comfortable taking their money to invest in our funds.”
