On the Outside of Hedge Funds Looking In
By KARA SCANNELL.- Mitchell D. Smith, a former stockbroker who runs an investing club in San Francisco, has a message for securities regulators: Let me invest in hedge funds! "Stay out of my wallet, stop trying to protect me from myself, stop presuming to know more than I do about my own life, risk-tolerance and financial sophistication," Mr. Smith wrote in March. Since the start of the year -- and even during the market's recent gyrations -- letters and emails have streamed into the Securities and Exchange Commission protesting a proposal to make it tougher for individuals to invest in hedge funds.
The SEC wants to bar anyone who has less than $2.5 million in liquid assets, excluding real estate. The current limit: $1 million, including the value of your home.
The SEC routinely receives letters commenting on its proposals, but usually they come from lobbyists or interest groups. Roughly 500 letters have arrived so far -- one from a 24-year-old fresh out of business school, others from 70-year-old investors who have seen several market booms and busts.
The letters come as lawmakers and regulators are struggling to find the right balance in overseeing the $1.3 trillion hedge-fund industry. Several funds were at the center of the recent stock-market turmoil, including two that specialized in subprime investments run by Bear Stearns Cos.
At the same time, some congressmen have criticized the SEC for not aggressively investigating potential illegal insider trading by hedge funds.
An SEC rule requiring hedge-fund advisers to register with the agency was tossed out in court last year. Since then, the SEC added an antifraud rule and set up a team of enforcement attorneys to focus on hedge funds. Now it wants to raise the qualification limits.
Gregory D. Kapraun of Rochester, Minn., said the proposal gives an unfair investing advantage to pop stars like Britney Spears, or heirs to family fortunes. Why should their fat bank accounts automatically qualify them to invest in hedge funds, while he is prohibited?
Mr. Kapraun's argument: Sports athletes with big signing bonuses, or entertainers like Ms. Spears, don't "even come remotely close to the sophistication I have."
Other letter-writers include a retired schoolteacher, a handful of medical doctors and scores of financial professionals and small-business owners across the country, from New York City to Anchorage, Alaska, as well as investors in Dubai and Thailand.
All the letter writers contacted by The Wall Street Journal say they haven't changed their position as a result of the markets' ups and downs. One didn't return calls.
Let 'Em Eat Mutual Funds
Some letters take a populist view, arguing that shutting out smaller investors only makes the rich richer. "Force all the very wealthy to invest only in mutual funds and see how that flies," wrote Arnold Peterson, an orthopedic surgeon.
"The limit should be lowered, not raised," said Harold Robinson of Chandler, Ariz. "The poor performance of most mutual funds shows that all citizens need to have access to more investment choices."
Some played the Enron card, noting that they lost money by investing in the now-failed energy company.
"I can appreciate your efforts to protect individuals from fraudulent investments, but is it any different than investing in Enron a few years ago?" said Mike Darraugh, a Lake Bluff, Ill., investor in private partnerships. "I don't expect any guarantees from you. ... If that was my goal then I would invest in T-Bills."
Hedge funds are widely considered among the riskiest places individual investors can put their cash. They're lightly regulated and often buy financial instruments that don't trade on stock or futures exchanges. Some hope to profit when stock prices decline.
When it proposed the new rule, the SEC said it wanted to account for inflation and the years-long surge in property values, which significantly expanded the pool of potential investors. Hedge funds, the SEC chairman said, are not for "mom and pop" investors.
SEC's View
An SEC spokesman said the agency worries that small investors don't have enough financial muscle to command the same disclosures as those received by institutions or rich individuals.
He also said the agency wouldn't comment on the comment letters it has received.
Some letter-writers offered the SEC advice, suggesting that it might instead consider restricting the percentage of a portfolio that can be invested in hedge funds.
Alan Gordon, an individual investor in Huntington, N.Y., offered a laddered approach: Investors with a $1 million net worth could invest as much as 10% in hedge funds; those with $2 million can invest 15%.
"Why stop with hedge funds?" asked Kenneth A. Gruber, a professor of biological sciences at California State Polytechnic University at Pomona, Calif. He said if the SEC wants to be paternalistic it should look to protect investors from other risky investments, such as penny stocks.
"Does any sophisticated investor [or the SEC] believe that penny stocks are a safer investment than hedge funds? I submit it is easier to lose one's shirt on penny stock investments than in hedge funds. Where will it end?"
Not all the letters opposed the SEC's new rule. "I'm 100% FOR the SEC raising the limits," said Benjamin W., a self-described advanced currency trader who wrote several missives that were posted on the SEC's Web site.
"I encourage them to do so for the protection of 'sophisticated' investors too stupid to understand what they are doing with their own money."
The SEC wants to bar anyone who has less than $2.5 million in liquid assets, excluding real estate. The current limit: $1 million, including the value of your home.
The SEC routinely receives letters commenting on its proposals, but usually they come from lobbyists or interest groups. Roughly 500 letters have arrived so far -- one from a 24-year-old fresh out of business school, others from 70-year-old investors who have seen several market booms and busts.
The letters come as lawmakers and regulators are struggling to find the right balance in overseeing the $1.3 trillion hedge-fund industry. Several funds were at the center of the recent stock-market turmoil, including two that specialized in subprime investments run by Bear Stearns Cos.
At the same time, some congressmen have criticized the SEC for not aggressively investigating potential illegal insider trading by hedge funds.
An SEC rule requiring hedge-fund advisers to register with the agency was tossed out in court last year. Since then, the SEC added an antifraud rule and set up a team of enforcement attorneys to focus on hedge funds. Now it wants to raise the qualification limits.
Gregory D. Kapraun of Rochester, Minn., said the proposal gives an unfair investing advantage to pop stars like Britney Spears, or heirs to family fortunes. Why should their fat bank accounts automatically qualify them to invest in hedge funds, while he is prohibited?
Mr. Kapraun's argument: Sports athletes with big signing bonuses, or entertainers like Ms. Spears, don't "even come remotely close to the sophistication I have."
Other letter-writers include a retired schoolteacher, a handful of medical doctors and scores of financial professionals and small-business owners across the country, from New York City to Anchorage, Alaska, as well as investors in Dubai and Thailand.
All the letter writers contacted by The Wall Street Journal say they haven't changed their position as a result of the markets' ups and downs. One didn't return calls.
Let 'Em Eat Mutual Funds
Some letters take a populist view, arguing that shutting out smaller investors only makes the rich richer. "Force all the very wealthy to invest only in mutual funds and see how that flies," wrote Arnold Peterson, an orthopedic surgeon.
"The limit should be lowered, not raised," said Harold Robinson of Chandler, Ariz. "The poor performance of most mutual funds shows that all citizens need to have access to more investment choices."
Some played the Enron card, noting that they lost money by investing in the now-failed energy company.
"I can appreciate your efforts to protect individuals from fraudulent investments, but is it any different than investing in Enron a few years ago?" said Mike Darraugh, a Lake Bluff, Ill., investor in private partnerships. "I don't expect any guarantees from you. ... If that was my goal then I would invest in T-Bills."
Hedge funds are widely considered among the riskiest places individual investors can put their cash. They're lightly regulated and often buy financial instruments that don't trade on stock or futures exchanges. Some hope to profit when stock prices decline.
When it proposed the new rule, the SEC said it wanted to account for inflation and the years-long surge in property values, which significantly expanded the pool of potential investors. Hedge funds, the SEC chairman said, are not for "mom and pop" investors.
SEC's View
An SEC spokesman said the agency worries that small investors don't have enough financial muscle to command the same disclosures as those received by institutions or rich individuals.
He also said the agency wouldn't comment on the comment letters it has received.
Some letter-writers offered the SEC advice, suggesting that it might instead consider restricting the percentage of a portfolio that can be invested in hedge funds.
Alan Gordon, an individual investor in Huntington, N.Y., offered a laddered approach: Investors with a $1 million net worth could invest as much as 10% in hedge funds; those with $2 million can invest 15%.
"Why stop with hedge funds?" asked Kenneth A. Gruber, a professor of biological sciences at California State Polytechnic University at Pomona, Calif. He said if the SEC wants to be paternalistic it should look to protect investors from other risky investments, such as penny stocks.
"Does any sophisticated investor [or the SEC] believe that penny stocks are a safer investment than hedge funds? I submit it is easier to lose one's shirt on penny stock investments than in hedge funds. Where will it end?"
Not all the letters opposed the SEC's new rule. "I'm 100% FOR the SEC raising the limits," said Benjamin W., a self-described advanced currency trader who wrote several missives that were posted on the SEC's Web site.
"I encourage them to do so for the protection of 'sophisticated' investors too stupid to understand what they are doing with their own money."
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