Private Equity is Coming for Your Nest Egg

November 14, 2014

Eileen Appelbaum
November 14, 2014, The Hill

VIew article at original source.

The decline in worker pensions creates a challenge for private equity (PE) funds. The funds currently get about a quarter of their capital from public-sector pension funds and another 10 percent from private-sector pension funds. But defined benefit pension plans, once enjoyed by most private-sector workers, have been largely dismantled by corporations. And public-sector pension plans have come under attack in recent years as part of a larger effort by politicians in some states to weaken or destroy public-sector unions. Private equity is worried that the goose that lays the golden eggs it relies on is on the endangered species list. With the industry so dependent on workers’ retirement savings, its future growth prospects are likely to be tied to its ability to tap the estimated $6.6 trillion in 401(k) accounts.

While private equity hasn’t tapped workers 401(k)s yet, Carlyle and other PE firms are currently developing new financial products that will let individual investors write small checks to PE funds.

This new focus on individual investors is facilitated by the Jumpstart Our Business Startups Act (JOBS Act) that went into effect in the fall of 2013. The JOBS Act requires the Securities and Exchange Commission (SEC) to rewrite the rules to permit general advertising. This means that organizations that issue private securities or invite participation in a PE fund can advertise their offerings to individuals and solicit their participation. The rules that implement the JOBS Act do not incorporate basic investor protections. As a result, private equity funds are now able to advertise and solicit funds from anyone. It is, however, still the case that individuals that participate in a PE fund must be “accredited investors.”

To be an accredited investor, an individual must have a net worth — alone or with a spouse — greater than $1 million, not including the value of his or her home. Alternatively, the individual can be an accredited investor if they have an annual income of $200,000 or more (or $300,000 with a spouse). These income thresholds were set in 1982 when $200,000 meant you were a lot richer. If these wealth and income thresholds had been adjusted for inflation, an accredited investor would have to have a net worth of $2.5 million or an annual income of $493,000 (or $740,000 with a spouse).

Granted, very few of us will ever qualify as an accredited investor. Still, about 8.5 million peoplemeet the current criteria. And that includes many professionals, especially in two-earner households, who may head toward retirement with a million dollars in their 401(k)s. To put that in perspective, a million dollars in a retirement savings account comes to $40,000 to $50,000 a year in pre-tax income during retirement.

The SEC is currently considering whether to revise the definition of “accredited investor” — an exercise the Dodd-Frank financial reform act requires it to undertake every four years. In mid-October, the Investor Advisory Committee approved several recommendations. The committee was right to recognize that the current income and wealth thresholds do not guarantee that individual investors are financially sophisticated or are able to withstand potentially large losses from riskier and less liquid investments. It made the reasonable suggestion that individuals who reach an income threshold be allowed to invest in private securities, including PE funds, based on a percentage of their income. But while it acknowledged that income and wealth did not necessarily translate into financial sophistication, it failed to directly address concerns about the low income and wealth thresholds in the current definition.

Moreover, the recommendations of the Investor Advisory Committee do not address the situation in which financially unsophisticated individuals may be tempted to respond to solicitations from PE firms and undertake risky investments with their retirement nest eggs, endangering their economic security in their old age. The SEC can do better. In 2011, the accredited investor definition was changed to exclude a person’s home from the calculation of net worth so that individuals cannot bet their house on a risky investment. In 2014 it should be updated to protect individuals’ retirement income. The SEC should revise the definition of an accredited investor to exclude money in tax-advantaged retirement accounts such as 401(k)s and IRAs. Investors in private securities and PE funds should be wealthy enough to withstand potential losses without relying on their retirement nest eggs.

Appelbaum is a senior economist with the Center for Economic and Policy Research and co-author, with Rosemary Batt, of the book Private Equity at Work: When Wall Street Manages Main Street.

Support Cepr


If you value CEPR's work, support us by making a financial contribution.

Si valora el trabajo de CEPR, apóyenos haciendo una contribución financiera.

Donate Apóyanos

Keep up with our latest news