Think of the huge backlog of "shi*ty" unregistered securities scooped up by all these accredited and qualified institutional buyers during the real estate boom, with Goldman's famous Timberwolf and Abacus CDO deals topping it off. These structured finance units were being run like industrial scale crystal meth labs. These securities need to be set free. Isn't there a way to float out chopped up tradable interests in debt securities (MBS, CMBS, ABS etc) on an exchange, SecondMarket or Prosper, with hedging abilities?
The system didn't give a sh*t about the underlying asset. The initial poorly underwritten mortgage (whether residential or commercial) with no income documentation at 95% LTV, originated by a broker for points (which is coming back by the way, there goes the train - Forbes), was then sold, securitized and bought by various "accredited" financial institutions for fees until it ultimately landed on a fund's balance sheet, that hopefully hedged with CDS, no?
Well it turns out all of these so called sophisticated, accredited financial institutions running the credit market lost all credibility when the 2008 financial crisis hit and they all went went bankrupt or lost a huge chunk of money, from Bear Stearns, Lehman Brothers, Merrill Lynch, Bank of America, Citigroup, Merrill Lynch, Washington Mutual, ABN Amro, IKB, ACA to the bond insurers FGIC, AMBAC and AIG. Which tells me the financial infrastructure in place is old fashioned, inefficient and a POS. These institutions should have never been considered "accredited investors" gambling with shareholders money, they were a systemic risk and nothing has changed people!
Sadly, mispriced debt securities (registered?) made their way down to the retail level inside strategic bond mutual funds and ETFs. For example, Morgan Keegan bond funds lost conservative investors 50%-80% of their money in 2007 and even Series 7/63/65 licensed financial advisors selling these funds had no idea why they kept losing value, they were misled. Morgan Keegan is a full service investment banking, securities brokerage, trust and asset management company aka an "accredited investor" and "qualified purchaser" as well as a registered broker/dealer and registered investment advisor with the SEC.
FINRA, SEC Hit Morgan Keegan With Enforcement Actions (NASDAQ.com)
"The FINRA complaint alleges that during January 1, 2006 through Dec. 31, 2007, Memphis-based Morgan Keegan used "false and misleading sales materials" when it marketed and sold the seven bond funds to retail investors. The complaint also states that "all of the funds invested heavily in structured products which caused them serious difficulties beginning in early 2007 and led to their collapse later that year, costing investors well over a billion dollars." The complaint continued, saying: "The sales materials, combined with the firm's misleading internal guidance and inadequate training, misled its own financial advisors." read article at nasdaq.com
SEC, FINRA, State regulators charged Morgan Keegan with fraud (Reuters)
"Several Morgan Keegan funds, including some marketed as conservative investments for older investors, lost more than 50 percent of their value in 2007.
"The scheme had two architects: a portfolio manager responsible for lies to investors about the true values of the assets in the funds, and a head of fund accounting who turned a blind eye to the fund's bogus valuation process," said Robert Khuzami, head of the SEC enforcement division, in a statement.
In its complaint, the SEC said that Morgan Keegan fraudulently hid the falling value of some mutual funds between January and July of 2007, and "recklessly" sold fund shares to investors based on inflated prices.
The SEC accused portfolio manager James Kelsoe, 46, of improperly directing his accounting department to make repeated, arbitrary "price adjustments" that boosted the fair values of securities." read article at Reuters
By the way, Kelsoe is a Chartered Financial Analyst (CFA) who's been involved with the advisor since 1991 and in the business since 1986 (see original prospectus). So if these people didn't know what the hell was going on, who the hell do you trust for a passive investment these days? Below are definitions of an "accredited investor", "qualified purchaser" and "sophisticated investor".
The federal securities laws define the term "accredited investor" in Rule 501 of Regulation D as:
1. a bank, insurance company, registered investment company, business development company, or small business investment company;
2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
3. a charitable organization, corporation, or partnership with assets exceeding $5 million;
4. a director, executive officer, or general partner of the company selling the securities;
5. a business in which all the equity owners are accredited investors;
6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;
7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes. (SEC.gov)
Qualified purchaser, defined by the Investment Company Act of 1940
"Qualified purchaser" means--
any natural person (including any person who holds a joint, community property, or other similar shared ownership interest in an issuer that is excepted under section 3(c)(7) [15 USCS § 80a-3(c)(7)] with that person's qualified purchaser spouse) who owns not less than $ 5,000,000 in investments, as defined by the Commission;
any company that owns not less than $ 5,000,000 in investments and that is owned directly or indirectly by or for 2 or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption, spouses of such persons, the estates of such persons, or foundations, charitable organizations, or trusts established by or for the benefit of such persons;
any trust that is not covered by clause (ii) and that was not formed for the specific purpose of acquiring the securities offered, as to which the trustee or other person authorized to make decisions with respect to the trust, and each settlor or other person who has contributed assets to the trust, is a person described in clause (i), (ii), or (iv); or
any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $ 25,000,000 in investments source: law.uc.edu
Rules 505 and 506 of REG D also provide registration exemptions. Rule 505 doesn't require non-accredited investors to be sophisticated if the offering is up to $5,000,000 while 506 says an unlimited capital raise requires non-accredited investors to be sophisticated or "they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment; (SEC.gov).
In conclusion, the "sophisticated investor" definition in my opinion is complete bullsh*t and I'm not alone.
Definition of "sophisticated investor" varies - MarketWatch
The Sophisticated Investor Farce - Forbes Advisor Soapbox
Open Thread: How SHOULD a “Sophisticated Investor” Be Defined? - Stone Street Advisors
When you have bond portfolio managers lying about marks, or have no clue about the underlying value (or credit risk) of a debt security, the credit market is broken and useless for any type of investor, except for maybe the big short. To prevent another black swan event in the credit markets, I think every single piece of debt packaged in a security or CDO and sold to investors should have real-time cash flow updates, yields, default/delinquency rates, credit ratings and insurance rates plus historical charts provided at FINRA.org or SecondMarket, etc. FINRA already provides decent bond information for investors on Treasuries, Agencies, Municipal and Corporate bonds. Check it out. Please correct me if I'm wrong on anything or have ideas, thanks.