Private Investment Companies in the Wake of the Financial Crisis: Rethinking the Effectiveness of the Sophisticated Investor Exemption

Document Type


Publication Date

January 2012


The Securities and Exchange Commission ("SEC") is the regulatory body that is charged with implementing the federal securities laws. It fulfills this obligation by actively pursuing its mission to protect investors, maintain fair, efficient, and competitive markets, and facilitate capital formation. While considerable disagreement exists with respect to the policies and mechanisms utilized by the SEC, the proper implementation of its mission is integral to the overall health of the capital markets. However, the current regulatory framework that divides public and private investment companies is compromising the fulfillment of this vital mission. This framework divides public and private vehicles based on the status of individual investors, where transactions that are restricted to sophisticated investors, which are statutorily defined as institutional or high net-worth individuals, are automatically deemed private.Yet, many such private investment companies are avid participants in the public capital markets and are capable of creating negative externalities that adversely affect unsuspecting third parties as well as the national economy. As such, this Article argues that the sophisticated investor exemption is no longer a reliable mechanism for separating private and public investment companies. This Article broadens this analysis by examining the extent to which the sophisticated investor exemption has undermined the SEC's ability to fulfill its mission to protect the public capital markets, and whether this failure has left the general public inadequately protected.