Players in the financial investment sector have forever heeded to the wayward movements of the “sophisticated investor”. The exclusive club of well-to-do money-savvy individuals have made a killing on that very title. Institutional investors, funds, VC’s and other financial block veterans have tossed silly amounts of coin into a pool, all because the pool-keeper deemed himself a “sophisticated investor”. Two months ago, you could have asked anybody on Wall Street if Bernie Madoff was a “sophisticated investor”, and any outlier answer would have had to come from a tourist. A great article written yesterday for the New York Times by Peter J. Henning, a professor at Wayne State Law School, emphasized the ambiguities, faults, and ethics issues wrapped up in the mountains that are moved in the investment world by the “sophisticated investor” title.
Henning’s article warns investors not to rely so blindly on the “sophisticated investor” branding, for it only denotes great wealth, and not investment savvy. While we contemplate the need to redefine this indicia of trust and confidence on Wall Street for the financial sector, we should also throw in some consideration for what might verify sophistication in intellectual property investments.
The market for, indeed the idea of, intellectual property as an investment vehicle is new to Wall Street, but it is taking hold. Still, certainly there can only be few, if any, individuals that might rightly deem themselves “sophisticated investors” in intellectual property. Even more alarming is the fact that shares of ownership in intellectual property, and the increasing frequency with which such shares are being traded, can constitute a security or securities under the Securities Act of 1933 or the Securities Exchange Act of 1934, triggering registration and disclosure requirements with the S.E.C. and governing state bodies. Rule 506 of the 1933 Act confuses matters further in the IP arena. In what is commonly called the “sophistication requirement”, in order for a private offering of securities to be exempt from federal S.E.C. registration and disclosure requirements, all non-accredited investors (See Rule 501 for a definition of “accredited investor”) must have “such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment”. The introduction of IP-focused investing, and the rise in interest and participation of hedge funds and private equity in such investments, sheds a new light on the “sophistication requirement”. Surely, few investors (especially one who is not a wealthy “accredited investor”) today have the requisite “knowledge and experience in financial and business matters” pertaining to intellectual property. Even more important, I would dare say that, with the considerable risk in valuing intellectual property because of the lack of any accurate valuation method or price discovery, nobody is completely capable of “evaluating the merits and risks of the prospective investment” in intellectual property. Despite these forward-looking thoughts, these are considerations that may have to wait to be tackled until they reach the level of litigation.
For now, if you are a prospective investor and some person or entity approaches you claiming they are a “sophisticated investor” in patent pools, IP portfolios, or IP funds, read Henning’s article and think twice before acting.