Sophistication is a difficult standard to nail down. The ability to fend for one’s self is ambiguous. The idea of the issue is whether the investor can understand and evaluate the nature of the risk based on the information they are provided. This may mean they must have exceptional business experience. However, previous investment experience is not generally sufficient by itself, and neither is formal education or a high income.
In requiring sophistication in the SEC rules, the SEC has stated as follows:
Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) [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.
Accredited investors are another way to address the sophistication of investors and will be discussed in a later post.
Next up…The Requirement of Access to Information in Private Placements