The Securities and Exchange Commission recently convened a meeting of its Small Company Advisory Committee. Normally news like that would not be big news for securities professionals, except for one point of discussion: overhauling the definition of an accredited investor.
We can probably all agree that the current definition is outdated. It was adopted in 1982, and based on a person’s annual income and assets owned. If the person meets those thresholds—$200,000 income per year and $1 million in assets, excluding your primary residence—then he or she is accredited.
That’s it. That’s the whole test to determine whether someone is allowed to participate in all those juicy private offerings exempt from the usual registration requirements. You just need to be wealthy.
The two problems here are obvious. First, $200,000 in income isn’t that much money any more; plenty of upper-middle class people earn that, and plenty of power couples can pass the $300,000 requirement for married households. If we want a bright-line test for who is accredited, this one is out of date. Second, plenty of people who are wealthy are also nitwits, who have no business dabbling in the risky, low-disclosure investments that private offerings often are. They only get that chance because they’re wealthy enough to afford another shirt, should they lose their first one in whatever private offering goes sour.
That last point is no exaggeration. The SEC itself says in Regulation D that its definition of accredited investors is “intended to encompass those persons whose financial sophistication, and ability to sustain the risk of loss of investment or ability to fend for themselves, render the protections of the Securities Act’s registration process unnecessary.” Ponder that the next time you’re talking to a client with an eight-figure trust fund and a room-temperature IQ.
Still, the more important question here is that first part of the definition, about financial sophistication—which is something far more people have today than when accredited investors were last considered in the Reagan Administration. We all now have access to financial data beyond the imagination of Wall Street traders 30 years ago. Anyone with a computer and an Internet connection can now research companies, mutual funds, commodities, and any other investment opportunity instantly, and in dizzying detail.
So if someone is whip-smart about investment opportunities and knows exactly what he wants, should that person really be blocked from private offerings simply because he made $175,000 last year and his e-Trade portfolio is only $800,000? Is he really at more risk than the trust-fund dunderhead mentioned above?
In fact, for a lot of Wall Street professionals, compliance or otherwise, this isn’t just a question about which client you would prefer for your firm. You personally fit that profile. Plenty of people work in financial services and are tremendously intelligent about investment decisions, yet they don’t qualify as accredited investors because they don’t pass the income and asset tests.
Accredit Where Accredit Is Due
The SEC understands all this. At the Small Company Advisory Committee meeting, SEC chairman Mary Jo White cited accredited investors as one important issue the agency wants to revisit in 2016. Last year the committee urged the SEC first not to harm the “private offering ecosystem” by shrinking the pool of eligible investors; and also to consider the idea of letting would-be investors pass a test: if you show enough sophistication on investment issues, you can qualify as accredited even with lower income and asset standards.
Where are we now? SEC staff published a report in December outlining a few proposals, and it is worth reading for anyone who deals with accredited investors often. (The SEC has also asked for public comment on the issue, so do your civic duty before your firm’s next offering under Regulation D.)
Some of the proposals are quite intriguing. For example, one idea is to let knowledgeable employees of private funds qualify as accredited investors for their employers’ funds; another would let people pass an accredited investor exam. A third is to qualify people with certain professional credentials, such as a Series 7 license. Another is to qualify people with a minimum amount of investments, rather than assets, since investing demonstrates sophistication. (As opposed to, say, inheriting an empire of dry cleaning shops.)
Ultimately, this may be a situation where any good decision for Wall Street won’t also be an easy one. If the SEC simply raises income and asset levels, that shrinks the pool of people who qualify as accredited investors. If the SEC adopts more subjective tests to gauge a person’s sophistication, firms will need to do more to confirm that prospective investors do indeed qualify as accredited.
But any way you cut it, small businesses want more access to investors, and investors want more access to private offerings. So somehow, some way, something is going to change here.