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Comment Period Ends on Proposal to Update the US Definition of an Accredited Investor. So Who Said What?

Crowdfund Insider | | March 18, 2020

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Towards the end of 2019, the Securities and Exchange Commission (SEC) proposed an update to the definition of an accredited investor. The rule change is part of a broader “concept release” that the SEC has issued to review the exempt offering ecosystem and how this can be improved.

When the rule change was revealed, SEC Chairman Jay Clayton had this to say:

“The current test for individual accredited investor status takes a binary approach to who does and does not qualify based only a person’s income or net worth. Modernization of this approach is long overdue. The proposal would add additional means for individuals to qualify to participate in our private capital markets based on established, clear measures of financial sophistication. I also am pleased that the proposal specifically recognizes that certain organizations, such as tribal governments, should not be restricted from participating in our private capital markets.”

The current definition is purely economic. If your salary is sufficient, $200,000 for an individual, or you have $ 1 million in net worth beyond your primary residence, you qualify. If you are married, your combined salary must be $300,000. The exact language is available here, if you are interested.

A blunt tool at best, just about everyone understands that the size of a bank account is not the best metric for financial acumen. Having a sophistication qualification, where anyone who qualifies may determine whether they want to invest in a private offering, simply makes more sense in the opinion of many.

See:  SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments

Yes, there are outliers – individuals and organizations that believe there should be a heightened hurdle for investors to participate in private offerings under Reg  D. But many people recognize the weakness of the argument. Any investment entails an element of risk. And younger companies tend to hold a greater degree of risk than established firms. But this is where the risk v. reward paradigm kicks in. Investors are willing to shoulder more risk if the reward may be greater. A better metric would be whether or not an individual completely comprehends risk and the potential to lose money.

Over time, as the cost to go public has dramatically steepened, the most promising firms are seeking to remain private for as long as possible. This means the opportunity to participate in these securities offerings are shuffled off to an exclusive segment of the population – typically wealthy VC firms and individuals.

So a change of the definition is in the offing but the exact language of the final amendment is pending.

Perspectives on the current proposal differ. Some believe “it still remains policy that only rich people are permitted to get rich.”

Others view the proposal as a really big deal.

It all comes down to the final wording.

After the proposed amendment was announced, a comment period was initiated for 60 days. The deadline was Monday, March 16th. While the SEC is known for letting tardy submissions slip through, the bulk of the comments are in. So what is everyone saying?

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Dara Albright, a long-time advocate of online capital formation and well known with the US Fintech sector, pointed to the fact that times have changed since the accredited investor rule was first minted:

“It was a very different world in 1982 when the SEC promulgated Reg D, and in doing so established the accredited investor definition. Four decades ago, the dearth of technology kept both trading commissions as well as investment minimums steep, making it impossible for small investors to self-diversify across many asset classes. Those days are long gone. Today, technology has significantly reduced the cost of financial transactions, making micro-investing a reality. Even the top discount brokerage firms have gone so far as to eliminate commission trading for conventional asset classes altogether. At the same time, technology has made it both simple and economically feasible for issuers to accommodate a sizeable number of micro-shareholders.”

Albright said that “investor-base diversification” is a topic that is rarely discussed.

“Not enough companies see the advantages in possessing a widely diverse cap table,” said Albright alluding to the fact that expanding the definition will make it more possible for issuers to have a more diverse cap table.

Albright’s comment letter is available here.

On the other side of the polemic is a group of individuals that focus more on the risk affiliated with private securities as opposed to the opportunity of investing in early-stage firms, debt, and real estate.

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Barbara Roper, Director of Investor Protection, and Micah Hauptman, Financial Services Counsel, at the Consumer Federation of America (CFA), worried that expanding the defintion will undermine public markets. The duo said the Commission’s “limited analysis is shockingly superficial.”

“While financial sophistication seems like a natural addition to the accredited investor definition, for decades after enactment of the ’33 Act both the SEC and courts insisted that financial sophistication alone, absent access to information, was not sufficient to satisfy the private offering exemption. In 1977, for example, the Fifth Circuit ruled on this question directly, stating that “there must be a sufficient basis of accurate information upon which the sophisticated investor must be able to exercise his skills. Just as a scientist cannot be without his specimens, so the shrewdest investor’s acuity will be blunted without specifications about the issuer.”

The CFA letter may be viewed here.

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