FFCON21 Breaking Barriers May 11-13, 2021

Don’t Backtrack on Loosening Accredited Investor Rules

Cato Institute | Jennifer J. Schulp | Jan 29, 2021

expanding accredited investor definition - Don't Backtrack on Loosening Accredited Investor Rules

Last month, the exclusive “accredited investor” club cracked open its doors to the public. But don’t celebrate yet. Chances are you still didn’t receive an invitation to join. Members in this exclusive club can legally invest in certain private offerings, like hedge funds and start‐​up companies. Until the SEC’s recent revision, entry was limited to people who earn at least $200,000 a year ($300,000 with a spouse) or have a net worth of at least $1 million. About 13% of U.S. households qualified under those rules.

See:  Statement on Modernization of the Accredited Investor Definition

The new SEC rule lowers that high threshold a bit, but only for people who hold certain securities licenses or work at private funds. So unless you are comparatively well‐​to‐​do or part of this group of financial industry insiders, most private securities offerings are still off limits to you.

Even this modest loosening of the restrictions has come under fire.  House Financial Services Chairwoman Maxine Waters urges the Biden administration to rescind the revised definition.

SEC commissioners Allison Herren Lee and Caroline Crenshaw suggest the wealth thresholds be indexed to inflation to ensure that the club remains limited.

The Biden administration should not heed these calls. Narrowing the accredited investor definition may be good news for the wealthy few because it concentrates investment opportunities in the hands of those who are already advantaged. Breaking down society’s wealth divides requires removing such barriers to opportunities for investors and entrepreneurs to make financial gains.

Broadening access to private offerings, rather than further restricting it, is a better solution.

In 2019, for example, registered offerings raised $1.2 trillion, while Regulation D offerings raised $1.5 trillion (of the $2.7 trillion total raised by exempt offerings).

The SEC reasons that less well‐​to‐​do investors are protected by limiting riskier investments to the financially sophisticated and those who can absorb losses.

See:  Retail investors are becoming more than shareholders

But being wealthy is no proxy for financial sophistication. The wealth test clearly misses the mark.

This line drawing lumps the elderly with substantial retirement savings and lottery winners with windfall profits in with people whose earnings depend on some financial know‐​how. It also excludes those who don’t have a substantial nest egg but have a great deal of general investment knowledge or have experience with the industry in which they seek to invest.

SEC Commissioner Hester Peirce has observed that the this limitation on investors “offends the principles of personal liberty, which allow people both to earn and spend money as they see fit.”

For investors, the accredited investor definition makes it harder to get rich unless you already are rich. It takes about 11 years for a company to go public today, meaning that it is likely past its high growth phase by the time most people can invest in it. There are also fewer public companies today than there were 20 years ago. So people have fewer choices in the public markets and those choices may offer lower potential returns.

Private offerings also provide different opportunities than those in the public markets, including diversification options and the ability to support a compelling idea or local entrepreneur.  And for investors and entrepreneurs alike, the accredited investor definition deprives many communities of capital needed to grow.

See: 

Accredited investors aren’t representative of the U.S. population: white families, on the whole, are considerably wealthier than others, and wealth is concentrated on the U.S. coasts. Would‐​be entrepreneurs in less‐​wealthy communities are thus limited in their ability to turn to those they know best in building their businesses.

Instead, 74% of aspiring entrepreneurs cite networks and connections as barriers to accessing capital, and too few can rely on angel investors, who tend to invest in nearby businesses. That’s why the SEC recognized that minority‐​owned businesses, in particular, may benefit from increased access to accredited investors. Where proportionally more minority‐​owned businesses have closed in 2020 due to the pandemic, expanded access to capital is even more crucial.

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