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Comment Letters Raise Doubts About Plans to Update Accredited Investor Definition

The SEC is planning to update its 34-year-old definition of an accredited investor. Investor protection groups want to make sure that the revised definition includes measures that protect investors, while start-up companies want a definition that includes enough people to allow them to freely raise investment capital.

As the SEC considers updating its definition of an “accredited investor,” investor protection advocates and a group representing the biotech industry said the commission needs to do a more thorough analysis before proposing a rule change.

Writing a joint comment letter, the Consumer Federation of America (CFA) and Americans for Financial Reform (AFR) said the December 2015 Report on the Review of the Definition of Accredited Investor , which explored different alternatives for updating the definition, suffered from “major shortcomings.”

The organizations said the report does not identify a population of investors who are able to fend for themselves without protections. In their view, the legal definition cannot be adjusted until the pool of sophisticated investors is identified.

They also said that the study lacks a meaningful assessment of the likely effect of the various alternatives put forward.

Barbara Roper of the Consumer Federation and AFR’s Lisa Donner wrote they are worried that the report simply says, “While the size of the accredited investor pool has increased significantly, the staff is not aware of evidence suggesting that individuals qualifying as accredited investors under the current financial thresholds and participating in the Regulation D market require the protections of registration.” Regulation D is the SEC rule governing unregistered offerings, and the term accredited investor applies to people and institutions who are eligible to invest in the unregistered offerings. The report was issued to satisfy a Dodd-Frank Act requirement that the SEC review the definition every four years.

Rule 501 in Regulation D of the Securities Act of 1933 classifies investors as accredited if they make $200,000 a year, or $300,000 jointly with a spouse, or have at least $1 million in net worth, not including their primary residence. The rule has not been adjusted for inflation since being issued in 1982, and if its definition were adjusted for inflation, the individual income threshold would rise to approximately $433,000 to $491,000, the report said. The $1 million net worth threshold from 1982 represents about $2.16 million to $2.45 million today.

The report said the SEC has several alternatives, including doing nothing. The agency could raise the financial limits to account for inflation, index the financial thresholds to inflation or another financial benchmark so that they are periodically updated to reflect the cost of inflation, or add some nonfinancial criteria, such as market knowledge or financial skill.

Businesses criticized the report for different reasons.

SEC Chair Mary Jo White said in March she instructed the agency staff to recommend a rule change to the commission about changing the definition, but it is unclear when the proposal will be issued.

In White’s view, the SEC needs to come up with a better proxy for accredited investor than the net worth and income standard the agency has employed for 34 years.

The Biotechnology Innovation Organization (BIO), which represents more than 1,100 biotech companies and academic institutions, said it is concerned that some of the changes contemplated in the study would decrease the pool of investors, shrink the capital available for companies, and delay research.

“A large, diverse pool of accredited investors is obviously integral to the success of” limited offerings, E. Cartier Esham, an executive vice president with BIO, wrote in an April 8 comment letter.

As opposed to arguments made by the investor protection groups, Esham wrote that precisely because the report does not identify any specific investor protection red flags that have arisen under the current definition, the existing definition sufficiently protects investors in unregistered offerings.

BIO said it would like the SEC to maintain the current financial thresholds.

“Completely removing a substantial portion of current investors from the accredited pool could have an immediate, drastic, and potentially devastating impact on capital availability for emerging companies,” Esham wrote.

For example, an increase in the annual income to $500,000 for individuals and $750,000 for married persons coupled with an increase in the net worth test to $2.5 million—as indicated in the staff report—would decrease the size of the accredited investor pool by nearly 65 percent if no provisions are included for investors meeting the current standards, BIO said.

“Maintaining some eligibility for today’s accredited investors would reduce the shock to the system while also preserving an investment outlet for individuals across the country who want to participate in the innovation economy,” the group said.