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Investor Panel Can’t Agree on New Definition for Accredited Investor

The SEC’s Investor Advisory Committee wants the market regulator to update the definition of “accredited investor” for the first time in more than 30 years. Not all committee members agree, and some believe making the definition too restrictive will undermine efforts to give investors more choices about places to put their money to work.

The SEC’s Investor Advisory Committee (IAC) is working on a recommendation to change the definition of an “accredited investor,” but the effort may not amount to much.

The panel’s divisions became evident during its July 10, 2014, meeting, making it clear that members aren’t likely to reach a consensus on the need for a new definition.

Business groups achieved a long-sought goal in July 2013, when the SEC lifted the marketing ban on private offerings in Release No. 33-9415, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings. The rule, which was mandated by the JOBS Act Congress passed in 2012, gave companies more access to the capital markets by permitting the marketing of limited offerings of securities to investors who met the accredited investor definition in the SEC’s regulations.

Now that the rule’s in place, regulators are preparing to debate which investors should qualify for accredited status, and the debate’s outcome may determine the reach of the loosened restrictions. Entrepreneurs and venture capitalists say the 1982 definition works well and shouldn’t be changed.

The definition in Rule 501 of Regulation D is intended to protect people from securities fraud and losing money because of the lack of information and transparency in limited offerings. Privately managed sales of securities are limited to accredited investors because policymakers believe they have the sophistication to judge for themselves the value of a stock or bond on the private market.

The definition applies to people with a net worth, or combined net worth with a spouse, of $1 million or more. An individual may also qualify with an income exceeding $200,000 in each of the last two years and a reasonable expectation that they’ll make the same amount in the current year. For a married couple, the income threshold is $300,000.

The definition hasn’t been updated for more than 30 years or adjusted for inflation, and some advocates for individual investors believe it’s time to bring the definition up to date. The advocates have pushed the SEC to revise the income and net worth thresholds to keep up with inflation and stay abreast of its responsibility to protect a broad pool of investors following the adoption of Release No. 33-9415, which established the limited securities offerings provisions in Rule 506(c).

The reliance of the current definition on dollar amounts is fundamentally flawed because it ignores an individual’s understanding of the financial markets and investments, said Barbara Roper, director of investor protection with the Consumer Federation of America and the leader of the IAC project.

Roper said it makes little sense to bar someone from a private offering because they have a net worth of $990,000 and are $10,000 shy of the $1 million threshold. She wants the SEC to incorporate criteria for financial sophistication into the definition.

Roper’s subcommittee is studying the use of limits for private offerings, such as putting a percentage of how much one can invest or considering whether a sophistication test should be included.

One mechanism would be to allow someone with a chartered financial analyst certification or a certified public accountant’s license to automatically be an accredited investor. But after a professional designation is established as a threshold, the criteria become harder to define.

Other IAC members challenged Roper’s efforts to introduce more qualitative criteria.

James Glassman, executive director of George W. Bush Institute, agreed that the definition could benefit from a review. But he doubted the need to go much further and reminded the SEC staffers present to not forget the “antique notion of people making their own decisions… in their own lives.”

Glassman said people don’t have to pass tests to buy houses or raise children.

“We should bear in mind that people want to provide for their own retirements, and they should be given the freedom to do that,” Glassman said.

Roy Katzovicz, the chief legal officer for the New York hedge fund Pershing Square Capital Management LP, said the dollar threshold makes sense because it’s easy to administer. Changing the definition to be somewhat more subjective will be unworkable administratively, and it would require the SEC to figure out how to police it.

Roper took exception to the notion of sticking with the current definition because of the ease in administering it.

“The only problem is, it doesn’t work,” Roper replied. You “can’t let simplicity override the function the rule is intended to perform.”

Stephen Holmes, general partner and chief operating officer for the technology and healthcare venture capital firm InterWest Partners in Menlo Park, California, disagreed with the contention that the current definition “is so bad that it needs to be totally thrown out.”

It makes sense to adjust the definition for inflation, Holmes said. He called the attempts to overhaul it and base it on new criteria no more realistic than Arthurian legends about the quest for the Holy Grail.