By Soyoung Ho
The SEC issued a proposal that would revise the definition of an “accredited investor” by adding new categories of individuals who may qualify based on their professional knowledge, experience, or certifications. Currently, the definition is solely based on a person’s wealth.
If the definition under Rule 501 exemption in Regulation D is revised as proposed, hundreds of thousands of more people would potentially be able to invest in private offerings. Unlike securities that are registered with the commission and trade on the public markets, securities in private offerings comply with fewer regulatory requirements, but they can also provide greater returns.
Among other things, an individual who holds a Series 7, 65, or 82 license or other credentials issued by an accredited educational institution would qualify.
A Series 7 holder is a licensed general securities representative, and the license was developed by the Financial Industry Regulatory Authority, Inc. (FINRA). North American Securities Administrators Association (NASAA) developed Series 65 — licensed investment adviser representative. FINRA developed Series 82, licensed private securities offerings representative.
“We preliminarily believe that individuals who have passed the necessary examinations and received their certifications or designations described above have demonstrated a level of sophistication in the areas of securities and investing such that they may not need the protections of registration under the Securities Act” of 1933, the SEC said in Release No. 33-10734, Amending the “Accredited Investor” Definition.
The proposal would also expand the list of entities that may qualify as accredited investors to include: limited liability companies, registered investment advisers, rural business companies; a new category of any entity that owns “investments” of more than $5 million; and family offices with at least $5 million in assets under management.
The commission decided to issue Release No. 33-10734 by a vote of 3 to 2 on December 18, 2019. SEC Commissioners Robert Jackson and Allison Lee dissented, arguing that the proposal lacks a rigorous cost-benefit analysis. “The release does not take seriously the investor protection concerns present in private markets,” Jackson said.
Comments are due 60 days after publication in the Federal Register, which normally occurs a few weeks after a rulemaking document is posted on the SEC’s website.
“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,” SEC Chairman Jay Clayton said. “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.”
To get the accredited investor status today, an individual must have an income of $200,000, joint income of $300,000, or at least $1 million in net worth, excluding a primary residence. It is designed so that the investors can withstand financial losses. That threshold, set in 1982, has not been changed, and some investor advocates said it should be adjusted to reflect inflation.
The SEC decided against changing the thresholds. Among other things, the proposal said that people today have more access to sophisticated tools to evaluate investments. A significant reduction by increasing the wealth threshold could also have disruptive effects on the Reg D market.
“Further, raising the financial thresholds from current levels may have disparate impacts on certain investors,” Release No. 33-10734 said. “For example, certain geographic areas of the United States, such as the Midwest and South, have a lower cost of living compared to other geographic areas and employees in those areas may be earning lower wages relative to other areas and therefore be less likely to qualify as accredited investors under the current financial thresholds.”
The work on the definition is part of a broader work to harmonize the exempt offering landscape. SEC Chairman Jay Clayton has prioritized simplifying rules to make it easier for smaller companies to raise funds from investors. The SEC in June issued a preliminary rulemaking document in Release No. 33-10649, Concept Release on Harmonization of Securities Offering Exemptions, to solicit comments about ways to streamline the rules related to private offerings. (See Concept Release Seeks Comments on Exemptive Offering Framework in the June 19, 2019, edition of ACA.)
Tom Quaadman, an executive vice president with the U.S. Chamber of Commerce, welcomed the SEC’s proposal.
“The SEC… moved forward with an important update to the accredited investor definition, which will expand the number of ordinary investors who are able to share in the most dramatic growth opportunities in our economy,” Quaadman said. “This will further increase access to capital for startups and growing companies while giving workers and main street investors more opportunities to help meet their savings and retirement goals.”
However, many investor protection advocates have been alarmed by Clayton’s business-friendly policies that may put more individuals at risk of losing money.
“The SEC is starting from assumptions that are at best unsupported, at worst flawed – that the pool of accredited investors should be expanded and that investors will benefit from access to private offerings,” said Barbara Roper, director of investor protection with the Consumer Federation of America.
She said the current definition includes millions of investors who cannot “fend for themselves” by any reasonable definition.
“They aren’t closely connected or influential enough to gain access to information private issuers aren’t required to provide. They aren’t financially sophisticated enough to assess the risks and opportunities of private offerings absent that information. And they aren’t wealthy enough to withstand potential losses,” Roper said. “It is frankly appalling that the SEC didn’t even take the most minimal step of indexing the financial thresholds to inflation going forward, but it appears from their public statements that Commissioner [Hester] Peirce and Commissioner [Elad] Roisman would have opposed such a move despite the broad support it has earned elsewhere.”
Commissioner Lee also criticized the failure to index it to inflation.
“The failure to index will create some eye-popping results in terms of the percentage of U.S. households that would qualify as accredited in the future,” Lee said. “Let’s look at some numbers using an estimated annual and constant growth rate for inflation of 1.51 percent: In ten years, approximately 22.7 percent; in 20 years, 39.32 percent, and in 30 years, 57.3 percent of U.S. households will have to ‘fend for themselves.’”
This article originally appeared in the December 27, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.
