The Dodd-Frank Act instructs the SEC to evaluate the definition of “accredited investor” and, if it sees fit, to modify the definition “as the Commission may deem appropriate for the protection of investors, in the public interest, and in light of the economy.”
As regular readers of this blog know, I’ve been optimistic that the SEC would not take this opportunity to kill Title II Crowdfunding and every other kind of Rule 506(c) private placement (which includes most angel investing as well) by creating an onerous new definition. The report issued recently by a SEC subcommittee, while surprising in some respects, doesn’t dent my optimism.
The subcommittee report makes two important, though obvious, points:
- The Committee does not believe that the current definition as it pertains to natural persons effectively serves this function in all instances.
- The current definition’s financial thresholds serve as an imperfect proxy for sophistication, access to information, and ability to withstand losses.
The existing definition is imperfect, yes. The question is, what to do about it?
Although the report does not provide a clear answer to that question, the good news, from my perspective, is that the report does not suggest merely indexing the current thresholds ($200,000 of income, $1 million of net worth) to inflation, which would disqualify most accredited investors and send the private placement market into a tailspin. Instead, the report seeks a standard that will address both financial sophistication and the ability to withstand loss.
The report suggests two specific measures of financial sophistication: the series 7 securities license and the Chartered Financial Analyst designation. Following the lead of the United Kingdom, the report also suggests that those with proven investment experience – for example, a member of an angel investing group – might qualify. Finally, the report suggests, as others have before, that the SEC could develop an examination for the purpose of qualifying investors.
Declining a suggestion from several quarters, the report does not include lawyers or accountants as investors who should be deemed to have financial sophistication.
The reports veers a little off track, in my opinion, when it speculates that, in conjunction with changing the definition of accredited investor, the SEC could limit the amount invested by each investor – following the 10% limit of Regulation A+, for example. That kind of limitation would be new to Rule 506 offerings.
In my Model State Crowdfunding law, I use a definition of accredited investors that includes lawyers, accountants, and anyone with the license from FINRA, as long as the lawyer, accountant, or license-holder has income of at least $75,000. Recognizing the imperfection of any definition, I think that strikes about the right balance. Bolt on an SEC-administered examination option and we’re right there with the subcommittee report.
All in all, it’s good to see the SEC, once again, thinking through the issues carefully. We can see the light at the end of the tunnel.
Questions? Let me know.
One thought on “SEC Subcommittee Reports On Accredited Investor Definition”
The current definition of Accredited Investor assumes that anyone who makes over $200,000/year knows enough about whatever they are investing in to make a good decision. However, I think that including certain professions or license holders instead makes the same assumption, if not worse. For example, an accountant or Series 7 holder most likely knows less about real estate than a real estate financial analyst that makes $50,000. The purpose of SEC regulations is to protect “unsophisticated investors.” However, any particular investor may be an expert in one asset class, but a novice in another. An income requirement is something that allows the investor to determine whether or not they are sophisticated in an asset class in which they want to invest. A license or profession requirement just broadly assumes that everyone who is an accountant or lawyer knows everything about every asset class and everyone else knows nothing.
Maybe a better idea would be to have the SEC define several broad asset classes and have investors who meet a certain income threshold certify that they understand the risks, etc. involved in the particular asset class in which they are investing. Easier said than done, I know!