The Misplaced Logic of Dodd-Frank: Protecting the Ordinary Investor by Redefining the Accredited Investor

Dodd Frank

Many of you are still reeling from the impact of the worldwide collapse of the financial markets in 2008. And most of us have rightfully observed that following one of the greatest debacles in financial history, no one has gone to jail – no one has been prosecuted.

Stop Reckless Gambling Now Wall StreetMeanwhile, rather than look back at the carnage, Congress looked forward – and put together one of the largest and most complex pieces of legislation ever in a Democrat-controlled Congress – The Dodd Frank Act of 2010 . Its purpose: to protect financial markets and the ordinary investor. And one of the gems that emerged from the Act – the Investor Advisory Committee – charged with being the watchful eye for the ordinary investor.

Following the mandates of Dodd-Frank, the Investor Advisory Committee met at the D.C. headquarters of the SEC on July 10, 2014, ostensibly to revisit the definition of “accredited investor” under U.S. securities laws, and with a view towards presenting its recommendations to the SEC. So in light of the recent meeting of the Investor Advisory Committee, this seemed like an opportune time to take stock of exactly how the ordinary investor fares today – four years after the passage into law of Dodd-Frank.

Let’s examine some facts.

The Great Recession of 2008 marked one of the largest implosions of household wealth in U.S. history. The large majority of Americans had their investment capital parked in either IRA’s or “managed accounts ” – in hindsight, a sucker’s bet, where Blue Chip investment managers pull in billions of dollars of investment capital, largely from ordinary investors, and rake off the top an annual fee of 1.5 – 2%, win, lose or draw. And most of this money was invested in publicly traded securities, shielded from those private placements deemed “too risky” for the ordinary investor. History recalls that the financial markets were caught by surprise, and billions of dollars vanished, almost overnight, from the accounts of ordinary Americans.

United States Capitol Building StopSo how is Dodd-Frank solving this problem? Of recent moment, Dodd-Frank mandated that the SEC reconsider the definition of “accredited investor” by July 2014. Hence, the meeting of the Investor Advisory Committee. For individuals, up until now this has meant those persons earning more than $200,000 per year ($300,000 if married), or those with a personal net worth over $1 million, excluding principal residence. Seems that these benchmarks have stood almost unscathed since they were adopted by the SEC in 1982. The only modification to these 1982 benchmarks came in 2010, courtesy of Dodd-Frank, when Congress decided to exclude from the calculation the value of an individual’s principal residence. Seems that most in Congress were caught unaware with the realization that most Americans saw the value of their homes plummet – and in some cases – wiped out. Or perhaps, Congress was simply hedging its bet, in case one had any equity left in their home.

Mary Jo White Talks Investor Advisory CommitteeSo how exactly does tightening up the definition of “accredited investor” help the ordinary investor? Well, for those legally anointed as “accredited investors,” they are legally privileged to invest in private placements, investments long labeled by consumer protection groups and state securities administrators as “too risky for the ordinary investor.” And SEC Regulation D, Rule 506, makes this group an attractive source of capital for companies: issuers can raise unlimited amounts of capital from accredited investors, without the need for SEC registration, and without the need to provide any specific type of investor disclosure. Sweet.

No wonder, therefore, that billions of dollars are raised every year from accredited investors under Rule 506.

Closed Store Bureau of Labor StatisticsOn the surface, tightening up the definition of “accredited investor” may have seemed like a good idea back in 2010 – at least to the organizations/lobbyists who populated the halls of Congress while Dodd-Frank was winding its way through Congress: The Consumer Federation of America, the AFL-CIO and the North American Securities Administrators Association (NASAA). After all, who better to protect ordinary investors from risky private placements. Better to limit ordinary investors to safer investments, such as managed accounts administered by the Captains of Wall Street.

But even those who are mathematically challenged will easily conclude that raising the bar to be an accredited investor would most assuredly shrink the available pool of capital for businesses, public and private alike. And the biggest loser of all – small businesses – a group with the least number of choices for raising capital.

So who are the winners by raising the bar for defining accredited investors?

$50 GrantSeems like a good deal for FINRA regulated Wall Street funds that make a living off of managed accounts for ordinary Americans. And according to NASAA, this would be a good deal for the ordinary investor and small business. It is not surprising that FINRA and NASAA would be on the same side of the issue of shrinking the available pool of accredited investors. After all, NASAA derives a good deal of its funding from broker-dealer exams administered by – you guessed it – FINRA.

And well, in theory at least, “ordinary investors” are the real winners – protected from risky private placements – according to NASAA, historically a haven for fraudsters.

So exactly where does this leave the ordinary investor, other than with the safety of accounts managed by seasoned Wall Street professionals or, the more risky self-managed account.

Crowdfunding you say? Not so, says the AFL-CIO, the Consumer Federation of America, and NASAA – and not so fast, says the SEC.

Frankly, all of this leaves my head spinning, as should yours.

SEC Headquarters in DCWhat to do about this?

Seems that at the July 10 Investment Advisory Committee meeting, Damon Silvers, an AFL-CIO representative, shared my frustration, albeit for very different reasons. At one point in the meeting he threw up his hands in frustration and stated, “perhaps we should just disband the committee and let markets decide … and the building here [the SEC] should disband.”

My suggestion to Mr. Silvers: perhaps, instead of shutting down the SEC Headquarters, a more diplomatic approach would simply be to throw up a picket line around 100 “F” Street.

Time to Take a Page from the Most Regulated Financial Market in the World

Mary Jo White and Barack Obama SECPersonally, feeling both nauseous and dizzy from the debate, I am taking my cue from President Obama, and following his lead after he learned that a U.S. Ambassador was dead – and a U.S. Consulate in flames – weeks before coming up for re-election. I am taking the weekend off and heading to Las Vegas – with the hope that in my absence better minds than mine can make some sense of this. And maybe I’ll even learn something in the process. After all, Nevada gaming is the most regulated financial market in the world – where alcohol flows freely and ordinary Americans can gamble away all of their hard earned money – 24/7. And where the myriad of carefully crafted and enforced gaming regulations leave off, the laws of mathematics will ensure the ultimate outcome – for the ordinary American.

_______________________

Samuel S. GuzikSamuel S. Guzik, a recognized authority on the JOBS Act including Regulation D private placements, investment crowdfunding and Regulation A+, writes a regular column, The Crowdfunding Counselorfor Crowdfund Insider.  A consultant on matters relating to the JOBS Act, he recently led a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy.   He is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience.  He is admitted to practice before the SEC and in New York and California. Guzik has represented a number of public and privately held businesses, from startup to exit, concentrating in financing startups and emerging growth companies.  He also frequent blogger on securities and corporate law issues at The Corporate Securities Lawyer Blog.

Sponsored Links by DQ Promote

  • Pingback: IS THE SEC’S ACCREDITED INVESTOR DEFINITION UN – CONSTITUTIONAL? | BrainiacFundedBlog()

  • Pingback: IS THE SEC’S ACCREDITED INVESTOR DEFINITION UNCONSTITUTIONAL? | Corporate Securities Lawyer Blog - Samuel S. Guzik()

  • Jason Coombs, CEO

    Perhaps Damon Silvers is correct that the SEC needs to disband so that securities and exchange in our country can be regulated more sensibly: by law enforcement rather than by politics and deception.

    On the subject of the proposed revision to the Accredited investor definition, nobody knows whether this is going to be a net negative or a net positive for small business capital formation until we know what the final Rulemaking process for Title IV and Title III of the JOBS Act delivers. In my opinion, and also in yours, Mary Jo White is seriously trying to reform the SEC and to deliver a workable marketplace for equity crowdfunding. I refer to your blog post of six months ago:

    https://www.crowdfundinsider.com/2014/01/30897-crowdfunding-speech-mary-jo-white-sec-chair/

    If Mary Jo White is able to deliver a viable equity crowdfunding regulatory ecosystem by preempting state securities regulators and NASAA, then perhaps it does make sense to increase the Accredited investor thresholds. Startups aren’t going to stop trying to raise capital, and everyone presumes crowdfunding will help startups more than any other category of issuer — so anyone who is upset about the proposed change to the Accredited investor definition needs to make it clear that they would only be upset about this if it in fact has a negative impact on startups, and obviously it won’t have a negative impact if it in effect requires every investor with a net worth of $1M to $2.5M to invest away from the Accredited investor community and alongside everyone else in crowdfunding transactions and Regulation A+ Offerings, instead. I have explained this in my own comment letters:

    http://www.sec.gov/comments/s7-11-13/s71113.shtml
    http://www.sec.gov/comments/s7-06-13/s70613.shtml

    Other than jumping to the illogical conclusion that startups would be harmed by the proposed change to the Accredited investor definition, your comments and written work on this subject are outstanding. Keep up the good work!

    • Samuel S. Guzik

      Jason,

      The purpose of the article is largely to make people think and rethink what Congress did in 2010, and to put some issues in a broader perspective. I welcome differences of opinion which are based on logic and reason, even if contrary to my points of view. Besides, even I have been known to change my mind on occasion.

      Yes, it may be that changing the definition of accredited investor will not necessarily shrink overall investment opportunities for the investor. Many investors who are ineligible may indeed flock to Title III or IV. However,there may be issuers who do not wish to do a Title III or IV offering, and instead prefer a traditional private placement to accredited investors – which means no SEC registration, no mandatory disclosure, and no ongoing reporting requirements in perpetuity. So to the extent that the definition of accredited investor is changed to cause a shrinkage in their numbers, this will mean less capital available for Title II offerings.

      And yes, i remain encouraged by the leadership that Chair White has shown – a marked difference from some of her predecessors. Ultimately she will be the deciding vote on a divided Commission on many important issues, and I do not believe she will shrink from strongly held views for the sake of political expediency.

      So we have been, and remain, on the same page on the important role of the Chair.

      And thank you for the feedback on my writings generally.

      Best,

      Sam

  • Pingback: The Misplaced Logic of Dodd-Frank: Protecting t...()