The SEC Advisory Committee on Small and Emerging Companies met yesterday at the SEC HQ on Capitol Hill. The main topic of discussion was the definition of an Accredited Investor. SEC Chair Mary Jo White was joined by her two remaining Commissioners, Michael Piwowar, and Kara Stein. The meeting was managed by ACSEC co-Chairs Sara Hanks and Stephen Graham with SEC staff participating to add insight into the issues.
The discussion regarding the definition of an accredited investor is an important one. As it stands now there is a hard line rule that only individuals earning at least $200,000 a year or with $1 million in net assets (minus a primary residence) may invest in Reg D private placements. The private securities markets are enormous – topping a trillion dollars each year. The IPO market, on the other hand, has continued to shrink. This is due in part to the excessive rules associated with going public. Simply put, promising young firms strive to remain private as long as possible to avoid the crushing regulatory environment and associated cost. The unintended consequences (and something that should have been foreseen) is that the vast majority of the population has been disenfranchised from a significant opportunity for wealth creation. As one ACSEC committee member so eloquently stated (paraphrasing); you can purchase $1000 worth of lottery tickets, bet $1000 at a casino in Las Vegas or invest $1000 in a Reg D security. In one of these situations, an individual may fall afoul of the law. Yep. If you want to invest your money and do not qualify as a wealthier sort you are in trouble. And why is this? All in the name of investor protection…
Now a common sense approach would be to allow ones sophistication or knowledge be the measure. Everyone understands that the size of a bank account is no guarantee of wisdom, hence the discussion by ACSEC members – as requested by the SEC.
“The Airplane was Invented by Two Bicycle Mechanics from Dayton Ohio”
While most regular folk know the exclusion of one segment of society for the benefit of another is a rather impolitic approach, there remain some individuals who believe why bother? Things work just fine now. As markets have changed, today most all capital gains are captured by early investors (read VCs/ wealthier individuals). An IPO has become more of an exit opportunity for early shareholders to sell and move on to the next promising investment. For the smaller investor things have not worked out quite so well.
Back in 2015 SEC staff presented a report that included multiple options to update the rule. The review, as mandated by Dodd-Frank, offered multiple alternatives. Some of them quite good.
“the definition of an “accredited investor,” is a familiar – and very important one – for all of us. Last year, this Committee provided recommendations, cautioning that the primary goal of the Commission’s review of this definition should be to “do no harm to the private offering ecosystem.” The recommendation also suggested including within the definition those investors who meet a test of sophistication. As you know, in December, the Commission published a staff report that analyzes various approaches for modifying the definition and provides recommendations for potential updates and modifications. I look forward to hearing your discussion on those approaches, and reviewing any further comments that are submitted to our public file on the report.”
Commissioner Stein posed the question, “what is the best way to supplement the definition of accredited investor”? Stein suggested it may be time to move to a more “nuanced” definition and away from a one size fits all approach.
“…should we layer onto quantitative thresholds, qualitative indicia of sophistication, such as professional credentials or experience investing in exempt offerings? Similar to Regulation Crowdfunding and Regulation A+, should we consider investment limitations? How can we gather and analyze data to test the definition to make sure that it continues to be appropriate? To answer these questions, we will need to craft a definition of “accredited investor” that is flexible enough to differentiate between investors.”
Commissioner Piwowar warned participants of the troublesome risk of exacerbating the wealth gap. This growing social problem has become a pointed issue as the affluent become more wealthy and less prosperous – more so. While a monolithic approach in the definition fears a single point of failure, clearly a diversified portfolio of early stage investments may provide solid economic gains for all. Shouldn’t this opportunity be the choice of all Americans?
While some ACSEC members appeared to support a “leave it alone” approach, many advocated updating the antiquated rule. One individual questioned if a definition was needed at all.
“The current Committee’s thoughts on the accredited investor definition were largely consistent with the previous Committee’s recommendations, especially noting that the current private financing ecosystem works well and any attempt to change the definition should first “do no harm”.”
During the afternoon session, SEC staff participated in a discussion on fraud.
It was interesting to note that Margaret Cain, from the SEC Division of Enforcement, said the agency is taking action on 8 cases of alleged fraud under JOBS Act exemptions. While one would not expect any apparent frauds falling under Title III as it just kicked off this past Monday, it appears multiple acts of fraud have taken place most likely under Title II and Reg A+.
To date, the Ascenergy case is the only publicly available example JOBS Act related fraud. This SEC enforcement action continues. Ascenergy, raising capital as an accredited crowdfunding offer, allegedly spent at least $1.2 million of the proceeds, but only a few thousand dollars appear to have been used for oil and gas-related expenses (the stated intent of the funding round). The enforcement filing was revealed just as Title III rules were announced last year causing some consternation as the industry reflected upon the very first case of investment crowdfunding fraud.
But as Hanks so eloquently stated, “Fraudsters gonna fraud, fraud, fraud and the JOBS Act hasn’t changed that one way or the other.”
Speaking on behalf of NASAA, Michael Pieciak explained that Reg D (not differentiating between 506c & 5o6b) offerings typically remain at the top of the list for state-based securities enforcement actions. NASAA has been no fan of investment crowdfunding, and there are no expectations for that to change anytime soon.
Yet no-one truly has complete data on fraud. And the JOBS Act has not been a catalyst for an excessive amount of scams according to the SEC. So far.
Currently, there is a bill in the House that may update the definition of an accredited investor. But the SEC has the power, and perhaps the gumption, to address the obvious shortcomings of the current definition. While the ACSEC debate may have the ear of the commission, there is little power beyond that. Now it is up to Chair White and her two Commissioners to decide if they propose updated rules. Or not.