Paper: Two Bills in Congress May Fix the Profoundly Flawed Definition of Accredited Investor, but One Bill is Better

The current definition of an accredited investor is profoundly flawed and a travesty of rule making. Everyone knows it.

As it stands today, an accredited investors must earn at least $200,000 (jointly $300,000) or have a net worth of $1 million beyond a primary residence. What the definition does not do is accommodate the millions of people who are sophisticated individuals that have the capacity to make investment decisions on their own without the hand of the government telling them what to invest in. This harmful regulation has disenfranchised millions of people while helping to further enrich the already wealthy.

According to a recent paper by David R. Burton of the Heritage Foundation,

“Making a registered offering (often called going public) is a very expensive proposition and well beyond the means of most small and start-up companies. In addition, the costs of complying with continuing disclosure and other obligations of being a registered, public company are quite high. The securities Act, however, exempts various securities and transactions from this requirement. the exemption of the greatest importance to entrepreneurs is the exemption for private offerings.”

Thus, the exemption of choice for promising early stage firms seeking growth capital is Regulation D, a private placement exemption adopted in 1982.

According to a recent statement by Securities and Exchange Commission (SEC) Chairman Jay Clayton;

“… those amounts, however, are eclipsed by the $147 billion reportedly raised in 2017 using Rule 506(c) of Regulation D [accredited crowdfunding], the new exemption that lifted the ban on general solicitation. And even that is dwarfed by use of the traditional private placement exemption in Rule 506(b) of Regulation D to raise over $1.7 trillion in 2017.”

Reg D is an enormous market that dwarfs traditional initial public offerings (IPOs). Most promising young firms seek to avoid going public for as long as possible, due to the cost, and thus much of the gain or wealth created by early stage firms accrue to the early investors. At most, according to Burton, 7% to 10% of the US public may participate in these offerings due to the fact they are already rich. The cycle continues as the poors get cut out of the option to participate in the growth of these firms.  Burton says that “Congress should democratize access to these private offerings so that they are available to more investors.” This is an obvious solution.

After many years of inaction, Congress has finally woken up to this discriminatory flaw in the securities law. Today, there are two bills moving through the legislative process that address the dysfunctional definition of an accredited investor.

In the House, Representative David Schweikert has authored legislation: The Fair Investment Opportunities for Professional Experts Act (H.R. 1585) was passed by the House of Representatives in November 2017.

In the Senate, a version of the legislation (using the same name) was introduced by Senator Thom Tillis and Senator Catherine Cortez Masto. But one version of the bill is better as the Schweikert version has a “drafting error” regarding the inclusion of “broker dealers,” a legal entity, instead of licensed individuals who work for brokers to being treated as accredited investors. While the flaw is minor, and most certainly will be addressed, it is an important factor to note. Legislation that opens up all Reg D offerings to all sophisticated investors must be the goal.

Regardless, addressing the shortcomings of the current definition of an accredited investor is long overdue. This is a fix that both parties should readily embrace as, at least in the past, benefiting one segment of the population to the detriment of another is frequently bad policy. Let’s get this rule changed.

You may read the Heritage Foundation Issue Brief “Congress Should Increase Access to Private Securities Offerings” here.

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