Recently, the Securities and Exchange Commission (SEC) proposed changes to the definition of “accredited investor.” Many issuers and intermediaries hoped the SEC would expand the definition of “accredited investor,” to include qualitative conditions, such as education, or by lowering quantitative thresholds, such as income and net worth. They claimed reduced requirements would allow more individuals to partake in private investments.
When the proposal was announced — with only subtle changes on the table — most industry professionals decried the new rules, claiming they were limiting choice and accessibility.
This criticism is completely misplaced.
The fact of the matter is that a path to accessibility has always existed. Issuers and intermediaries can reach all Americans if they want to, without requiring any rule changes from the SEC.
So why don’t they? Let’s take a closer look.
Why do some want to see an expanded definition?
Current SEC regulations broadly define individual accredited investors as having a net worth of at least $1,000,000 or an individual income of $200,000 or combined partner income of $300,000. Many, including real estate investment platforms, broker-dealers, and crowdfunding sites, want to see this definition broadened. With a broader definition or one that allows for more exemptions – say, for example, anyone with an MBA – these entities would instantly be able to grow their currently limited pool of investors.
On the surface, this sounds like a good thing, right? After all, individuals should have a right to determine for themselves whether or not they decide to invest. And, there are many private placement deals that drive strong returns. The problem is that these entities who are relying on a broader definition of accredited investors are the same ones choosing to operate under Regulation D, which broadly allows you to sell investments so long as the purchasers are accredited investors. The benefit for an entity to operate under Regulation D is that the firm does not have to disclose much in the way of financials, conflicts of interest, compensation arrangements, or other information that the average investor may find material. Further, they do not disclose anything to the SEC, and even though anti-fraud provisions apply, the information they give their investors is scarcely better.
So for firms working under Regulation D, the only way to materially increase their audience without having to disclose more information is to change the rules as to who is an accredited investor.
To summarize, these entities view the proposed rule changes as the perfect trade-off: additional investors, but no additional oversight.
Why don’t more take advantage of options to sell investments to the general public, like Regulation A or a registered offering?
This is a very good question. Some might say that the cost is too high. Others will say that it requires too much time to qualify or register an offering that would allow you to sell investments to the general public.
As someone who has qualified securities through Regulation A [Reg A+], it’s possible for these firms to qualify their securities in a reasonable amount of time and for a reasonable cost, should they so choose.
I believe the real reason these firms don’t operate through a more accessible regulatory framework is because they don’t want to release the required financial and operating disclosures. They don’t want the transparency and accountability that comes with accessibility. That tradeoff is not one they are willing to make.
Did the SEC make the right decision?
Yes, the SEC made the right decision. Their perceived inaction was actually taking action to protect investors. If they did, in fact, broaden the scope of an accredited investor, it means more people – individuals who may not have tremendous net worth – could participate in deals where there is little oversight and little information available. I believe the SEC saw this as a recipe for disaster.
Recall the Bernie Madoff scandal. In the end, his Ponzi scheme squandered away $65 billion dollars from those who entrusted him with their investments. These individuals were mostly accredited investors.
What if the definition were broader in this instance though? What if middle-class Americans could have given their money to Madoff? There was not nearly enough oversight there, but if there was any silver lining to that disaster, it was that the defrauded investors could perhaps more easily absorb the loss and pursue restitution. There have been many other instances of Ponzi schemes with accredited investors on much smaller scales.
Let me be clear though. I’m not suggesting that all the entities operating through Regulation D are Ponzi schemes. Rather, I’m illustrating the point of why the limited definition of accredited investor is needed: to protect those who cannot afford to invest in spurious private placements or offerings where information is limited. Put another way: society requires doctors, people entrusted with carrying out serious work, to invest a lot of time and money in education, training, and licensure. When you are selling investments to the general public, why should it be any different?
Don’t blame the SEC’s definition of “accredited”
The high net worth requirements for being an accredited investor are, in reality, guardrails protecting investors from issuers who aren’t more transparent with financial and operational disclosures.
For those who have blamed the SEC for the lack of accessibility, this is just a strawman for the more pressing issue: platforms and issuers claiming, under a false flag, of representing the interests of Mainstreet, while they refuse to qualify or otherwise register their offerings in a way that other Mainstreet accessible investments are.
No issuer or intermediary has the right to talk about “democratizing investments” or “accessibility” without also answering why they are not able or willing to qualify or register the investments they are selling.
Nick Bhargava is a co-founder of GROUNDFLOOR. He leads product development and is responsible for regulatory strategy. An expert in securities law, Nick was heavily involved in the JOBS Act as an early pioneer who advanced the concept of crowdfunding. His years in finance have included work for the Financial Services Roundtable, SEC, FINRA, TD Waterhouse and RBC Financial Group. Nick received his LLM at Duke University School of Law and holds a BS in Biological Sciences and Business from the University of Alberta.