It should be obvious to most everyone that the current definition of an Accredited Investor not only disenfranchises the vast majority of the population it is not really an effective proxy to evaluate an individual’s ability to assess risk and the opportunity affiliated with private securities. Tomorrow (Wednesday, August 26, 2020), the Securities and Exchange Commission (SEC) is expected to update the current rule which may include a sophistication qualification – a pretty common-sense move.
While the devil is in the details, most observers anticipate a broadening of the rule. Good for individual investors and good for the private securities market depending on the final wording. But some individuals remain adamantly opposed to opening up the rule to more people. So who are these individuals and why are they against enabling more choice for such a sizeable and important market ($1.4 trillion) that is largely dominated by Regulation D offerings?
Below is a selection of individuals that have told the Commission not to democratize how an Accredited Investor is defined and why they believe they are right.
Lev Bagramian, Senior Securities Policy Advisor, at Better Markets, believes the SEC should not amend the current definition. Bagramian had this to say in his comment letter:
“[We] argue that there is no evidence to show that currently, non-Accredited Investors are clamoring to invest in companies that disclose at best stale information about themselves and their prospects, or at worst, are total frauds. Our comment letter would also discuss that given the size and growth of the exempt offering space, companies that have reasonable prospects of success are able to find funding. We will also argue that only those companies that have been turned down by their friends and family, angel investors, local or national banks, private equity or venture funds, and other “smart money” are maybe having challenges raising funds, but that investors who do not have the financial wherewithal to withstand the highly-probable loss should not [be] permitted to be exploited by financial professionals who will peddle these unregistered securities.”
Bagramian believes the Commission has “not produced rigorous data analysis” that there is any demand from non-Accredited types and no amendment should be made.
A group of Attorneys General submitted a comment letter to the Commission stating it should “raise the financial thresholds, index the thresholds to inflation going forward, and use its rulemaking and other authority to gather data about private offerings” before making any changes.
Pointing to the “complete lack of data” the AGs had this to say:
“Institutional investors who participate in private offerings generally have sufficient resources to spread their risk over numerous private investments. Individual investors, especially under the current financial thresholds, are far less likely to have sufficient wealth or income to diversify their risk. Absent data showing that individual investors regularly benefit from investing in private offerings, there is no justification to expand the definition to those who do not even meet the financial thresholds, regardless of their purported level of sophistication.”
The AGs said the failure of crowdfunding was indicative of no need to broaden the current definition.
Barbara Roper, Director of Investor Protection at the Consumer Federation of America, along with Micah Hauptman, Financial Services Counsel at the CFA, believes the Commission, with help from Congress, has promoted private capital raising at the expense of both investor protection and public markets.
The CFA comment letter echoed a similar line of thought by other opponents that data is lacking and thus the definition should not be expanded:
“Predictably, the Commission’s limited “analysis” fails to include any consideration of whether Regulation D offerings actually promote true capital formation and sustainable job creation. While Reg D is highly successful in promoting capital raising, true capital formation is a very different thing. It is certainly possible that Rule 506 offerings make a meaningful contribution to sustainable job growth, for example, but the Commission provides no evidence that this is the case. It is equally possible that such offerings disproportionately result in the kind of churn and burn of job creation and destruction commonly associated with small company capital raising. It is worth noting, moreover, that the largest users of Rule 506 in terms of dollar amount raised are private equity funds, whose record of job destruction has recently garnered increasing attention.”
The CFA is of the opinion that “including a financial sophistication requirement in the accredited investor definition is theoretically sound [but]… the Commission’s proposal is deeply flawed.”
So the above groups and individuals believe the federal government is in a better position to determine investment decisions for sophisticated individuals. The ongoing theme appears to be there is no apparent demand and no data to support an expansion so why do it?
Last year, David Burton, a Senior Fellow, Economic Policy Institute for Economic Freedom, at the Heritage Foundation, reflected upon a comment letter by the SEC’s Investor Advocate that oddly sought to deny individual choice for private offerings (not exactly advocating on behalf of the investor):
“Investor Advocate Rick Fleming’s July 11, 2019 comment letter shows that he thinks he knows better than investors whether there is “retail investor demand for exempt offerings” and that he knows better than issuers whether “companies actually want small investors.” Investors and issuers should be entitled to make these decisions for themselves. Specifically, younger and less affluent investors should be provided the opportunity to invest in higher return private offerings. This is particularly true for those that have demonstrated the sophistication to evaluate the merits of the investment.”
Burton’s statement highlights the dichotomy between the two policy perspectives as to whether an individual, who understands risk, should make their own investment decisions or should the federal government compel its expertise on these sophisticated investors.