One of the top items on the Securities and Exchange Commission (SEC) agenda under the leadership of Chair Gary Gensler is changes to Regulation D (Reg D) along with updates to the definition of an Accredited Investor. Currently, these amendments are number seven on the list and packaged as “improvements,” but the Commission has yet to make a solid case on any potential changes that will actually improve the ecosystem and allow more investors to participate while helping to fund more private firms.
Reg D is the securities exemption that powers the private markets in the US. More than a trillion dollars is raised under Reg D each year. A recent report pegged the amount of money raised under Reg D in 2022 at over $2.2 trillion. While much of the money raised under the exemption is for pooled investment funds, Reg D is exceptionally vital for early-stage firms seeking access to growth capital. Just about all of the most successful, well-known tech firms utilized the exemption before they became public companies. Any changes to the exemption could undermine this robust market, impeding economic activity while hampering innovation.
The definition of an Accredited Investor has been in place since the 1980s. In brief, an accredited investor is someone who earns more than $200,000 a year ($300,000 if married) or who has a net worth of over $1 million (not counting a primary residence). Most observers recognize the shortcomings of the current definition as it does not take into consideration education or experience. One popular recommendation is to add a sophistication qualification for interested investors who would take a brief test to effectively display they understand the risk intrinsic to private investments and understand the structure of a securities offering.
Just recently, the SEC Small Business Forum, with the assistance of SEC’s Office of the Advocate for Small Business Capital Formation, issued a report providing multiple recommendations for the Commission to improve access to capital. The Forum told the Commission to expand the definition of an Accredited Investor, making recommendations like:
Allow non-accredited investors to participate in venture capital funds.
Do not revise the Accredited Investor definition to make it more difficult to qualify based on wealth thresholds.
Expand the Accredited Investor Definition to achieve greater diversity among startup investors and entrepreneurs.
Expand the Accredited Investor definition to include additional measures of sophistication.
Expand the Accredited Investor definition to include any person who invests not more than 10% of the greater of their annual income or net assets.
At the recent SEC Investor Advisory Committee meeting, the opening statement asked the Commission to please do no harm in regard to Reg D.
A presentation at the same meeting saw the Angel Capital Association sharing it had invested hundreds of millions of dollars into private firms under Reg D and had yet to encounter any significant amount of fraud. At the same time, the ACA called for the Accredited Investor definition to be expanded, as the more qualified angel investors we help create, the more fuel will be provided to our entrepreneurs.
There have been recent Congressional hearings where testimony was given outlining how excluding investors from accessing these investments was simply wrong. One hearing lambasted the exclusionary status of the current definition, with one advocate stating: “To scale, succeed, and sustain, Congress and the SEC must make it easier, not harder, to become an accredited investor in America,” adding that the pool of Accredited Investors must grow, not shrink by raising wealth metrics.
CI reached out to members of the Association of Online Investment Platforms (AOIP) for their feedback on the issue. Doug Ellenoff, managing partner of the law firm of Ellenoff, Grossman & Schole and advisor to AOIP, said that the current fragility of both private and public markets would seem to be an inopportune time to increasing restrictions on investors. Ellenoff said that any redefinition could serve as a “further chokehold” on entrepreneurship and innovation.
Given the current fragility of both the private and public markets, it would seem to be a particularly inopportune time to be increasing the restrictions imposed on investors who should be deemed to be accredited and able to invest- any redefinition that is approved will serve as a further chokehold on our pipeline of entrepreneurship and innovation.
SeedInvest co-founder (acquired by StartEngine) Ryan Feit echoed Ellenoff’s sentiment, saying that a higher hurdle for Accredited Investor status would further limit opportunities for investors and “cast a long shadow” on the entrepreneurial environment.
“Furthermore, this would come at a time when access to capital is already undergoing the sharpest correction in 15 years. We should empower the private sector to administer an exam that ensures investors are sophisticated enough to properly understand the risks of investing in startups and small businesses instead of continuing to just allow rich people to invest.”
Rebecca Kacaba, CEO and co-founder of DealMaker, worried about the impact of changes that restrict capital and access to opportunity.
“Any change to Regulation D that decreases the accessibility of private market transactions stands in opposition to efforts to support innovation and entrepreneurship, modernize the capital markets, and build a resilient economy. If these changes are made, they must be supported by parallel measures that streamline access to capital from non-accredited investors via Regulation A and Regulation CF.”
While we know the Commission intends to change Reg D as well as change how an Accredited Investor is determined, we don’t know the final wording of any amendments to existing rules. Let’s hope the Commission thinks better of altering the exemption that helps to power innovation in America and finds a way to make it easier for retail investors to participate in these private securities offerings. Again, the first rule is to do no harm.