SEC Small Business Capital Formation Advisory Committee to Discuss Definition of an Accredited Investor. Again.

The Securities and Exchange Commission (SEC), Small Business Capital Formation Advisory Committee (SBCFAC), is scheduled to meet next week, and it has just posted its agenda. Probably the most interesting subject on the list of topics is the segment on the definition of an Accredited Investor.

An Accredited Investor is currently roughly defined as an individual who earns over $200,000 a year or has a net worth of over $ 1 million – not counting a primary residence. If the individual is married, the income threshold is bumped up to $300,000. While it has been adjusted slightly in recent years, the vast majority of observers understand that a wealth metric is not the best way to determine financial acumen. For example, a Professor in Finance (or student, for that matter) may not be deemed to be Accredited yet clearly understands markets and capital formation.

At the same time, the current definition is exclusionary, disenfranchising the majority of individuals in the US to participate in private placements under Reg D (Regulation D). This market is enormous, measured in trillions of dollars annually. Many successful public companies used Reg D prior to becoming a registered or reporting firm.

As policymakers have pursued a rule-upon-regulation approach for public firms, the cost of being a public company has increased dramatically. And this cost is ongoing with quarterly reports and a growing list of disclosure requirements. In effect, policymakers have pushed private firms to remain private longer. The losers in all of this are smaller investors who may miss out on significant gains as big money (VCs and the wealthy) jump to the head of the line when investing in promising young firms.

There is a move on Capitol Hill to incorporate a sophistication qualification to allow not-so-rich individuals to participate in Reg D private placements. The idea is for individuals to show an understanding of private securities and the risk entailed in backing a younger firm.

Unfortunately, current leadership at the SEC wants to make it more difficult for individuals to be deemed Accredited. There is a touch of irony here because government mandarins seem to be okay with a trip to Vegas or buying loads of lottery tickets, but investing in a private company (under Reg D) is a bit more difficult. You get the government you elect, I guess.

Depending on the details of any alterations to the Accredited Investor definition, a change could harm a crucial aspect of the economy.

The Agenda for SBCFAC states:

“The Committee will review and evaluate the existing accredited investor definition. Members will share their views on, and experiences with, the existing definition and consider whether there are potential changes that could positively affect capital-raising opportunities for both entrepreneurs and investors.”

It should be pointed out that this is not the first time the SBCFAC has addressed the topic of an Accredited Investor. The last incarnation of SBCFAC addressed the Accredited Investor definition as well.

The previous Committee asked the Commission not to increase the difficulty of becoming Accredited, requesting it to do the opposite and broaden the definition as the market is a “critical source of early-stage capital for small businesses in communities across the country” and a change could  “shrink the pool of currently accredited investors would have a detrimental effect on small business capital formation.”

The SEC ignored the request to expand the definition, among other recommendations submitted by the previous Committee. It will be interesting to see how the new Committee addresses the Accredited Investor definition.

The SBCFAC will be live-streamed on the SEC website on Wednesday, November 29, 2023, beginning at 10 AM.

The complete agenda is available below.

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