The SEC Small Business Capital Formation Advisory Committee (SBCFAC) returned to meet this past week with the definition of an Accredited Investor at the top of the list for discussion.
The SBCFAC provides guidance to the Commission on issues that impact smaller firms, which frequently garner little attention from the SEC. Meanwhile, SMEs are one of the most critical aspects of the US economy. These firms can be unduly harmed by regulations designed for far larger firms.
The definition of an Accredited Investor is a key component of private markets. Most frequently identified with Reg D, the definition determines who can, and who cannot, participate in these private offerings, which is an enormous market, measured in the trillions of dollars. Reg D is essential for fostering innovation and driving economic growth. A recent study on the market claimed that at least $4.4 trillion of Reg D securities were sold in 2021 and 2022, which is 13% more than the $3.9 trillion proceeds from public offerings.
The same study shared that in recent years, Reg D securities offered were sold to more investors per offering with a lower amount sold per investor as interest has increased in private markets. It is generally understood that as policymakers have taken a rule-upon-regulation approach to public markets, and the cost has risen dramatically, firms have been pushed to remain private as long as possible. This may also mean that a lot of the early capital gains end up in the hands of VCs and other affluent segments of society, excluding smaller investors. Going public can be more of an exit opportunity instead of an entry point.
Under current leadership at the Commission, the SEC has noted that “Regulation D and Form D Improvements” are top items for rulemaking. While no concrete rules have been released publicly yet, the expectation is that the Commission will demand more disclosure in Form D and a higher hurdle to be deemed an Accredited Investor. The change to the definition may include indexing wealth metrics to inflation – something that could slash the number of individuals able to participate in Reg D offerings – further disenfranchising a significant portion of the investing public.
At the beginning of the meeting, SEC Chairman Gary Gensler shared a statement on the definition. The Chair said:
“Any discussion about the definition of an accredited investor raises the question about when it may be appropriate to have exceptions to this basic bargain at the heart of our capital markets. In essence, when is it appropriate that investors get—or not get—that full, fair, and truthful disclosure that Roosevelt worked with Congress to embed in the securities laws? I look forward to hearing the Committee’s thoughts on the ways that they think we might improve on the current definition of an accredited investor.”
His words allude to his desire to reign in the Reg D marketplace with greater disclosure and a higher wealth hurdle to participate in these private offerings.
Commissioner Caroline Crenshaw was more explicit in her belief that broadening the definition would put too many investors at risk and could “amplify wealth inequality.”
Commissioner Hester Peirce provided greater clarity in her opinion. The Commissioner said access to markets is part of the American ethos of freedom and individual rights:
“The capital markets help us to live out that freedom. The Commission, which is charged with regulating those markets, needs to be careful not to trample on the ability of Americans to think, dream, and do. Americans should be able to invest and build wealth without having to convince regulators—even those operating with a protective impulse—that they are sophisticated enough or rich enough. Rather, our role is to ensure that capital can flow freely to enable Americans—all Americans—to make the most of their time and talents. That includes the freedom to build businesses and invest in others’ businesses. Freedom and risk-taking are the backbone of our thriving, dynamic, innovative economy. Any regulations we adopt must be very careful not to impede that freedom.”
And what about SBCFAC? They are putting together recommendations which should be revealed at their next meeting. Several members of the Committee were vocal in their support of expanding the Definition and making it more inclusive.
Bart Dillashaw, founder of Enterprise Legal Studio in Omaha, Nebraska, stated that any reduction in the number of available angels would hurt smaller private firms. Expansion of the definition will help it. Dillashaw said he is “in the camp of the dollar thresholds should not be indexed with inflation and stay where they are.” He added that the SEC should create a sophistication test “similar to a driver’s license” that ensures investors are aware of the risks.
Agreeing with everything that Dillashaw said, Laura Niklason, founder, President, and CEO of Humacyte in Durham, North Carolina, said if you want to expand the Accredited Investor definition, any indexing or raising the threshold would have a side effect of making the number of qualified individuals smaller and more exclusive.
Marcia Dawood, Venture Partner at Mindshift Capital, shared boots-on-the-ground experience, noting they “have seen extremely low fraud.” Dawood is also Chair of the Board of the Angel Capital Association (ACA).
Dawood said there is a misconception there is fraud within angel investing. We are not seeing fraud, she stated. She added that as far as the indexing, the ACA went back and looked at indexing, completing an informal study of their members, asking how many angels indexing would eliminate. She said the “numbers are staggering” as about 50% of Angels in the US would be eliminated. Dawood added that there are about 16 million individuals who currently qualify as Accredited Investors, but only around 300,000 are active.
Founder and CEO of HoneyComb Credit – a regulated Funding Portal, George Cook, cautioned the Committee that if they index the definition back to the 1980s, they will destroy a lot of opportunities. As an investment crowdfunding platform, Cook said they have not experienced any increase in fraud in regard to online capital formation.
Cook explained that private capital markets are not just equity. Private Debt Markets are huge, and there is also wine, whisky, and other collectibles. There are also Fractional shares of assets. He cautioned about a certification of sophistication being too extensive, sharing his opinion that it should be relatively simple, providing a path for investors that don’t meet the net worth metric.
Esusu co-founder and co-CEO Wemimo Abbey issued a comment that hit home: the US is a country about liberty and freedom, and they should not be in a position of telling people what they should do, but you should give them information on risk.
“I do not want people to miss out on the wealth-building journey,” said Abbey – who also shared that 75% of the people on his cap table are people of color and women. Some of these people invested in his company when it was valued at $10 million. Today, it is valued at $1 billion.
Esusu is a Fintech that enables households to use their on-time rent payments to build credit.
Only a couple of members spoke out in support of new restrictions regarding the Accredited Investor definition.
In the end, the SBCAC expects to make recommendations to incorporate greater education for private markets, keep the existing wealth metrics while providing a sophistication path. Voting is expected to take place at the next meeting. In the interim, the details of the recommendation will be hashed out.
This is not the first time the Committee has addressed this issue. The previous incarnation of the Committee told the Commission to expand the definition with little success. The SEC has a long history of ignoring advice from SBCFAC and its predecessor. It appears that politics overrides propriety at the SEC.
This past September, Patrick Gouhin of the ACA told the SEC Investor Advisory Committee:
“It would be counter-productive to knock some large percentage out of the game by arbitrarily raising thresholds when there is no problem to correct. Such an increase in thresholds would also disproportionately affect underserved communities throughout the U.S., eroding some 20-plus years of momentum as angel communities have infiltrated middle America contributing to local growth.” [emphasis added]
The above is a telling statement. Will the leadership of the Commission listen? Probably not.