Discussion of what constitutes an accredited investor was popular at Thursday’s SEC Small Business Forum. Held at the SEC headquarters in Washington, DC and streamed over the web, there was not only a panel discussion but also a breakout session devoted to discussing whether and how to change the accredited investor definition.
Some thought that it should be left alone; while others wanted to add additional methods of determining whether or not an investor was accredited. One panelist, Professor Donald Langevoort of Georgetown University Law Center, noted that the definition of an accredited investor is more of a political answer than an analytical one. So, where does that leave us?
I was honored to moderate the breakout group that was tasked with coming up with five recommendations on the accredited investor definition to present to the Commission. The breakout group’s recommendations will not be finalized for a couple of weeks so the views below are my own and may not represent the final recommendations from the group.
Any discussion of the accredited investor definition should start from the basic premise that those persons who are not accredited investors are those who need the protections that the federal securities laws were designed to provide – balanced disclosure with respect to the risks and rewards of an investment. Investors who should have the advantage of those protections include those who meet the income and net worth standards currently in use.
We all have plenty of examples in our lives (professional and personal) of smart people with not a lot of money and not so smart people with lots of money. Just because one has a significant net worth or income does not mean that he or she is knowledgeable with respect to making investments. Conversely, investors shouldn’t be precluded from accessing investment opportunities solely based upon their annual income or bank balances if they have the knowledge to make informed decisions with respect to their investment portfolio.
While a bright line test based upon income or net worth is simpler to administer, it does not reflect reality when it comes to analyzing investment opportunities and the risks that one is willing to take in order to increase returns on investments.
One alternative (either in addition to or instead of) to the income/net worth test would be a measure of sophistication. While there are many ways one could formulate a measure of sophistication relating to investments, some of those discussed in the breakout group included an examination developed to test financial knowledge, holding certain licenses or certifications (such as FINRA licenses, CPA, CFA), achieving certain levels of education, or having certain business experience.
Another alternative discussed was to limit investments to a percentage of net worth (similar to the state suitability standards in the non-traded alternatives space).
While there seems to be no one magical way to determine whether an investor does not need the protections of the securities laws, the general consensus was that opening up private capital formation to more investors who are knowledgeable and sophisticated was a benefit to everyone.
The breakout group’s recommendations, along with the other breakout groups’ recommendations, will be published by the SEC Small Business Forum on the SEC’s website in the coming months.
Notwithstanding the recommendations to come out of the breakout group, one thing is certain – there is currently insufficient data on the investors in private placements under Reg D to decide exactly who should be allowed access to those offerings and who should be precluded and protected. This lack of data makes it difficult to measure any impact changes in the definition of accredited investor might have on private capital formation activities and the harm that exists with respect to current investors.
Given this uncertainty, it seems that leaving the income and net worth thresholds as they are (if it ain’t broke, don’t fix it) while expanding the definition to include measures more reflective of an ability to determine the potential risks and rewards of an investment in a private placement, would be a good start.