Home Alts News Guest Contributor: Net Worth – A Poor Measurement for Accredited Investor Thresholds

Guest Contributor: Net Worth – A Poor Measurement for Accredited Investor Thresholds

By: John Harrison, Executive Director of The Alternative and Direct Investment Securities Association (ADISA)

By: John Harrison, Executive Director of The Alternative and Direct Investment Securities Association (ADISA)

The Securities and Exchange Commission recently announced plans to consider tightening the threshold for accredited investment qualifications. At one time, just 2 percent of the U.S. population was wealthy enough to fit into this category. Thanks to inflation and other factors, a much larger percentage now meets accredited investor criteria.

But if the SEC decides to tighten things up, it’ll knock the percentage down once again. This means most middle-income Americans won’t have access to potentially valuable investment opportunities, such as real estate, hedge funds, venture capital funds or crowdfunding enterprises.

Since the Securities Act of 1933, the government has supported arbitrary regulations to “protect” people from large monetary losses by restricting their investment in higher-yield assets. However, preventing investors from such opportunities isn’t necessarily protection, and it can rob younger companies from much needed capital. Restricting investment bars investors (and we must also count start-up sponsors as a type of investor) from building wealth. While government-imposed restrictions serve to curb risk, by the same token, it limits reward.

Currently, there is movement afoot to examine raising the accredited investor threshold.  The SEC earlier expanded the focus of accredited investors to include those with more sophisticated financial qualifications.  Here’s where the definition lives currently:

  • An annual income of $200,000 (for single) or $300,000 (for joint income) and/or
  • A net worth of $1 million (excluding the primary residence), or
  • A person of certain professional certifications, credentials, or other knowledgeable fund or investment entity employees (sophisticated investors)

The thinking behind this definition is that the wealthy are less likely to suffer losses than middle-income individuals, and that they’re more likely to make intelligent investment decisions. But there’s no magic number where a certain net worth yields immunity from monetary loss. Think Madoff Investment Securities and its high net-worth investors. History is littered with stories of Ponzi schemes and fraudulent funds targeted specifically to the rich.

A six-figure income or seven-figure net worth is no guarantee against making poor financial decisions.  Indeed, an individual who receives a lottery windfall of $6 million could qualify as an accredited investor, with or without financial sophistication. On the other hand, the well-read person, who carefully researches investment opportunities and thoroughly understands risk and reward—but earns $150,000 a year—cannot qualify, at least, without specific credentials.

The Protection Argument

Let’s grant that the SEC’s investor protection intent is sincere though not based on a demonstrably useful threshold:  There is an altruistic protection built into any limit whereby those under it are blocked from private investments. As a result, individuals blocked from private investments are basically limited to what’s available on publicly traded stock exchanges.

Not only is the stock market a cumbersome way to build wealth, but there’s nothing necessarily “safe” about it. The value of corporate shares doesn’t have much to do with returns or earnings. Rather, stock values rise and fall, based on the more volatile factors of a secondary market. The nature of public-traded markets makes them risky to non-accredited investors. Furthermore, those investors are not going to benefit from potentially higher yields through privately traded assets.

Let’s take a look at GameStop. In January 2021, GameStop’s earnings were dismal and the company was struggling; certainly not something that would provide a solid, or “safe” investment to shareholders. But Reddit users convinced others to buy shares of the company on the New York Stock Exchange, artificially driving up the price. The trading mania drove the stock price to $482 a share before it plunged to less than $90 less than a week later, as traders dumped the stock to take profits. Those who bought the stock at its peak (“protected” non-accredited investors) lost a lot of money.

Upping the Threshold

ADISA has argued to the SEC that indexing the threshold may provide future adjustment. If we go along with the idea that “protecting” the middle-income earners from investment risk is even a sound strategy, the already built-in index factor rests in the exclusion of primary residence.

Real estate has increased in value much more than the rate of inflation since this whole argument began. As the accredited investor net worth equation excludes the primary residence, then presumably a larger number is subtracted from the investor’s net worth figuring each year.  Voila, we have an inflation adjustment greater than inflation already built in.  This saves perennial readjustment of the threshold amount by regulators with business calculators plugging in the time value of money.

Leaving the threshold to be adjusted based on real estate values versus individual net worth provides more investment opportunities to Americans willing to participate. It can help grow their wealth more quickly, while providing diversification. As pointed out above, few investment options exist for non-accredited investors; those that are available can be volatile, often with lower yields. Allowing more Americans the status of accredited investor means they can build wealth and nest eggs through involvement in crowdfunding, hedge funds and private placement funds.

Wrongful Paternalism

The SEC and other government entities need to temper the concept that middle- and lower-income people require continual protection from investment risk. Let’s face it; people already make risky decisions impacting their livelihood, whether they have a high net-worth or earn less than $2,000 a month. Many are more than capable of determining their levels of investment risk.  Blocking investment opportunities simply because people aren’t rich enough by some arbitrary threshold smacks of paternalism, while getting in the way of allowing Americans to build wealth.

John Harrison is a regular contributor to The DI Wire. Since 2012, Harrison has been the executive director of ADISA, an organization that represents the non-traded alternative investment industry. Harrison has been in association management for more than 25 years and has served in industry, education, and health associations in the U.S., Europe, and the Middle East. He was a cum laude graduate in biology and psychology from the University of Georgia and earned an MBA and a doctorate in business administration from Georgia State University.

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The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.