For the first time in 32 years, the idea of who should qualify as an accredited investor and be able to partake in private placements is being seriously questioned. The ultimate decision will impact which Americans can invest in nonpublic offerings — and potentially how much.
The SEC Investor Advisory Committee took an important step toward change last Thursday. By voice vote, with one dissenter, it recommended
considerable revisions the Securities and Exchange Commission should make to the definition of a sophisticated investor, saying it should broaden the potential pool and strengthen verification that they qualify.
The accredited-investor standard currently limits private placement purchases to individuals who earn at least $200,000 annually ($300,000 for a married couple) or have a net worth of $1 million excluding their primary residence.
Rather than just upping the thresholds, the committee asserted that relying on income and net worth “oversimplifies the factors that determine whether an individual truly has the wealth and liquidity to shoulder the potential risks of private offerings.” The thresholds don't provide adequate protection for investors whose net worth is based on a retirement nest egg or on illiquid holdings, such as farmland, the IAC noted.
“We believe there are ways to solve problems with the current definition that don't necessarily involve raising the thresholds and that don't necessarily involve restraining the flow of capital for private offerings,” Barbara Roper, director of investor protection at the Consumer Federation of America and a member of the IAC, said at Thursday's meeting.
The committee said the SEC should
scrap the income and net worth floors and instead consider a definition of sophisticated investor that takes into account an individual's education; professional credentials, such chartered financial analyst designation or Series 7 license; and investment experience. Another approach would be to develop a financial-sophistication test.
If the SEC decides to maintain income and net worth standards, the agency should limit participation in private placements to a certain percentage of an investor's income or assets, the IAC said.
Responsibility for verifying accredited investor status should shift from securities issuers to third parties, who could include brokers, investment advisers, accountants and attorneys, the committee said.
The committee also recommended that the limited number of non-accredited investors who can participate in private offerings based on a recommendation from a “purchaser representative” should get stronger protection. Any such representative should be required to act in the investor's best interest, the committee said.
“We've sought to at least maintain and possibly expand the pool of available investors, if we can adopt appropriate protections in the process,” Ms. Roper said.
Under the Dodd-Frank financial reform law, the SEC must review the accredited-investor definition every four years. This is the first such required review since Dodd-Frank was enacted in 2010. About 8.5 million investors currently qualify as accredited.
The Investor Advisory Committee was established by Dodd-Frank to represent retail investors to the SEC. The agency is not obligated to adopt the IAC's recommendations.
SEC Chairman Mary Jo White told reporters on the sidelines of the meeting that the agency is undertaking a “deep-dive study into the [accredited-investor] definition,” but that she doesn't know “ultimately where we'll land.”
She said the agency would consider the IAC's approach.
“They did a very, very impressive job with a range of difficult, subtle, nuanced issues,” Ms. White said.
The IAC member who voted against the recommendation, Hester Peirce, a senior research fellow at the Mercatus Center at George Mason University, said it was too narrowly focused and would exclude ordinary Americans with “local” knowledge of a company or investment deal from participating.
“We need to look more broadly and try to get away from the notion that the government's assumptions about people's capabilities and abilities should trump people's individual determinations about how to invest,” Ms. Peirce said.
An advocate of crowdfunding, a process by which equity in companies is sold in small increments to ordinary investors over the Internet, also is wary of IAC’s proposal.
David J. Paul, chief strategy officer at Propellr, an online platform for real estate investing, said the panel’s recommendations are aimed ultimately at restricting the number of people who qualify as accredited investors. He said that move would curtail a private-offering market that provides more than $1 trillion in capital annually for small and medium-size businesses.
Instead, Mr. Paul wants the SEC to maintain the existing income and net worth rubric and expand the accredited-investor pool by allowing in people with expertise and experience, if not wealth.
“We believe that the current standard is not so much inadequate as incomplete,” said Mr. Paul, co-chair of Crowdfund Intermediary Regulatory Advocates. “It should be broadened to include not just rich people but smart people, not that those two categories are mutually exclusive. It is one more arrow in the quiver in the direction of helping more people create wealth and redistribute wealth based on merit.”
But an IAC committee member, Roger Ganser, chairman of BetterInvesting, said the elderly, who often have large pension assets, need stronger protections from opportunistic private offerings.
“They are a vulnerable class out there,” Mr. Ganser said. “We know they're targets.”
