The accredited investor rule should be redefined, not erased

It should not come as a surprise that there is a general push emanating from Washington for less regulatory oversight, which is the context for recent comments by the acting SEC chairman supporting greater investor access to certain private and exotic investment strategies.

While far-out actions and ideas have never been foreign to the politically charged world inside the Beltway, we can only hope this proposal is little more than an ill-fated trial balloon.

The suggestion, as laid out during a speech by acting Securities and Exchange Commissioner Michael Piwowar, is to revise and possibly remove the definition of an accredited investor, which for 35 years has basically meant rich folks.

From Mr. Piwowar’s perspective, the accredited investor rule has produced “forgotten investors,” who haven’t been able to benefit fully from the potential returns and diversification provided by products like hedge funds and private placement strategies.

“In my view, there is a glaring need to move beyond the artificial distinction between ‘accredited’ and ‘nonaccredited’ investors,” Mr. Piwowar said. “I question the notion that nonaccredited investors are truly protected by regulations that prevent them from investing in high-risk, high-return securities available only to the Davos jet set.”

Style points should be awarded for Mr. Piwowar’s nimble mount aboard the populist wave, but we see it differently.

As established in 1982, when the SEC adopted Regulation D to help small businesses raise capital through the sale of unregistered securities, accredited investors are defined as individuals with a net worth in excess of $1 million or annual income above $200,000, which climbs to $300,000 for couples.

Imperfect as the restrictions were then and are now, the general idea is that individuals with more resources are better equipped to conduct independent due diligence on less-regulated investments and are in a better position to absorb some investment losses.

Over the past three-plus decades, as the world of less-regulated investment strategies has evolved into such forms as a $3 trillion hedge fund industry, the debate over greater access for retail investors has become near constant.

One of the more popular arguments compares a wealthy celebrity with a middle-class economics teacher or financial journalist and poses the question of which is likely better qualified to comprehend an unregistered investment strategy.

investor sophistication

The message that wealth alone is a lousy measure of investor sophistication comes across loud and clear, which is part of the reason regulators, lawmakers and industry advocates have been wrestling for years with ways to improve the accreditation requirements.

The most recent effort came in December, when the House of Representatives voted overwhelmingly in favor of updating the accredited investor definition to encompass individuals with securities licenses, as well as those with education and experience related to a particular investment.

That would be a step in the right direction, even though it would likely put more onus on financial advisers to ensure the investments appropriately match the investor.

The 2010 Dodd-Frank financial reform law requires the SEC to regularly review the accredited investor standard, and last year the SEC Investor Advisory Committee expressed support for an updated definition of an accredited investor.

For so many reasons, it is way past time to revamp the accredited investor rules.

If nothing else, the dollar amounts should be adjusted for inflation, which would push the net-worth limit to just over $2.6 million.

This isn’t to suggest that net worth or income is a perfect and fair gauge of investor sophistication, but until something better is in place it would be foolhardy to remove it as the only restriction between retail investors and the vast universe of private and exotic investment opportunities.