The Securities and Exchange Commission should proceed with caution as it considers whether to expand the “accredited investor” standards to allow individuals who don't meet the wealth threshold to
invest in private placements — provided they have a financial adviser, or are trained in accounting, economics or finance.
While we support the idea of encouraging capital formation and believe that the definition of an accredited investor needs to be updated, the SEC must avoid doing anything that would make it easier for “unsophisticated” investors to invest in vehicles that are unsuitable for them.
In a Nov. 15 letter to Rep. Scott Garrett, R-N.J., and Rep. Patrick McHenry, R-N.C., SEC Chairman Mary Jo White said the regulator is considering modifying the definition of an accredited investor to allow professional certificants, such as certified public accountants or chartered financial analysts, to buy unregistered securities or buy into private-equity and hedge funds.
Currently, only investors who have a net worth of $1 million, excluding the value of their homes, or an income greater than $200,000 can buy those securities.
The SEC also is weighing whether investors who use a financial adviser could qualify as accredited.
If the SEC goes down that path — and at this point, we are not convinced that is the best route — the regulator must take steps to ensure that advisers recommending investments in private placements are professionally certified and have a clear understanding of the risks associated with those investments. They also should demonstrate a clear understanding of how those risks apply to a client's specific financial situation.
Finally, the SEC should put in a place a mechanism to ensure that clients also are aware of the risks.
TACKLE THRESHOLD
No matter what, the accredited-investor standard needs to be updated. Before expanding the definition of an accredited investor, the SEC should tackle the $1 million threshold.
Simply put, the threshold is too low to keep “unsophisticated” investors from buying private offerings that are unsuitable for them. That's because the existing threshold was set in 1982 and has not been revised or adjusted for inflation since. In 1982, just 1.3% of households qualified for accredited-investor status, compared with 9.04% today.
For that reason, we reiterate our call for the SEC to adjust the threshold for inflation and to readjust it every four years. Adjusted for today's price level, the $1 million threshold would rise to $2.3 million.
In July, the Government Accountability Office released an analysis of federal data on household net worth, which showed that adjusting the $1 million minimum to approximately $2.3 million would decrease the number of households qualifying as accredited to 3.7 million, from 8.5 million.
We do not fault Mr. Garrett and Mr. McHenry for wanting to expand the definition of accredited investor so more sources of capital are available to fledgling companies and more investors can avail themselves of private offerings.
But it should never be forgotten that private placements are fraught with risks — if for no other reason than they come with less transparency, less liquidity and higher costs.
