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ANALYSIS: The Accredited Investor—Where Do We Go from Here?

Nov. 4, 2019, 11:10 AM

Accredited investor status is the key that unlocks the door to thousands of private securities offerings. Currently, for individuals, financial benchmarks determine whether a particular investor satisfies the requirement for participating in unregistered offerings. If an investor has $200,000 in income (or $300,000 jointly with a spouse), or a net worth of more than $1 million (individually or jointly), they may participate in private offerings.

We will be hearing a lot about accredited investors in 2020. The comment period just closed on an SEC concept release seeking input on the current confusing mix of the Commission’s exemptive rules. The accredited investor definition was a key component of the SEC’s request for comment.

Will the SEC act to change the definition of an accredited investor? To do so, they will have to answer several basic questions in 2020:

1) Should the SEC expand the number of individuals who can qualify as accredited investors?
2) Are financial benchmarks the appropriate measuring stick for accredited investor eligibility?
3) Is there an untapped pool of demand that issuers can access with a broadened circle of eligible investors?
4) Is the SEC working at cross-purposes if it permits more people to participate in private offerings while also trying to increase the number of publicly-traded companies?

The Dollar Figure

At first glance, the logical move for the SEC would be to increase the thresholds for accredited investor status. The base numbers of $200,000 of income and $1 million in net worth have not been adjusted since 1982, with the exception of the exclusion of the investor’s primary residence from the net worth calculation pursuant to the Dodd-Frank Act. Inflation has vastly expanded the circle of accredited investors since the 1980s.

The SEC discussion of the accredited investor definition in the concept release seems to focus in the other direction, however, as it examines ways to increase the number of eligible investors. It is highly unlikely that the SEC would act in a way to restrict that pool.

Other Measures

Should the Commission continue its reliance on financial measures as the sole qualifying factor? That reliance is problematic, because wealth does not signal investment sophistication. The Bernie Madoff scandal certainly proves that point. In addition, is the ability to take a financial hit the proper measure of whether an exemption is appropriate? Expertise, sophistication and access to information will also be factors for the Commission to consider in 2020. Should an individual with specified credentials or expertise, such as a certified financial planner, a holder of financial industry licenses—or a Bloomberg Law analyst—be treated as accredited investors?

Will Changing the Definition Help?

Let’s assume that the Commission does expand the exemptive definition. Will the coffers of issuers be suddenly filled by these newly-discovered investors? SEC Investor Advocate Rick Fleming thinks not. He doubts that issuers will be able to raise significant capital from those currently outside the accredited investor definition. He noted in a July 2019 comment letter that “when one looks beyond that top decile of households, the likelihood of stock ownership falls off dramatically.” He also questioned whether companies even want to have a large number of small investors on their books.

Working at Cross-Purposes?

Finally, since taking the helm of the SEC, Chairman Jay Clayton has emphasized the importance of increasing the number of publicly-traded companies in U.S. markets. The concept release, however, provides a roadmap for more companies to stay private longer, and legislative changes in the JOBS Act allow private companies to remain so while significantly increasing their investor base. While companies obviously need access to capital before they are ready for public ownership, the Commission seems to be working against itself stressing these two contradictory objectives.

Next Steps

It is likely that 2020 will see Commission action to expand the accredited investor definition. Time will tell, however, if the excitement for change leads to equally exciting results in the marketplace, and whether there is significant pushback from consumer protection advocates.

Read about other trends our analysts are following as part of our Bloomberg Law 2020 series.