The Securities and Exchange Commission is considering a variety of input on the possibility of changing current accredited investor definitions and thresholds. The assumption that accumulated wealth (at least from some sources) equates with investing sophistication continues to meet with skepticism.“I know some very smart people who are extremely sophisticated that aren’t accredited investors, and I know some accredited investors I wouldn’t trust with a potato gun, you know, so – but how do we build – what is that test?,” asked a panelist at the Nov. 20 meeting of the SEC’s Small Business Capital (SBC) Formation Forum.
The meeting touched on suggestions the SEC’s Investor Advisory Committee (IAC) made to the Commission the previous month. These suggestions included swapping out existing wealth and income thresholds for knowledge-based criteria that would be verified by testing, securities licenses or professional experience. But the SBC forum asked many more questions than it provided suggestions. “I think all of the proposals for refining the definition stumble on definitional questions that are essentially fatal,” one panelist said. A wide range of possibilities arose at the forum, starting with making no changes to the existing thresholds. There was also discussion of deducting retirement assets from net worth, while another scenario involved defining accredited investors as those who have $750,000 or more in investments.
Panelists noted that the threshold definitions have remained mostly unchanged since 1982, except for the elimination of primary residences as qualifying assets, which reduced the number of accredited investors.
Making the dollar thresholds more timely by updating them for inflation would significantly reduce the size of the accredited investor pool, though this option received careful consideration at the forum. If updated to take inflation into account, the current $200,000 individual and $300,000 joint income minimums would become $492,000 and $628,000 today. Likewise, 1982’s $1 million net worth would become about $2.46 million.
Updating for inflation would reduce the pool of accredited investors from approximately 12 million to households to half or even a quarter as many, depending on several scenarios devised by the SEC.
Percentage of U.S. Households (Millions) Qualifying as Accredited Investors
The table above illustrates how changes to current definitions could change the pool of accredited investors. This table, produced by the SEC, also illustrates the effect of taking retirement assets out of the picture.
Such reductions would have serious implications for Rule 506(c) exemption, and for the JOBS Act’s goal of freeing up more capital from more investors. There would also be ramifications for angel investors, who provide substantial capital, especially to early stage companies if accreditation financial thresholds were to be increased. “Startup funding would be devastated if the financial thresholds were adjusted for inflation,” according to a representative of the angel community who said one-third to one-quarter of existing angels would lose their accredited status.
As it is, the panelist said, many angels already decline to review offerings filed under Rule 506(c). “So, we have found that most of the angel groups in ACA will actually only consider 506(b) deals. That really just negates the JOBS Act intent entirely.”
Over two years since the passage of the JOBS Act, panelists were concerned about how long it is taking to clarify related issues. “We should be able to walk and chew gum at the same time,” said one individual on the accreditation panel. “Even as we work to rationalize and improve the entire system, we should move as quickly as possible to finalize the proposals that are before us.
“I know what happens when the Commission tries to reinvent the wheel,” another respondent said.
The Commission is aware of such concerns. In mid-January, for instance SEC Commissioner Daniel Gallagher gave a speech in which he said the Regulation A JOBS Act rules need to be completed soon. He spoke more generally of a regulatory climate that is hindering the role of the U.S. in the global capital marketplace.
“Rather than thinking creatively about ways to promote capital formation,” Gallagher said, “legislators and regulators are layering on law after law, regulation after regulation – strangling entrepreneurs, their enterprises, and of course their employees and customers. We are not even resting on our laurels – we are actively throwing those laurels on a bonfire.”
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