In August 2020, the U.S. Securities and Exchange Commission (SEC) decided in a 3-2 vote to formally amend the definition of “Accredited Investor,” which had up until that point remained nearly unaltered for more than 35 years.
The updated definition significantly broadens the amount of categories of individuals and entities that have consistently exhibited the requisite amount of financial sophistication to avoid being excluded from the expansive, diverse, and significant private capital marketplace.
The dissenting SEC commissioners who voted against the new definition objected mainly to the fact that one central provision was left untouched—specifically the subject that is commonly referred to as ‘wealth thresholds.’ These had not been adjusted to account for inflation, despite the fact that there has been a net increase of over 550% in qualifying households since the initial implementation of the threshold all the way back in 1983. The dissenting SEC officials also noted the inherent risk of potential fraud as well as possible senior abuse during private market transactions that lack a substantial amount of transparency.
SEC Commissioner Roisman also underscored that the Accredited Investor criteria also functioned as a barrier to market entry, stating that liquidity is a poor gauge of an individual’s capability to intelligently make informed financial related decisions. Accordingly, mandating a certain degree of wealth in order to qualify for Accredited Investor status ultimately results in a disproportionately represented and unfair system in which small businesses are unable to invest in private offerings.
The onset of the Great Depression in 1929 and the irresponsible financial conduct that attributed to it resulted in the passage of a host of Federal securities statutes, starting with the Securities Act of 1933. Section 5 of the Act mandated the SEC registration for all securities prior to being sold unless very limited exceptions were applicable. One of these notable exceptions is outlined in Section 4(2) and provides that registration is not mandatory for “transactions by an issuer not involving a public offering.” The issue, however, is the fact that neither the 1933 Act nor any subsequent Federal securities publication defines what constitutes a “public offering” within the context of accredited investors. The uncertainty has resulted in multiple instances of litigation up until present day and was one of the contributing factors that led to the SEC’s recent decision to update the definition.
The purpose of the accredited investor label is to identify individuals whose level of financial sophistication and ability to independently shoulder the inherent risk of investing makes it unnecessary to avail themselves of the Securities Act’s registration process. The balancing act that the SEC was attempting to get right in updating the definition was that an overly restrictive definition that limited the number of accredited investors could potentially restrict the corporate sector’s access to a much needed source of funding and be incongruent with the SEC’s capital formation mandate. On the opposite end of the spectrum, too loose of a definition that flooded the market with accredited investors would go against one of the primary tenets of the Securities Act by not providing investors with the requisite amount of disclosure prior to them making an investment choice.
The updated definition incorporated both new categories of natural persons and entities that could qualify as accredited investors including holders of certain professional certifications, designations or credentials and knowledgeable employees of funds. The new entity categories that can now achieve Accredited Investor status include: LLCs that meet the same asset requirements as corporations; any SEC or state-registered investment adviser; any adviser to a private fund that is exempt from SEC registration per the Investment Advisers Act of 1940; a rural business investment company (RBIC); Any entity owning over $5 million in investments; and family offices with at least $5 million in assets.
What does this all mean in practical terms? Has the SEC accomplished its self-pronounced role per its ‘investor protection mandate’? Or has it merely reworded some verbiage that will ultimately have little impact on investors? Hopefully, it is a step towards the governmental regulatory officials exhibiting more confidence in the intuition and freedom of choice in the American populous to make their own decisions regarding what they do with their financial assets.
