Securities and Exchange Commission Chairwoman Mary Jo White says that the agency will take a “deep dive” into how to revise its decades-old accredited investor definition, and is weighing recommendations on how to update the terms that were recently proposed by the agency’s Investor Advisory Committee.
During its meeting at SEC headquarters in mid-October, the Investor Advisory Committee approved five recommendations, including a provision to allow investors to qualify based on their “financial sophistication” and not just their net worth. The committee also wants educational requirements and designations to be considered.
Barbara Roper, director of investor protection at the Consumer Federation of America, who heads the committee’s Investor as Purchaser Subcommittee, said during the meeting at SEC headquarters in Washington that the recommendations include several significant changes from the discussions the committee had regarding changing the definition at the Investor Advisory Committee’s July 10 meeting.
The committee’s proposal, which Roper said was a product of “a lot of back and forth” between the Investor as Purchaser and Investor Education subcommittees, applies to “natural persons” under the SEC’s accredited investor definition, not institutional investors.
“When Congress removed the ban on general solicitation” under Rule 506 offerings under Regulation D, Roper said, the accredited investor definition “divide in the public and private markets became more important.”
The Dodd-Frank Act requires the SEC to review the accredited investor definition every four years. White told reporters on the sidelines of the meeting that the SEC’s Division of Corporation Finance has been performing a “deep dive” into the definition. White said that the agency is “in the process of making real progress on all of the issues that you see addressed” in the committee’s recommendations.
The committee offered five recommendations.
1. The SEC should carefully evaluate whether the accredited investor definition, as it pertains to natural persons, is effective in identifying a class of individuals who do not need the protections afforded by the Securities Act of 1933.
The current definition’s financial thresholds, which haven’t been updated since 1982, “serve as an imperfect proxy for sophistication, access to information and ability to withstand losses,” the committee’s recommendation said.
Roper noted the ongoing debate regarding whether to raise the thresholds. “We have concerns about the current definition,” she said, but the committee is offering “ways to solve it […] that don’t involve raising the thresholds and constraining private offerings.”
The committee noted that if, as it expects, the SEC’s analysis reveals that a “significant percentage” of individuals who currently qualify as accredited investors are not in fact capable of protecting their own interests, the commission should initiate rulemaking to revise the definition to better achieve its intended goal.
However, the committee opined in its recommendation that the SEC “not simply make a binary decision over whether or not to adjust the thresholds to reflect inflation.”
As it stands now, a natural person who qualifies as an accredited investor is a person with income exceeding $200,000 in each of the two most recent years; joint income with a spouse exceeding $300,000 for those years; or joint net worth with a spouse that exceeds $1 million at the time of the purchase, excluding the value of the primary residence.
The SEC, the committee said, “should also consider whether the current approach of relying on income and net worth minus the value of the home makes sense or whether an alternative approach would be more effective.”
2. The committee said that the agency should revise the accredited investor definition to allow individuals to qualify as accredited investors based on their financial sophistication.
The committee noted that under the Jumpstart Our Business Startups (JOBS) Act, Rule 506 offerings that include general solicitation can only be sold to accredited investors. As a result, “there is currently no means for sophisticated investors who do not meet the financial thresholds in the accredited investor definition to invest in such offerings.”
Said Roper: “There should be a way for people who can assess risks to participate in this market regardless of whether they meet an income threshold.” Holding the Chartered Financial Analyst (CFA) credential or having a Series 7 license, she said, “would arguably attest to someone’s financial sophistication.”
Professional experience, she added, “would also seem logical places to look.”
3. The committee stated that if the SEC decides to continue with an accredited investor definition that relies “exclusively or mainly on financial thresholds,” the agency should consider alternative approaches to setting such thresholds—“particularly limiting investments in private offerings to a percentage of assets or income—which could better protect investors without unnecessarily shrinking the pool of accredited investors.”
4. The committee recommended that the SEC develop alternate means of verifying accredited status so as to “shift the burden away” from issuers who may be poorly equipped to conduct such verifications.
Roper noted that “a significant addition” to the recommendations is that the SEC “study third-party verifications.”
5. In its final recommendation, the Committee asked that the SEC “strengthen the protections that apply when non-accredited individuals” qualify to invest solely by virtue of relying on advice from a “purchaser representative,” which could include an investment advisor or broker-dealer.
As the committee explained, relying on a purchaser representative enables individuals who might not otherwise qualify as accredited investors or as sophisticated non-accredited investors to invest in Rule 506 offerings.
However, the committee noted that “unfortunately, the commission’s rules do not, in our view, achieve an appropriate balance.” Instead, the rules “allow unsophisticated, non-accredited investors to invest in private offerings in reliance on a recommendation from a purchaser representative who may have significant conflicts of interest and who isn’t subject to a clear legal obligation to act in the bests interests of the investor.”
The committee recommended that the SEC consider requiring that those individuals or entities who wish to serve as a purchaser representative notify regulators and that the agency consider additional oversight of such persons or entities.