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Accredited Investor Is an ‘Artificial Distinction’: SEC Acting Chair

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Noting the agency’s “time of transition,” Michael Piwowar, the Securities and Exchange Commission’s acting chairman, said Friday that despite the challenges in dealing with a two-person commission, “work continues” with the securities regulator moving ahead with four new disclosure recommendations forthcoming on March 1.

Speaking at the Practising Law Institute’s annual SEC Speaks conference in Washington on Friday, Piwowar noted his hope that a new chairman would be confirmed quickly and that the two other vacancies on the commission would also be filled in short order.

Sullivan and Cromwell partner Jay Clayton was nominated by President Donald Trump to serve as the next SEC chairman. His nomination hearing is said to come in early March.

Piwowar zeroed in on the Dodd-Frank Act, which he argued “is rife with examples of burdens ultimately borne by the ‘forgotten investor’ through shareholder money and company resources being expended to provide nonmaterial disclosures — the conflict minerals, pay ratio and resource extraction provisions to name a few.”

The theme of his talk was “Remembering the forgotten investor.”

Piwowar also argued that there was a “glaring need” for the agency “to move beyond the artificial distinction between ‘accredited’ and ‘nonaccredited’ investors.” He questioned “the notion that nonaccredited investors are truly protected by regulations that prevent them from investing in high-risk, high-return securities available only to the Davos jet-set.”

Two “well-known concepts” from the field of financial economics, Piwowar continued, can be used “to show that, in maintaining an ‘accredited’ status in our regulatory structure, we may have forgotten — and in fact disadvantaged — a set of investors.”

The first, he maintained, “is the risk-return tradeoff. Because most investors are risk averse, riskier securities accordingly offer higher returns. Therefore, prohibiting nonaccredited investors from investing in high-risk securities amounts to a blanket prohibition on their earning the very highest expected returns.”

The second concept is modern portfolio theory. “By holding a diversified portfolio of assets, investors reap the benefits of diversification,” Piwowar said. That is, the risk of the portfolio as a whole is lower than the risk of any individual asset. The correlation of returns is the mathematical key. When adding high-risk, high-return securities to an existing portfolio, so long as the returns from the new securities are not in perfect positive correlation with the existing portfolio, investors may reap higher returns with little to no change in overall portfolio risk. In fact, if the correlations are low enough, the overall portfolio risk can even decrease.”

These two basic concepts of economics, he added, “demonstrate how even a well-intentioned policy of investor protection can do more harm than good, for instance, by exacerbating inequalities of wealth and opportunity.”

In adopting Regulation D in 1982, he said, the SEC divided “the world of private offering investors into two categories: those persons accorded the privileged status of accredited investor and those who are not.” Investors “lucky enough to earn $200,000 or more in annual income or with a net worth of more than $1 million have available to them myriad investment choices, both public or private.” By contrast, “les Misérables on the other side of the line are severely restricted in their investing options.”

The $200,000 income test, he added, “has not been updated since 1982, whereas the net worth test was revised by the Dodd-Frank Act to disallow the counting of home equity raising the bar even higher to qualify as an ‘accredited investor.’”

As to assessing civil monetary penalties on corporations in enforcement actions, Piwowar noted that he has “voted both for and against corporate penalties,” and said he is “fully prepared to support imposition of civil monetary penalties” on regulated entities, such as broker-dealers or investment advisors. “These entities clearly disclose in their corporate filings the degree to which they are regulated and the risk that they may be hit with a penalty if they violate the securities laws. So shareholders are on fair notice—and the market has presumably priced in—that they are investing in a type of entity subject to particular enforcement risks.”

Similarly, he said: “I am generally comfortable with assessing civil monetary penalties in Foreign Corrupt Practices Act cases.”

Despite the commission being “constrained in our ability to discuss the work of the commission without creating a quorum and becoming subject to the Government in the Sunshine Act,” Piwowar noted that the agency will consider the following disclosure recommendations March 1:

Industry Guide 3: The last substantive revisions to Industry Guide 3 (Statistical Disclosure by Bank Holding Companies) were undertaken over 30 years ago. The commission will consider publishing a request for comment to seek public input about disclosures provided by registrants in the financial services industry.

Exhibit Hyperlinks and HTML Format: The commission will consider introducing a requirement to include a hyperlink to each exhibit listed in the exhibit indexes of filings under Item 601 of Regulation S-K (or on Forms F-10 or 20-F). The commission will also consider whether to require registrants to submit such registration statements and reports to Edgar in HTML format.

Inline XBRL Filing of Tagged Data: The commission will consider whether to propose amendments to require the use of “Inline XBRL” format for the submission of operating company financial statement information and mutual fund risk/return summaries.

Further, the commission will consider whether to eliminate the requirement for filers to post interactive data files on their website and whether to terminate the commission’s voluntary program for the submission of financial statement information interactive data.

Exchange Act Rule 15c2-12: The commission will consider whether to propose amendments to Rule 15c2-12 to amend the list of event notices that a broker, dealer, or municipal securities dealer acting as an underwriter in a primary offering of municipal securities must reasonably determine that an issuer or obligated person has undertaken, in a written agreement or contract for the benefit of holders of the municipal securities, to provide to the Municipal Securities Rulemaking Board. The proposed amendments would add two event notices relating to certain financial obligations incurred by issuers and obligated persons.

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