The SEC has proposed expanding the definition of “accredited investor” to include investment advisers and licensed professionals, among other new categories. The SEC did not propose changing or indexing the $200,000 income or $1,000,000 net worth test. The proposal includes the estimated 13,400 SEC-registered investment advisers and approximately 17,500 state-registered advisers in the definition of accredited investors, but the proposal does not include exempt reporting advisers. The proposal also includes financial professionals who have their Series 7 or 65 licenses. Additional new categories include knowledgeable employees of private funds, certain family offices, and a catch-all category for entities owning at least $5 Million in investments.
This proposal is a good start, but we urge the SEC to go further. The income and net worth tests unduly restrict lower net worth, but knowledgeable, individuals from investment opportunities, while failing to protect wealthy, but unsophisticated investors. Rather than the income and net worth tests, the SEC should consider knowledge, background and financial sophistication as litmus tests for accredited investor. We believe that the burden should be on the investor to make representations, upon which an issuer could rely, to determine whether s/he is sophisticated enough. Alternatively, the SEC could develop a financial quiz that potential investors would have to complete before becoming accredited.
The SEC has issued a Concept Release that requests comment and input on possible changes to the offering rules including the “accredited investor” definition and the use of private funds to raise capital. With respect to the “accredited investor” definition, the SEC asks for input on whether it should (i) revise financial thresholds for qualification; (ii) add categories of qualifying investors based on prior experience, professional credentials, or an examination; and/or (iii) measure accreditation based on amount of investments rather than income. For private funds, the SEC wants input on whether it should (i) include 3(c)(7) (qualified purchaser) funds within the definition of “accredited investor” and (ii) change the definition of qualified client for purposes of taking performance fees. The SEC is also considering changes to Regulation D private placements, Regulation Crowdfunding and secondary trading rules.
We believe that the SEC should expand the “accredited investor” definition and allow broader use of private pooled funds for capital raising and investment. However, we have been here before in 2017, 2013, and 2010. Let’s hope Chairman Clayton, who focuses on capital raising, can make true reform happen this time.
In a recent speech SEC Commissioner and acting Chairman Michael Piwowar argued that the SEC should dispense with the “accredited investor” definition for private offerings. He asserted that the “artificial distinction” between “accredited” and “non-accredited” investors hurts lower-income investors because they are deprived of higher-yielding investments that offer portfolio diversification. He maintained that this artificial distinction does more harm than good by “exacerbating inequalities of wealth and opportunity.” In the same speech, Mr. Piwowar also questioned corporate penalties but not against advisers and broker-dealers, which are regulated entities whose shareholders should fully understand the regulatory risk to the stock price.
OUR TAKE: Back in 2013, the SEC changed Rule 506 to allow general solicitation so long as issuers only targeted “accredited investors.” (See “SEC Allows Private Fund General Solicitation with Conditions”). Mr. Piwowar’s suggestion to eliminate the “accredited investor” definition, thereby opening private funds to retail investors, would have far-reaching implications for fund-raising, compliance, and civil litigation.