SEC Acting Chair Seeks Looser Accredited Investor Definition

In December 2015, the Securities and Exchange Commission staff issued a report on its review of the "Accredited Investor" definition under Regulation D. At the February 2017 annual SEC Speaks conference, attendees heard that the SEC Acting Chair seeks a looser accredited investor definition in line with the staff review and report. Read on to find out why the SEC seeks this change.

Artificial Distinction. SEC Acting Chair Piwowar indicated that the distinction between an accredited investor and a non-credited investor was an artificial one. The current language of Regulation D defines an "accredited investor" (as it relates to natural persons) as one having:

·         $200,000 in annual income ($300,000 with a spouse) in each of the last two years and reasonable expectation of the same income in the current year, or

·         a net worth of $1 million (individually, or with a spouse), not including the primary residence

Piwowar indicated that the net effect of these rules is to bar non-accredited investors who do not meet these wealth thresholds from receiving the same investment returns/diversification as investors at the higher income thresholds.

Regulation D. When the SEC adopted Regulation D in 1982, it divided the investor world into two components: accredited investors and non-accredited investors. The SEC intended Regulation D to protect investors not able to protect themselves in the investment marketplace. While the SEC may have had good intentions, the result of Regulation D accredited investor rules is that it excludes non-accredited investors from the higher investment returns that usually accompany higher-risk investments.

In addition to higher investment returns, Piwowar says that adding higher risk investments to a portfolio provides diversification and alleviates risk. The Acting Chair questioned whether the accredited investor rules worsen the gulf that exists in US income inequality.

Investors to Qualify Based on Other Measures. A year ago, in February 2016, the House of Representatives passed legislation (The Fair Investment Opportunities for Professional Experts Act [H.R. 2187]), that directed the SEC to modify its accredited investor definition to include those who have professional knowledge relating to a particular investment and to allow them to participate in private placements based on education or employment history - regardless of income or wealth.

Investments Available to Accredited Investors. The distinction between accredited and non-accredited investors is significant because of the types of investments available to accredited investors that are unavailable to non-accredited investors, such as:

·         private companies

·         hedge fund offerings

·         private equity fund offerings

·         venture capital funds.

In addition, unregistered structured financial products and debt securities also come under Regulation D's restrictions.

Impacts on Disclosures. Issuers must provide financial and non-financial disclosures set out in Rule 502(b) to any non-accredited investor. The SEC has issued a series of rules commonly referred to as Regulation D. The rules established two exemptions and two non-exclusive safe harbor from the registration requirements of the Securities Act. The accredited investor definition is perhaps the single most critical component of Regulation D.  In general, greater disclosure is required for non-accredited investors.

Several proposed changes to the accredited investor definition (including an accredited natural person definition) suggested during the early part of the 2000 decade never came to fruition.

Many international jurisdictions provide exemptions from disclosure and registration requirements for the sale of securities to sophisticated or accredited investors. These approaches generally use income or net worth to identify sophisticated or accredited investors.

Effect of Inflation. The SEC staff report also suggests that inflation has eroded the income and net worth thresholds put in place in 1982 as well as the joint income threshold adopted in 1988. If Regulation D adjusts those provisions for inflation, it would significantly impact the number of individuals who qualify as accredited investors under existing thresholds.

Disagreement in the Industry.  Not everyone agrees with the SEC’s Acting Chairman.  Some financial advisers, in particular, have reacted negatively to Piwowar’s comments.   However, some others embrace Piwowar’s ideology and dismiss the negative reaction by those financial advisers as self-interested stances taken to protect their closed networks.