According to a new report, the U.S. Securities and Exchange Commission (SEC) is potentially open to modifying and improving its exempt offering framework, including the popular Rule 506(c) exemption for accredited investors in Regulation D. We believe that there is room for improvement and all investors should have a fair chance at certain investment opportunities. That being said, we understand the need to balance financial freedom with the responsibility to safeguard investors. Let us explain.
Changes Could Affect Available Investment Opportunities
Modifications to Regulation D and other exemptions could impact the opportunities available to investors. Recently, the SEC began accepting comments on its report, entitled “Concept Release: Harmonization of Securities Offering Exemptions.” The report broadly reviews exemptions to registration requirements under federal securities law and solicits comment on their consistency, accessibility, and effectiveness for both investors and issuers.
Let’s take a closer look at one of the most popular exemptions. On July 10, 2013, the SEC issued new final regulations allowing public advertising and solicitation of Regulation D offers to accredited investors. Under Rule 506(c) of Regulation D, businesses may publicly solicit and advertise their private offerings only if they take reasonable steps to verify that their investors are all accredited investors.
The SEC adopted Regulation D in 1982, and the term “accredited investor” is defined in Rule 501 of Regulation D. An individual may become an accredited investor if their net worth exceeds $1 million USD, excluding the value of their primary residence. Alternatively, they may be accredited if their income over the past two years was above $200,000 USD ($300,000 USD with a spouse), with the expectation that it will remain consistent in the current year.
Should We Increase the Accredited Investor Threshold?
A lot of people might want to raise the threshold amount in an effort to limit certain investments to a few privileged investors. First of all, they point out that the standard has not changed since 1982, even though 2019 prices are 166% higher due to inflation, according to the Bureau of Labor Statistics. As the SEC is required to adjust the $2 million USD net worth threshold for qualified clients every five years for inflation, why not do the same for accredited investors? In addition, individuals with a high net worth or annual income have a greater ability to bear the loss of their investment, so the idea is that by restricting access to only wealthy investors we can limit the potential financial harm to those who cannot afford it. These same arguments also justify the accredited investor concept.
Changing the Rules for Accredited Investors
On the other hand, investments may potentially become available to everyone, not just the privileged few. The concept of financial freedom notwithstanding, there must be ways to balance the protection of non-accredited investors with allowing broader access to the capital market. Consider the example of a Registered Investment Adviser who handles accredited investors’ funds. The adviser is capable and financially literate, even if he or she may not meet the standard income or net worth requirements for accredited investors stated above.
Now, consider a non-accredited investor who retains the services of this adviser. We could potentially provide this person with a derivative accredited investor designation, similar to the way a benefit plan or trust can currently obtain accredited investor status when handled by qualified persons. Therefore, the term “accredited investor” could be expanded to include sophisticated or licensed financial professionals or entities. Furthermore, the SEC could potentially approve financial literacy tests as a viable alternative for people who are not licensed financial professionals.
To address the ability to bear investment risks or to minimize risk, limitations on investment amounts, along with requirements on the number or ratio of accredited investors to non-accredited investors, may be included in a future exemption. In addition, standard disclosures could be created to better explain the risks of a private placement investment.
Our existing securities laws have served us reasonably well over the years, but the times and financial landscape have changed. It may be high time to reform or recreate the regulations governing the accredited investor standards.