In a closely-watched move, the SEC voted 3-2 this past Wednesday to expand the definition of an “accredited investor” to include both state-registered and SEC-registered investment advisers with $5 million or more in assets. Accredited investors are those who are permitted to purchase unregistered securities such as those typically sold in a private placement. The current definition includes individuals or married couples with $1 million or more in investments and individuals with $200,000 in annual income or total income with a spouse of $300,000.
Also added to the definition are individuals who hold Series 7, 65, and 82 licenses. Those correspond to examinations for the general securities agent or representative, the investment adviser representative, and the private placement agent, respectively. “Knowledgeable employees” of a private fund are now also accredited investors. In addition to the new categories included, the Commission established a framework whereby additional categories of sophisticated investors can be added to the definition over time.
The Commission also voted not to adjust upward for inflation, the traditional wealth-based definition of “accredited investor.” The issue exposes a fundamental debate about the adequacies of protections that currently exist in the private securities market, as well as issues of class-based access to markets.
The wealth-based test is beset by critics on all sides of the political spectrum. Some argue it is an insufficient way to determine whether an individual is sophisticated enough to understand the risks of an investment that is not accompanied by the fulsome disclosures of publicly-traded securities, while others see it as an artificial class-based barrier that prevents participation in a large part of the US investment marketplace.
The vote followed party lines, with the Republican appointees voting against the inflation adjustment. Those Commissioners voting against raising the thresholds argued that the private securities market is currently anti-democratic in that it already forbids lower-income individuals from participating in such investments, regardless of their sophistication. The current wealth test, argued Commissioner Jay Clayton, is a binary test that “disadvantages otherwise financially sophisticated Americans living in lower income/cost-of-living areas.”
Also voting against the proposal was Commissioner Hester Pierce. In a statement at an open meeting last December, Commissioner Pierce referred to the wealth-based definition as having “a corrosive effect on an individual’s economic liberty.” In a separate release regarding the vote on Wednesday, she questioned: “Why shouldn’t mom-and-pop retail investors be allowed to invest in private offerings?,” adding, “Why should I, as a regulator, decide what other Americans do with their money?” She later tempered that rhetorical question by recognizing that the need for a definition of accredited investors will continue as long as securities are offered without the disclosures mandated for registered securities. She called upon the Small Business Capital Formation Advisory Committee to offer recommendations on what types of additional mandatory disclosures for private placements, short of full registration, might be sufficient to allow the accredited definition to be further expanded.
But the two Democratic Commissioners, Allison Herren Lee and Caroline Crenshaw, issued a joint release accusing the SEC of steadily expanding the market for unregistered securities without regard for the higher risk they entail, including risks stemming from the absence of the registration and reporting requirements that accompany public securities. They predict that both fraud and outsized risk will continue to fester in the private markets and that senior citizens who have accumulated enough savings to qualify will be vulnerable.
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