Three of the five SEC commissioners voted to publish a proposal for updating the definition of “accredited investors,” a category of people and institutions that are allowed to require part privately financial markets, on Dec. 18. the overall public has 60 days from the proposal’s publication within the Federal Register (the official record for the U.S. government) to discuss whether the securities regulator should approve the expanded definition.
The proposal was lauded by many within the cryptocurrency community, who hoped the new definition would allow individuals to participate in unregistered token offerings supported how well they understand the products, not arbitrary standards of wealth.
However, though the proposal lists variety of criteria and considerations the SEC is evaluating, the ultimate expanded definition won’t widen the pool of latest accredited investors all that much, industry lawyers said.
“So far it appears that this expansion of accredited investor status is usually applicable to Wall Street insiders like licensed brokers or ‘knowledgeable employees’ of personal investment ,” said Zachary Kelman, a partner at Kelman Law. “It’s not as expansive as people would really like to think.”
While the proposals look promising, “as altogether things, the devil is within the details,” said Drew Hinkes, general counsel at Athena Blockchain and an attorney with Carlton Fields.
The text provides a tentative framework that credentials from academic institutions would qualify, including an examination or series of exams administered by a self-regulatory organization.
That part “could have a huge impact,” Hinkes said.
But consistent with the complete text of the proposal, the SEC would need to designate the precise certifications, designations or credentials that might qualify an investor.
“Does that mean anyone with a four-year degree from an accredited university, which might probably include many new investors, or is it limited to Ph.D.s, which might probably not be material?” Hinkes said. “We’ll determine once we get more details from the commission. For now, it’s promising but not yet actionable.”
The SEC proposal touches on recommendations stretching over a decade, with a number of the amendments stemming from a 2015 report et al. reaching as far back as 2007.
Some $1.7 trillion was raised in 2018 in Rule 506 offerings, including equity and debt, compared to $1.4 million raised in registered offerings, the text said, indicating significant demand for these sorts of exempt offerings.
“We are mindful that an excessively broad definition could potentially undermine important investor protections and reduce public confidence during this vital market,” the proposal said. “At an equivalent time, an unnecessarily narrow definition could limit investor access to investment opportunities where there could also be adequate investor protection given factors like that investor’s financial sophistication, net worth, knowledge and knowledge in financial matters, or amount of assets under management.”
Commissioner Hester Peirce said investors’ sophistication – that’s , their understanding of the markets they’re investing in – should be wont to determine accreditation status.
“Our current definition includes investors that spend their days cruising around during a Ferrari that Daddy bought them, yet excludes investors whose weeks are spent earning money and weekends are spent deciding how best to take a position it,” she said during a statement.
However, Commissioner Allison Lee, who voted against the proposal, said during a statement the proposal could create some “serious risk to retail investors,” citing elderly individuals and retirees as examples.
Similarly, Christopher Gerold, president of the North American Securities Administrators Association, said the proposal could expose retail investors “to the many potential harms related to unregistered, illiquid offerings” with no ongoing disclosures.
The proposal “offers several changes to the definition, but few if any improvements, and clearly misses a chance to supply meaningful reform to the present outdated standard,” he said.
While expanding the definition of “accredited investor” to incorporate more individuals and entities is widely being hailed, the framing of the conversation online has largely ignored the term’s historical context, Kelman said.
Under current law, an accredited investor is a private with $1 million in assets or a minimum of $200,000 in annual income; a marriage with a minimum of $300,000 in annual income; banks, savings or loan institutions defined under the Securities Act of 1933; brokers or dealers defined under the Securities Exchange Act of 1934; investment companies registered under the investment trust Act of 1940; licensed small businesses; state plans with a minimum of $5 million in assets; employee benefit plans with a minimum of $5 million in assets; or a couple of other entities.
Historically, the status was granted to the rich as “a function of practicality instead of privilege,” Kelman said.
“The exemption for wealthy investors is premised on their financial latitude to lose their shirt without posing systemic risks like bank runs and financial crises,” he said.
To be clear, Kelman said the proposal “represents a step within the right direction,” but treating it as an issue of accessibility instead of systemic risk ignores that the concept of an “accredited investor” (if not the precise term itself) was created within the wake of the good Depression.
“In my view, shifting the premise of the accredited investor status from ‘systemic risk mitigator’ into ‘investor IQ test’ raises an issue on why investors need SEC protection in the least ,” he said.
Indeed, Peirce said the move “takes some important first steps” in updating the definition by factoring in “an investor’s actual sophistication,” instead of finances.
Likewise, Commissioner Elad Roisman seemed to support moving faraway from the historical approach, calling wealth a “crude measure” of an investor’s ability to form decisions about which markets they participate in.
“I doubt that even the Commission who first adopted Regulation D would argue that they came up with perfect criteria for who should qualify as an accredited investor,” he said. “Did anyone consider the result that only the wealthiest Americans would have access to investments that might have the foremost upside for growth over time?”