SEC Loosens Restrictions On Non-Public Investing
A key role of the Securities and Exchange Commission (SEC) is to protect the public not only from fraudulent investments but also from misunderstanding the risk associated with otherwise legal ones. The Securities Act of 1933 promulgated the initial rules that publicly traded securities were required to follow in order to help ensure their investment risks are clearly disclosed. But in order not to restrict businesses’ access to capital too much, certain types of private investments were exempted from SEC registration. To mitigate the risk to investors with these less regulated private offerings, the SEC created the “accredited investor” criterion. Non-registered investments were prohibited from being sold to individuals who were not accredited, i.e. who supposedly lacked the financial sophistication to be able to fully understand the benefits and the risks of such less-regulated investments. This criterion was primarily based on income or net wealth, on the presumption that wealthier individuals are more financially astute than the general public.
Unfortunately, the myriad investment scams that have not only proliferated but succeeded over the subsequent years serves to point out that wealth is not an especially good indicator of financial sophistication. Barbara Roper, director of investor protection for the Consumer Federation of America, is on record as stating that the SEC “continues to refuse to grapple with the fact that the vast majority of individuals who currently qualify as accredited investors lack the … financial sophistication or access to information necessary to ‘fend for themselves’ without the protections afforded in the public markets.”
What does it take to be considered an accredited investor today? You need to have either a net worth of at least $1 million, excluding your home, or have income of at least $200K per year for the last two years. Roper’s concern is that the SEC has not indexed these thresholds for inflation, allowing more and more people much lower on the wealth scale to slip into this category over time. To her point there have been no substantial changes to the definition since 1982.
While protecting the public vs. supporting capital investment is a balancing act, it is arguable that over time the SEC has tended to lean towards loosening the rules rather than tightening them. This latest change is an expansion of the definition of accredited investor to include, among others, individuals holding professional certifications such as licensed financial advisors. Personally that makes sense to me. If there is anybody who ought to have the financial expertise and knowledge to be able to understand complex financial investments it’s these kinds of people. Even Roper has expressed no opposition.
Unfortunately the latest changes do nothing to address the fact that as many as 10% of all U.S. households today are considered to be accredited investors based on the current criteria. That means they are all expected to be able to discern the legitimate private investments from the fraudulent ones, as well as understand whether or not each is appropriate or not to meet their financial goals. Given the level of financial literacy that our educational system provides, I am highly skeptical.
Here’s a link to the latest rule changes: https://www.sec.gov/rules/final/2020/33-10824.pdf.