Last week, the Securities and Exchange Commission's (SEC) Investor Advisory Committee — on which I currently serve — recommended, over my objection, that the SEC change the way it assesses who qualifies as an "accredited investor." Although sensibly challenging the existing approach to accreditation, the committee's approach was too conservative. Instead, the committee should have called for a more fundamental reconsideration of whether existing investment restrictions are consistent with investor protection.
Under existing law, companies can raise funds through public and private offerings. A public offering involves registration of the offering with the SEC and compliance with an ever-expanding list of regulatory requirements. Anyone can buy shares in a public offering. A private offering, by contrast, is subject to a much shorter regulatory checklist, but — with limited exceptions — only accredited investors are able to buy shares.
Accredited investors include institutional investors and wealthy individuals. The accredited investor concept is linked to a 60-year old Supreme Court case, which held that private offerings are only for investors "who are shown to be able to fend for themselves." Using wealth and income as indicators of ability to fend for oneself carries with it obvious flaws; we can all think of a rich person who has a lot of dollars, but little investment expertise. On the flip side are people of limited financial means who possess a wealth of investment knowledge that they are eager to put to work.
The Investor Advisory Committee wisely recommended widening the pool of people deemed able to fend for themselves. Rather than looking solely to income and net worth, the committee recommended defining accredited investors to include financially sophisticated people. Under this approach, financial professionals and maybe even people who pass an investment test would be able to invest in private offerings.
What the committee gives with one hand, however, it takes away with the other. The committee hints at raising the current dollar thresholds and suggests that perhaps certain assets — such as nonfinancial assets and retirement accounts — should not count toward a person's net worth. Dodd-Frank already took a step in that direction by excluding the value of a person's home from the net worth calculation. The committee also suggested limiting the percentage of income or net worth an investor could invest in private offerings.
Underlying the committee's approach is a belief that the government should decide which investors are qualified to think for themselves. Although this belief is consistent with standard SEC mindset, it is not the type of big thinking the committee should be undertaking.
As an adviser to the SEC on "initiatives to protect investor interest," the committee should take a fresh look at how well our securities laws are protecting investor interests. Dodd-Frank, which established the committee, authorizes it to make recommendations that include "proposed legislative changes." The committee, therefore, need not limit itself to suggesting tweaks to the accredited investor definition, but should consider whether the existing statutory framework — as the Supreme Court has interpreted it — works in the interest of investors.
Protecting investors' interests includes the important job of putting fraudsters out of business. It also includes augmenting investors' freedom to choose from among a broad array of securities offerings, including the large swath of investments available only through private offerings. Investors should be able to choose only to invest in public offerings, which are registered with the SEC, are easy to sell, and come with a heavy dose of regulation. They should also be permitted to invest in less liquid, less regulated private offerings. Some of these investments undoubtedly will turn out to be losers, but investors ought to be the ones to make the call about how much risk they can stomach. The current regulatory framework (with the exception of the soon-to-be-operational crowdfunding framework) reserves many investment opportunities for investors deemed worthy by the government. The rest of the population is not permitted to freely put their local knowledge, formal and self-education, industry-specific insights, and business acumen to work in their investment portfolios.
Restoring a greater measure of investor autonomy might require legislative changes. Recommending such changes is well within the committee's mandate. I voted against the committee's recommendation because the committee was thinking too small and because it fails to acknowledge the importance of investors' freedom to think for themselves, even if they lose money in the process.