The regulatory definition of accredited investor needs to be amended to allow more investors to access private markets and spur capital market growth, witnesses told the House Financial Services Capital Markets Subcommittee this week.
During the hearing, entitled ‘A Roadmap for Growth: Reforms to Encourage Capital Formation and Investment Opportunities for All Americans’, committee members acknowledged that the accredited investor standard has limited access to private markets to the wealthiest Americans and institutional investors, saying that that has limited capital growth for entrepreneurs.
Subcommittee vice-chair and New York Congressman Andrew Garbarino, a Republican, noted that under the current accredited investor definition, a business owner with about “5,000 employees and with a one-to-one investment match” could still not qualify as an accredited investor simply because of financial thresholds, but could still invest in “highly risky penny stocks and bitcoin.”
The standard limits private markets investments to those deemed “sophisticated” – a metric itself primarily defined by net worth. But Garbarino said using wealth as the sole indicator of sophistication excludes a significant amount of potential investors who may have other forms of knowledge, experience or expertise to make an informed investment decision.
Brandon Brooks, a founding partner at Overlooked Ventures, agreed that the current definition should be expanded to include other criteria.
“It’s an asinine rule if we want to expand access,” Brooks said.
He suggested that entrepreneurs may be struggling to build businesses and attract investors because of the restrictive standard.
California representative Brad Sherman, a Democrat, said the standard is “unfair and illogical,” and should be replaced by one that ensures accredited investors have enough expertise, or that have their own independent advisers with that expertise, to evaluate potential investments. Sherman went as far as to proffer a potential standard that would restrict eligible investors from putting more than 5 or 10 percent of their net worth into any one offering, or more than 50 percent of their net worth into private offerings more broadly.
But he cautioned that amending the accredited investor standard could reduce investor protections overall.
“Ultimately, if you don’t have investor protection in the economy, you don’t have investors. Investor protection is not the antithesis of capital formation. It is a necessary antecedent,” Sherman said.
Missouri Congressman Emanuel Cleaver II, a Democrat, added: “I understand that people should have freedom, but many don’t have significant savings, and the more these standards are liberalized, the more people are going to lose their money and not have the ability to get the money back.”
Committee members and witnesses pointed out that another way to allow more investors in private markets is to raise the limit on how much closed-end funds can invest in them. Under the current regulatory regime, most retail investors are prohibited from investing directly in private funds. Publicly traded closed-end funds, however, are available to all investors.
The SEC currently imposes a 15 percent limitation on a closed-end funds investments in the private markets, which highly restricting retail investors access.
Given that closed-end funds are strictly regulated and professionally managed, Henry Ward, CEO and co-founder of Carta, said he does not think it is appropriate to limit their investment in private market and thus exclude many Americans from potential high growth opportunities.
“Individual fund managers decide how much to allocate into a liquid or private market asset on behalf of their investors as part of their fiduciary responsibility. I don’t think it should be a regulatory number that decides how much an investor can diversify their portfolio across different asset classes,” Ward said.
To that end, subcommittee chair and Missouri representative Ann Wagner, a Republican, introduced a bill Thursday with New York Congressman Gregory Meeks, a Democrat, that would amend the Investment Company Act of 1940 so it could not restrict closed-end funds’ access to private markets.
“The bipartisan bill would increase access to investment for more Americans, creating opportunities for Main Street investors, and making clear that more investors should have access to private markets,” Wagner said in a statement.