Both state- and SEC-registered investment advisers would be automatically deemed to be accredited investors under a proposed rule approved in a 3-2 commission vote on December 18 that split along partisan lines.
The proposal would keep the current financial tests for establishing who is an “accredited investor” but would add new categories that demonstrate “financial sophistication,” said SEC chairman Jay Clayton in the commission’s first public meeting in some time.
RIAs would join the current list, which includes broker-dealers, banks and insurance companies. The status would permit them to place clients in private offerings.
A growing list
Others that would be deemed to be accredited investors should the proposal be finalized include financial professionals who have been granted series 7, 65 and 82 securities licenses; “knowledgeable employees” at private funds; and family offices that manage at least $5 million in assets (along with their members). The list could expand based on one’s “professional knowledge, experience and certifications,” said Corp Fin director William Hinman.
The proposal would allow “spousal equivalents” to pool assets to reach the definition’s threshold.
Five other rulemaking items came up for votes in the December 18 meeting, including three that would conclude the commission’s Dodd-Frank security-based swap rules.
It has been nearly 40 years since the commission adjusted the thresholds defining an accredited investor (for example, one who earns more than $200,000 a year and holds more than $1 million in assets). “It’s time we review this [income] approach,” said commissioner Elad Roisman.
Commissioners agreed that dollar amounts do not necessarily confer financial sophistication upon investors, thus permitting them to take part in potentially riskier private offerings. However, unanimity ended there.
The two Democratic commissioners warned that expanding the accredited investor definition would harm investors. “There is serious risk to retail investors, particularly elder investors who have spent a lifetime saving” to meet income thresholds, said commissioner Allison Herren Lee.
Commissioner Robert Jackson decried the lack of data supporting the proposal. He said his staff had dug into the enforcement data on their own. “Brokers who put investors in private securities are unusually likely to be subject to both customer complaints … and regulatory inquiries about misconduct,” he said.
Roisman acknowledged the topic sits at the nexus of the commission’s two missions – protecting investors and promoting capital formation in markets. However, he said it was unfair to “shut out all but the wealthy” from successful private investments, and that the proposal would not “open the flood gates” for fraudsters to fleece investors.
Clayton noted that any final rule should stress that the interests of financial advisers and their clients must be aligned before advisers can invest their clients’ money.
The notion that all investors were not equal offended commissioner Hester Peirce. “The definition’s corrosive effect on an individual’s liberty is one that I hear about all the time,” she said. “These are commonsense proposals that are long overdue.”
The accredited investor definition also affects institutional investors. The proposal would deem Native American tribes and certain governments to be accredited, as well as limited liability companies with at least $5 million in assets. A ‘catch-all’ provision would extend the label to other entities with at least $5 million in investments.
The “proposal offers several changes to the definition but few if any improvements, and clearly misses an opportunity to provide meaningful reform to this outdated standard,” said Christopher Gerold, president of the North American Securities Administrators Association and chief of the New Jersey Bureau of Securities.
He added that the proposal “exposes far more retail investors to the significant potential harms associated with unregistered, illiquid offerings that have no ongoing disclosure obligations to shareholders”. Gerold also panned the proposal’s exclusion of an inflation provision that would have hiked income thresholds in the future.
There are 60 days to comment on the proposal once it appears in the Federal Register.