SEC committee rejects ‘paternalism’ in accredited standards

The SEC’s small business advisory committee has rejected the “paternalism” of commission chairman Gary Gensler and urged regulators not to increase wealth standards for accredited investors in private funds.

The committee met on Tuesday and voted to recommend broad, yet-to-be-determined “educational requirements” that would allow non-accredited investors into private equity, venture capital and hedge funds. When asked whether the committee should recommend that regulators raise the accredited threshold by pegging it to inflation, only one hand – committee chair and Reign Ventures founder Erica Duignan’s – went up.

The committee’s recommendations are non-binding but they’re another warning for Gensler over his attempts to regulate the private funds industry more strictly.

Under Regulation D of the Securities Act, private funds are allowed to make “general solicitations” – that is, offer their wares publicly – so long as they sell mainly to accredited investors. The wealth thresholds for accredited investors were set in 1982. They haven’t been updated since. If the small business committee has its way, not only will they not be raised; existing standards will be lowered.

‘Cornerstone’

When he took office, Gensler put Reg D reforms near the top of his agenda. It has since slid down his priority list, although it remains on the commission’s official agenda. Privately, Gensler has told allies that he is weary of fighting the private funds industry and that he’s looking for easier political wins ahead of November’s elections and in what may be his last full year as commission chairman, sources tell Private Funds CFO.

Addressing the small business committee ahead of its meeting on Tuesday, Gensler reiterated his claim that Reg D is “a cornerstone” of the “basic bargain” underlying the US’s securities regime.

“Any discussion about the definition of an accredited investor raises the question about when it may be appropriate to have exceptions to this basic bargain at the heart of our capital markets,” he said. “In essence, when is it appropriate that investors get – or not get – that full, fair, and truthful disclosure that President Franklin Roosevelt worked with Congress to embed in the securities laws?”

“I don’t think of it as paternalism,” Gensler added, responding to criticisms from Republican Commissioners Hester Peirce and Mark Uyeda. “I think that basic bargain where issuers give information to investors is important.”

‘Completely catastrophic’

Critics of the Reg D regime vary, but they make two broad arguments. The first is that Reg D allows shady or even outright fraudulent fund managers to set up their tents, take people’s cash, and disappear before state or federal regulators even know they’ve been there.

The second is that, even if wealth is a useful proxy for sophistication, it is certainly not useful if wealth standards do not keep pace with inflation. In 1989, less than one in 25 American households qualified as accredited investors. By the end of 2022, nearly one out of every five American households qualified as accredited investors. At this pace, nearly half of American households will be accredited by 2042.

Defenders of the Reg D regime have arguments of their own. Inflation has wobbled valuations and small- and start-up businesses – particularly women- and minority-owned businesses – cannot get access to capital, they say. Since 2021, the total number of “angel investments” has fallen nearly one-quarter, the SEC’s small business advocate found in its fiscal 2023 report.

“Changes that would decrease the pool of accredited investors, including angel investors, would impact small business capital formation and especially for first-time founders and racially and ethnically diverse entrepreneurs,” the advocate said.

Raising the wealth standards, committee member and Honeycomb Credit co-founder and CEO George Cook said at Tuesday’s meeting, “would be completely catastrophic for the start-up community.”