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E-MailLuis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent meeting of the SEC Advisory Committee on Small and Emerging Companies; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.
Thank you and good morning. I want to start by welcoming the members of the Advisory Committee on Small and Emerging Companies to today’s meeting. I appreciate your efforts and look forward to today’s discussions. I would also like to thank the staff of the Division of Corporation Finance’s Office of Small Business Policy for organizing this meeting.
Since its formation in 2011, this Committee has provided the Commission with advice related to privately-held small businesses and the smaller publicly traded companies. It is well-known that these businesses have an outsized impact on the growth of our country’s economy and on job creation for all Americans.
As you know, today’s meeting will focus on the definition of “accredited investor.” This definition is critical to the Commission’s Regulation D exemption from the registration requirements of the Securities Act of 1933. Regulation D may be the Commission’s most widely used exempted offering. It is regularly used by small businesses to raise funds in the capital markets.
As many of you know, roughly one month ago today, this topic was the subject of a lively discussion at the Commission’s Forum on Small Business Capital Formation. At the November 20th Forum, I spoke about the urgency and importance of improving upon the “accredited investor” definition.
The “accredited investor” definition is critical for the protection of investors. At its essence, the definition attempts to identify those individuals who are expected to be able to fend for themselves and protect their interests. The current “accredited investor” definition attempts to do that for individuals by focusing on whether an individual has either an annual income of at least $200,000 per year ($300,000 with their spouse) or a net worth of at least $1 million.
Generally speaking, securities offerings made to “accredited investors” under Rule 506 of Regulation D are exempted from the registration and disclosure requirements of federal securities laws and the securities purchased cannot be freely resold. Because of the importance of the “accredited investor” definition, Congress has mandated that the Commission undertake a periodic review of the definition, as applied to natural persons, to determine whether it should be modified for the protection of investors.
Notwithstanding the Congressional mandate, there are those that think that the Commission should not review the income and net worth tests contained in the “accredited investor” definition. The view is that we should not examine a definition that identifies eligible purchasers to be “millionaires” and other affluent persons—and that these individuals simply do not need to be protected.
While that might make for a nice sound bite, it simply fails to convey who is really impacted. Accredited investors are not only individuals like Bill Gates or Warren Buffett—but constitute a large pool that includes a large swath of Americans. For example, generally, the following individuals would be eligible “accredited investors:”
- A single working parent of three children with an annual salary of $205,000, and likely with a home mortgage to pay;
- A recent widow who inherited $1 million, but is not earning a separate income; and
- A senior retiree who has accumulated over $1 million in his or her retirement account and needs that money for the retirement years.
While these individuals qualify as “accredited investors” under the income and net worth tests, there is nothing in the definition that helps to identify whether these individuals have the financial sophistication and/or investment experience to be able to assess whether any particular investment is appropriate for them.
Many observers believe that the definition’s failure to consider investors’ actual financial sophistication is a serious flaw. As the SEC’s Division of Economics and Risk Analysis has reported, many investors whose financial wealth gives them “accredited investor” status may have limited investing experience. In addition, other studies have shown that accumulating financial wealth is not necessarily correlated with intelligence. One finance professional has found that “there are often people whose net worth puts them in the accredited category. They may be smart and successful in their fields, but most are confused about the basics of investing and managing money.”
It is time for the Commission to review the appropriate conditions for determining whether someone is, or isn’t, an “accredited investor.” Beyond the fact that Congress mandated a review of the definition, it is an appropriate task to be undertaken by the agency responsible for regulating the capital markets. Investors who are considered “accredited” under these rules are carved out from the basic investor protections that the securities laws mandate with regard to registered securities offerings. These protections—provided, in part, through mandatory filings and required disclosures—simply do not exist for those deemed to be “accredited investors.”
As a result, the single working parent with three children, the widow with the inheritance, and the retiree all deserve the Commission’s attention to make sure they are not made more vulnerable by an “accredited investor” definition that may fail to distinguish between individuals who can protect their own interests and those who cannot. For these reasons, it is entirely appropriate for the Commission to review whether the “accredited investor” definition is accomplishing its intended goals.
Moreover, as the Commission’s Investor Advisory Committee (“IAC”) has pointed out, the current “accredited investor” definition may be under-inclusive. Potential investors who most people would consider to be financially sophisticated, such as a Chartered Financial Analyst or a graduate professor of corporate finance, may not have the income or the accumulated net worth to be eligible to be “accredited investors,” but they may actually be better able to protect their own interests.
This is why the IAC has recommended changes to the accredited investor definition that take into account other ways of measuring financial sophistication. These recommendations include assessing an individual’s specialized work experience, investment experience, licensing, or other professional credentials.
Ultimately, it is important that we get this definition right. There is no doubt that the definition of “accredited investor” under Rule 506 of Regulation D will remain critical to the success of capital formation. In the long-run, the continued success of Rule 506 ultimately will depend on whether the “accredited investor” definition appropriately identifies the individuals who do not need the protection of the Commission’s securities registration and disclosure requirements—and those who do.
For these reasons, I am pleased that this Committee will today focus on the definition of “accredited investor,” and I look forward to your discussions. Thank you.
