By Vanessa Malone
This week, the Securities and Exchange Commission (SEC) made amendments to the “accredited investor” definition, expanding eligibility requirements for investors who want to participate in the private capital markets.
The new amendments enable investors to qualify as accredited investors based on defined measures of professional knowledge and experience or certifications, in addition to the existing tests for income or net worth.
Initially, the SEC doesn’t expect the pool of accredited investors to change significantly, as the amendments cater to individuals and entities already in the securities market, for example those with an entry-level stockbroker’s license, “knowledgeable employees” of private funds, SEC or state-registered investment advisers, family offices, etc.
Nevertheless, while the amendments to the accredited investor rule may not change too much on the surface, we believe the ideological change can open the doors to meaningful legislation down the line. It’s a safe next step from which the SEC can comfortably evaluate the impact of widening the accredited investor net and make further adjustments.
For decades, the measure for how capable someone is to invest was based solely on wealth. The justification for this rule was investor protection: private securities offerings are exempt from the extensive disclosures involved in a registered offering, and it was agreed upon that only those with the financial means and sophistication to understand the risks would be able to safely invest in these types of offerings.
As we discussed last week, the private market is evolving and we don’t believe that only the wealthy should be able to reap the benefits.
The private market continues to outpace the public markets when it comes to new capital formation. $2.7 trillion was raised through exempt securities offerings in 2019 and of that, $1.56 trillion was raised through Rule 506(b) and 506(c) of Regulation D.¹ This means the majority of early stage investment opportunities were offered to accredited investors only.
Additionally, more companies are staying private longer than they have in the past. According to the SEC report, “issuers have been able to grow to a size historically available only to their public peers.” ²
This trend can be attributed to a number of factors including high costs, stringent regulatory and disclosure requirements, and ongoing compliance costs that come with going public. Companies are finding access to the capital they need to grow in the private market without those hurdles.
Further the SEC report suggests that because of these factors, “the high-growth stage of the lifecycle of many issuers occurs while they remain private.” Thus, “investors that do not qualify for accredited investor status may not be able to participate in the high-growth stage of these issuers because it often occurs before they engage in registered offerings.” ³
All of this commentary supports the SEC’s decision to expand opportunities for investors to participate in these offerings. Expanding the rules to take financial education into consideration creates a tangible path for the general public to have greater access to early stage offerings.
It seems SEC Commissioner Hester Peirce agrees as she tweeted the following in response to the amendments.
These amendments to the investor accreditation rule are a positive step in the right direction but we still have a long way to go. Wealth shouldn’t be the defining indicator for how financially literate some is, or represent someones understanding of an offering. Those with an active education in investing with no formal involvement in the field should be able to spend their money how they’d like.
While this certainly represents a challenge for the SEC to create accurate, accessible measures for accreditation, it’s a necessary step as the private market continues to thrive.
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¹,²,³ SEC Accreditation Report