Columbia Law School
Sky Blog
The accredited investor definition is the single most important investor protection in the private market.[1] Today’s amendments purport to “update” that definition while leaving in place 38-year old wealth thresholds, declining to index the thresholds to inflation, and declining to provide economic analysis to show how the failure to index will affect American investors—the bulk of whom are seniors—going forward.
With its actions today, the Commission continues a steady expansion of the private market, affording issuers of unregistered securities access to more and more investors without due regard for the risks they face, and without sufficient data or analysis to ensure that our policy choices are grounded in fact rather than supposition.
Failure to Index for Inflation
The most significant policy choice the Commission makes today is the decision not to index the wealth thresholds to inflation going forward. This choice runs counter to widespread support for such a measure, even among groups that often diverge in their views regarding Commission policy. The Small Business Capital Formation Advisory Committee recommended indexing to inflation.[2] Investors and their advocates, industry groups, state regulators, crowdfunders, a diverse group of academics, and even SEC staff have all made the case for this common sense measure.[3]
Such support is hardly surprising given that the failure to update the thresholds thus far has resulted in an increase of 550% in qualifying households since 1983.[4] This figure will only continue to rise.[5] How much can we expect it to rise? We will not find the answer, or even the roughest of estimates, anywhere in the release. Thus we not only reject a recommendation with remarkably broad support, but we fail to undertake basic economic analysis in support of that choice.
Instead, the release merely states that indexing going forward would “reduce the potential aggregate capital supply available for exempt offerings going forward.”[6] That capital supply, however, is hardly in danger. In fact, capital raised in the private markets continues to grow at unprecedented rates, surpassing the public markets, accounting for nearly 70 percent of new capital raised in 2019.[7]
In further justification of this failure, the release cites increased investor access to information now, [8] compared to 1982, including through the internet and social media and, “powerful home computers and mobile computing devices.”[9] This ignores the naturally opaque nature of the private market where issuers are not required to provide the robust disclosures that are features of public offerings.[10] No matter how powerful your computer is, you cannot access information that is not there.[11]
Risks to Seniors
In fact, private offerings are not just less transparent, but also illiquid, and prone to fraud.[12] In response to evidence of fraud in the private market, the adopting release argues that “commenters did not provide information that would indicate that any such incidents of fraud in the private markets are driven or affected by the levels at which the accredited investor definition is set.”[13] This quite plainly misconstrues the point: it’s not that the accredited investor definition somehow causes fraud, it’s that it allows more investors to be exposed to the risks of fraud.
And what types of investors are we exposing to this risk? Mainly seniors.[14] We know that an increasing amount of wealth is concentrated in older households,[15] and that, for the households that fall just below the accredited investor financial thresholds, their assets are concentrated in retirement accounts.[16] We know that older investors are more likely to have accumulated wealth gradually over time, rather than necessarily as a result of financial sophistication. We know also that unregistered offerings are consistently used in fraudulent schemes to target seniors.[17] Thus, with today’s amendments, we are putting some of the most vulnerable investors at risk.
Lack of Visibility into the Private Market
While the release fails to address known risks to investors, it also evidences another problem: there is a great deal we simply do not know about how the private market functions. We don’t know how many investors participate in these offerings.[18] We can’t distinguish individual investors who participate in such offerings from institutions.[19] We don’t know how much they invest or how they fare.[20] We can’t say with confidence how many private offerings even take place.[21] We don’t know how many investors will be newly eligible for private offerings under these amendments.[22] Thus we are operating under significant data constraints—largely of our own making[23]—and today’s rulemaking regrettably does not include any efforts to enhance visibility into this market.[24]
We appreciate the diligent and thoughtful work of the staff on this rulemaking.[25] They continue to perform remarkably well under extremely challenging conditions, and we are awed and appreciative of their dedication. Unfortunately, we cannot support the policy choices made by the Commission majority today because they fail to ensure that the accredited investor definition functions effectively to protect vulnerable investors, fail to acknowledge and analyze existing data revealing the risks these choices pose for investors, particularly seniors, and fail, once again,[26] to address the lack of data regarding private markets more broadly. We respectfully dissent.
ENDNOTES
[1] Private offerings lack the traditional investor protections that attach to registration, most importantly transparency and liquidity. Thus, the principal means of protecting investors in private markets is to work to ensure that those offering unregistered securities can only sell to investors who can assess and bear the heightened risks in private markets. Some argue that such an effort is paternalistic and that all investors should be free to risk their livelihoods as they see fit. But that evinces a disregard for the very reason the SEC was created and the fundamental differences between the public and private markets. The SEC’s core mission is to protect investors and we should not substitute a policy of “caveat emptor” for meaningfully carrying out that mission.
[2] See Small Business Capital Formation Advisory Committee Recommendation on Accredited Investor (Nov. 12, 2019).
[3] See, e.g., Letters from the CFA Institute (May 4, 2020); North American Securities Administrators Association (NASAA) (Mar. 16, 2020); Investment Company Institute (Mar. 12, 2020); CrowdCheck (Oct. 30, 2019); and Elisabeth D. de Fontenay, et al. (Sept. 24, 2019) (stating that “inflation undermines the effectiveness of the safeguards built into the Accredited Investor net-worth and income tests”); Staff Report on the Review of the Definition of “Accredited Investor” (Dec. 18, 2015) (recommending indexing for inflation “consistent with the Commission’s approach in its 2007 proposed revisions to the definition, as well as the approach Congress took in the Dodd-Frank Act with respect to the ‘qualified client’ definition and in the JOBS Act with respect to crowdfunding and emerging growth companies.”).
[4] See Amending the Accredited Investor Definition, Final Rule, Rel. No. 33-[], 143 (Aug. 26, 2020) (Adopting Release). In other contexts, the Commission does not hesitate to adjust disclosure thresholds to account for the passage of time, sometimes far exceeding inflation growth. See, e.g., Reporting Threshold for Institutional Asset Managers, Proposed Rule, Rel. No. 34-89290 (July 10, 2020) (proposing to increase the reporting threshold by 35 times for institutional investment managers that must report equity holdings on Form 13F, thus eliminating visibility into portfolios controlling $2.3 trillion in assets); Modernization of Regulation S-K Items 101, 103, and 105, Rel. No. 33-[] (Aug. 26, 2020) (effectively increasing the threshold for disclosure of environmental proceedings by [] times).
[5] See Commissioner Allison Herren Lee, Statement on the Proposed Expansion of the Accredited Investor Definition (Dec. 18, 2019) (analyzing household data from the Federal Reserve Board’s SCF for 2013 and 2016 and assuming an estimated annual and constant growth rate for inflation of 1.51% to project the effects of inflation on the accredited investor definition: “In ten years, approximately 22.7%; in 20 years, 39.32%, and in 30 years, 57.3% of U.S. households will have to ‘fend for themselves.’”).
[6] See Adopting Release at 145.
[7] See id. at 5.
[8] See id. at 72-73 (“As stated in the Proposing Release, we believe that in evaluating the effectiveness of the current thresholds, it is appropriate to consider changes beyond the impact of inflation, such as changes over the years in the availability of information and advances in technologies. Information about many issuers and other participants in the exempt markets is more readily available now to a wide range of market participants, which was not the case at the time the accredited investor definition was adopted.”).
[9] See Amending the ‘Accredited Investor’ Definition, Proposed Rule, Rel. No. 33-10734, 79 (Dec. 18, 2019) (“Given the rise of the internet, social media, and other forms of communication, information about issuers and other participants in the exempt markets is more readily available to a wide range of market participants. Technologies such as powerful home computers and mobile computing devices, as well software-based tools with which to evaluate investment opportunities, were not available to investors at the time the accredited investor definition was promulgated.”).
[10] It also ignore evidence of widespread misinformation through these mediums. See Janna Anderson & Lee Rainie, Internet and Technology, “The Future of Truth and Misinformation Online,” Pew Research Center (Oct. 19, 2017) (noting widespread belief that “fake news” stories cause confusion and finding that 51% of technologists, scholars, practitioners, strategic thinkers and others believe the information landscape will not improve in the next ten years); see also Katherine Clayton, et al., “Real Solutions for Fake News? Measuring the Effectiveness of General Warnings and Fact-Check Tags in Reducing Belief in False Stories on Social Media,” Political Behavior 1: 1–23 (Feb. 11, 2019) (“The public’s vulnerability to false information has grown as people have come to increasingly rely on social media as a source of news.”); David M. J. Lazer, et al., “The Science of Fake News,” 359 SCI. 1094 (Mar. 2018) (“The rise of fake news highlights the erosion of long-standing institutional bulwarks against misinformation in the internet age.”).
[11] We also cite the fact that, since the adoption of the wealth thresholds, the Commission has excluded primary residence from the net worth calculation. First, this has no bearing on the income element of the wealth thresholds. Second, the release provides that inclusion of primary residence in that calculation would result in approximately two percent more households qualifying as accredited, vastly less than the increase that inflation has wrought, from less than two percent of households qualifying in 1983 to thirteen percent in 2019. See Adopting Release at 145 n.416.
[12] See Letter from NASAA (Mar. 16, 2020) (noting that “private offerings are often characterized by opaque disclosures, related party transactions, illiquidity, minimal financial information and, unfortunately, fraud.”); see also NASAA Enforcement Trends, 2014 Report on 2013 Data (“The state securities regulators continue to report unregistered securities and unregistered investment professionals as the most common problem they face.”).
[13] See Adopting Release at 75.
[14] Distribution of Household Wealth in the U.S. since 1989, Board of Governors of the Federal Reserve, https://www.federalreserve.gov/releases/z1/dataviz/dfa/distribute/chart/#quarter:122;series:Net%20worth;demographic:age;population:1,3,5,7;units:shares (showing a majority of assets held by people age 55 and older).
[15] See Stephen Deane, Elder Financial Exploitation: Why it is a concern, what regulators are doing about it, and looking ahead, SEC Office of the Investor Advocate (June 2018), at 5 (citing research showing that Americans over the age of 50 account for 77 percent of financial assets in the United States).
[16] See Letter from Rick Fleming, SEC Investor Advocate, on the Concept Release on Harmonization of Securities Offering Exemptions (July 11, 2019) (“Of course, the portion of the population lying just below the current accredited investor thresholds—which would likely include households between the 75th and 90th percentiles in terms of net worth—is more likely to have the financial wherewithal to invest in the exempt markets. For these households, the median value of financial assets held is $283,900.13 Consider, however, the investment portfolios of these households. For this segment of the population, the median value of retirement accounts is $198,000, which means that most of these households’ financial assets are in retirement accounts.”).
[17] See NASAA 2019 Enforcement Report (showing unregistered securities are the most common scheme used to target seniors); NASAA 2018 Enforcement Report (same).
[18] See Adopting Release at 102 (“We lack data to estimate the actual number of unique accredited investors who participate annually in Regulation D offerings.”).
[19] See id. (“Additionally, from the information reported on Form D, we cannot distinguish accredited investors that are natural persons from accredited investors that are institutions.”).
[20] See id. at 110. (“In the Proposing Release, the Commission acknowledged that it is difficult to reach rigorous conclusions about the typical magnitude of investor gains and losses in exempt offerings.”).
[21] See id. at 95 n.317 (“The data likely underreport the actual amount sold due to two factors. First, underreporting could occur in all years because Regulation D filings can be made prior to the completion of the offering, and amendments to reflect additional amounts sold generally are not required if the offering is completed within one year and the amount sold does not exceed the original offering size by more than 10%. Second, Rule 503 requires the filing of a notice on Form D, but filing a Form D is not a condition to the availability of a Regulation D exemption. Hence, it is possible that some issuers do not file a Form D for offerings relying on Regulation D.”).
[22] See id. at 104 (“[W]e are unable to more precisely estimate how many individuals will be newly eligible under the final rules.”).
[23] In 2013, the Commission put out a rule proposal aimed in part at enhancing our visibility into private offerings claiming exemptions from registration pursuant to Regulation D. See Amendments to Regulation D, Form D, and Rule 156, Release No. 33-9416 (July 10, 2013). We never completed that rulemaking, and our lack of visibility into that market persists.
[24] Indeed, the release includes the claim that “these amendments will provide a foundation for our ongoing efforts to assess whether the exempt offering framework, in its component parts and as a whole, is consistent, accessible, and effective for both issuers and investors” with no explanation as to how these amendments will enhance our ability to assess this market. See Adopting Release at 4.
[25] In particular, we would like to thank Bill Hinman, Michael Seaman, Betsy Murphy, Jennifer Zepralka, and Charlie Guidry in the Division of Corporation Finance; Bryant Morris and Connor Raso in the Office of the General Counsel; Vlad Ivanoff, Mattias Nilsson, Andrew Glickman, Hari Phatak, and Lauren Moore in the Division of Economic and Risk Analysis; and Dalia Blass, Sarah ten Siethoff, Melissa Gainor, Jennifer Songer, and Lawrence Pace in the Division of Investment Management.
[26] See Commissioner Allison Herren Lee, Statement on the Proposed Expansion of the Accredited Investor Definition (Dec. 18, 2019) (noting data constraints in the private markets and the failure to finalize the 2013 rulemaking aimed at enhancing our visibility into that market); Commissioner Allison Herren Lee, Statement on Proposed Amendments to the Exempt Offering Framework (Mar. 4, 2020) (same).
This statement was issued on August 26, 2020, by Caroline Crenshaw and Allison Herren Lee, commissioners of the U.S. Securities and Exchange Commission.