The SEC is considering measures that could increase the investment options available to retail investors by relaxing the definition of accredited investors, and this is proving to be a contentious issue based on the continuing debate on the topic.

The measures being considered by the SEC are part of a concept paper, released in June, that explores ways to “simplify, harmonize and improve” the exemptions currently available to certain investors.

The concept paper was among the main topics of discussion at a Thursday meeting of the SEC’s Investor Advisory Council.

Among other things, the IAC advises the SEC on regulatory priorities, investor protection and investor confidence.

Jennifer Zepralka, chief of the Office of Small Business Policy of the SEC, said the accredited investor topic proved to be a “very popular comment topic” in the more than 150 comment letters received by the SEC in response to the concept paper.

The views expressed by commenters showed a lack of consensus, ranging from “don’t change anything” to “adjust for inflation” to “expand the accredited investors definition to include criteria not related to wealth,” Zepralka said at the IAC meeting.

Potentially more assets for advisors

For brokers and advisors, having more flexible accredited investor rules would mean having a bigger pool of investment products and strategies to offer retail investors who could qualify as accredited investors if the rules change.

However, state regulators have warned that relaxing the definition of accredited investors could end up hurting retail investors. Consumer advocates say the SEC’s actions could even lead to conditions like those that caused the U.S. stock market crashes of 1929 and 2008.

“The idea that these exemptions maintain investor protection is laughable.”
Tyler Gellasch
Healthy Markets Association

At the IAC meeting, SEC chairman Jay Clayton said it’s the regulator’s “obligation to explore whether we can reduce cost and complexity and increase opportunity for our Main Street investors.”

That includes giving Main Street investors access to professionally managed funds that invest in the private market on terms like those available to institutional investors, Clayton said.

Irresponsible or helpful?

At the lively debate at the IAC meeting, Barbara Roper, a member of the group and director of investor protection at the Consumer Federation of America, called the plans to ease accredited investor rules — without having the data to support why this should be done in the first place — “just beyond irresponsible.”

But Sara Hanks, CEO of CrowdCheck, which provides investment due diligence research, said expanding the definition of accredited investors will ensure “retail investors and employees [of companies with initial public offerings] are not excluded from opportunities.”

The SEC lets accredited investors participate in investment opportunities that are generally not available to non-accredited investors. These include investments in many private issuers and offerings by hedge funds, private equity funds and venture capital funds.

Under SEC rules, individuals are classified as accredited investors if:

  • Their income exceeds $200,000 in each of the two most recent years (or $300,000 in joint income with a person’s spouse) and they reasonably expect to reach the same income level in the current year;
  • Their net worth exceeds $1 million (individually or jointly with a spouse), excluding the value of their primary residence.

The accredited investor definition also includes — among others — banks; registered broker-dealers; insurance companies; registered investment companies; employee benefit plans under Erisa (if a bank, insurance company, or registered investment advisor makes the investment decisions, or if the plan has total assets in excess of $5 million) and a tax-exempt charitable organizations, corporations, or partnerships with assets in excess of $5 million.

The key questions the SEC is asking in the concept paper include:

  • Should we change the definition of accredited investor or retain the current definition?
  • Should we revise the financial thresholds requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify?
  • Should we revise the accredited investor definition to let individuals qualify as accredited investors based on other measures of sophistication?

CrowdCheck’s Hanks suggested the current financial qualifications for accredited investors be kept but adjusted for inflation.

Other qualifying factors should be included in the accredited investor definition, such as individuals with securities designations and those who pass a specific test for private investors, according to Hanks.

Barbara Roper

Hanks also suggested allowing an “accredited by chaperone” category for individuals who rely on advisors who make decisions on their behalf and in their best interest.

However, Tyler Gellasch, executive director of the Healthy Markets Association, said “the idea that these exemptions [discussed in the SEC concept paper] maintain investor protection is laughable.”

Healthy Markets is an investor-focused group that aims to educate market participants and promote data-driven reforms.

“If the biggest and brightest investors aren’t getting the information … and returns they need, do we think the dentist from Toledo is going to do any better?” he asked.

Gellasch gave as examples the sophisticated investors and pension funds let down by the IPO of Peloton and the failed IPO of WeWork.

Peloton shares are currently trading below their IPO price, while WeWork’s plans for an IPO imploded in September.