SEC proposes changes to “accredited investor” definition
dlapiper.com
dlapiper.com
In all my dealings with the SEC (from working at multiple regulated investment platforms, AngelList and Republic, and now as a VC), it's become clear to me that they're extremely pragmatic and want to support innovation and create a level playing field for everyone. They have great intentions, but are obviously quite careful and conservative about their approach.
I think it's important to note two things:
1/ The stated mission of the SEC is "to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation." — the last part is important, and these changes go towards furthering that goal.
2/ The SEC is a civilian enforcement agency. They do not write the rules, they are here to interpret them and enforce them. They issue guidance, monitor, and sue entities that break the rules. The rules are written by congress. Even if the SEC wanted to change a rule, they could not do it without following the laws written by congress. At best, they can slightly tweak their interpretations of the rules (as we're seeing here).
USA has by far world's most byzantine and bizarre securities laws.
To me, this doesn't seem to be going well along that statement.
No, insider trading is the subject of laws passed by Congress; at a minimum, the Insider Trading Sanctions Act of 1984 and Insider Trading and Securities Exchange Act of 1988. And those laws are where the SEC enforcement powers over insider trading come from.
https://www.natlawreview.com/article/house-passes-proposed-l...
Congress in general gives extremely wide power to particular administrative bodies that does result in conduct being treated as legal or illegal purely as a result of shifting regulations. You can argue that it "derives from" legislation at some level of removal so they're not "making law"; that's a distinction without a difference.
Consider, the proposed law uses the word espionage does that cover say counting the number of trucks leaving a factory? That’s the kind of thing where any specific choice is reasonable as long as everyone operates under the same rules.
That's true in the narrow sense that they don't have a definitions section with the term “insider trading” and a definition. They both use “insider trading” in their titles and internal headings of the code sections they add, and specify the covered behavior (which differs slightly between the two) in the body, “purchasing or selling a security while in possession of material, nonpublic information” (15 USC 78t-1) and “purchasing or selling a security or security-based swap agreement while in possession of material, nonpublic information, or...communicating such information in connection with, a transaction on or through the facilities of a national securities exchange or from or through a broker or dealer, and which is not part of a public offering by an issuer of securities other than standardized options or security futures products” (15 USC 78u-1.)
While Congress did give the SEC the ability to set the rules around insider trading, it didn't give the SEC a blank check which the SEC used to pull the idea of insider trading and regulating it out of thin air.
When do you imagine they had such ability, and does much of th Byzantine nature of the securities laws really post-date that period?
> There is so much friction in the partisan fights.
No more than usual, except in the sense that because of the partisan realignment (or two overlapping realignments, one stemming from the New Deal itself, the other from Johnson's signing on to civil rights) from the New Deal until the 1990s the bitter ideological fights were somewhat less often aligned with party boundaries.
This is what has made things worse in my view. The people in Congress don’t vote anymore for what they personally think is right but what the party tells them to do.
They don't vote any less for what they think is right, either. Political expediency has always been a major factor, even during the realignment when the national party may not have been as big of a factor (though it was always a big factor) in the expediency calculation.
I’d like to avoid the use of the all-encompassing “they” when referring to US politics. It’s demonstrable that one, specific, major political party lost all semblance of a moral compass (or even an ideological compass) in the past couple of decades and it would be an error of judgement to presume they vote for and support what they actually believe is morally right - even by their own definition of what is right and good.
Is that true? Is there a similar period in history where the Senate simply didn't hear the bills being passed by the House?
Very broad statement. 'Anyone' in 'any' amount? Surely you are not advocating that. Are you?
In what way do you think the average person 'anyone' knows enough to essentially bet on a typical startup (called it 'gambling')? So you have a typical person living paycheck to paycheck but yes let them put whatever savings they might have into a startup?
I don't believe that restrictions on private investments make sense. If anything, they perpetuate the "rich get richer, poor get poorer" problem. Unaccredited investors are kept out of great potential wealth creation. The problem is not bad investments, it's fraudulent ones. Fraud is still illegal even if you kill the accredited investors restrictions.
Someone with a $20M net worth can deal with losing $1M. It sucks, but it's not going to put them on the streets. Someone who puts all of their savings into a fraudulent investment then becomes one car break-down away from not paying their bills. Consider also if that person is retired and is living on a fixed income.
The kind of people in the latter group are probably more likely to fall for a scam or fraud. I would love to lift investment restrictions -- I absolutely agree that this is a "richer get richer, poor get poorer" issue -- but not without a way to better protect more vulnerable investors.
The first thing that comes to mind is some sort of government-provided investment fraud insurance. But then I worry about perverse incentives: every time someone's investment tanks, they're incentivized to try to prove that the investment was a fraud.
While I think there is some merit in restricting what purchases people can make beyond their means, only applying it to certain types of speculative investment (which doesn't even include things like real estate) seems arbitrary to me when it's not applied to something with even more risk like gambling, say.
Said another way, 'anyone' can invest 'any' amount in a public stock today and lose it all tomorrow. Heck people were even suckered into mortgages they couldn't afford by our trusty banks.
The problem with small investors is that it is really damn hard to bring a CEO doing obviously fraudulent things to heel. It takes a significant fraction of a million dollars to bring a successful lawsuit--and what you get in the end isn't worth much.
The SEC needs to be much more vigilant on this front if they want to increase the investor pool significantly.
If it’s “obviously” fraudulent, why isn’t law enforcement involved? No lawsuit required since fraud is a crime.
This is a problem if you genuinely want more small companies funded by more small investors.
If the SEC doesn't figure out how to police the $1-$5 million range of companies, all they are doing is creating a nice fertile ground for conmen.
"Beyond reasonable doubt" is generally only when jail is involved.
Are you aware of the history of the accredited investor rules? When just anyone could invest there was too much opportunity for swindlers .. a problem that goes back the Mississippi company back in 1719.
Televangelists defrauding poor people is bad enough; we don’t need wall atreet bucket shops doing the same.
Contrast that with small angel investments from “widows and orphans” - that money generally doesn’t end up controlled by the government.
The fact that some people might get swindled is not an argument for why I shouldn't be allowed to invest my money how I see fit. Just like the the fact that somebody might sell a defective toothbrush doesn't justify forcing me to get the approval of some bureaucrat in order to buy one.
Non-accredited investors, by definition, don’t have a lot of money.
If that money is stolen from them via fraud, where does the money to fund the lawsuit come from?
What if the total potential judgement is less than the cost of the court case?
Regulations exist, in part, because legal remedies are incredibly inefficient.
By definition the people you could rightfully sue are misusing the money and likely living it large with it.
To my knowledge, the investees only need to ask you if you're an accredited investor, and tell you what that means. They don't need to actually verify that you meet the requirements. If you'ld like to invest in shady things, go right ahead.
Funny how these rules don't apply to gambling and lottery tickets.
(I am not recommending breaking the law.)
And if you lie, you (righly) don’t get the default protections available to small investors.
Having a clear standard that I can point to to say “these investors are grown-ups that knew what they were investing in” helps minimize things like superfluous lawsuits from people that really shouldn’t have been risking their only savings in an angel investment.
I don’t want to dig deep into an angel’s personal finances to determine if they can really afford to invest or not based on savings and risk profile and having a legal bar an investor has to meet makes the process of raising money slightly less onerous.
There really should be another crack at trading places. I hope those accredited producers out there in Holywoot can make it happen.
[1] https://www.cnbc.com/2019/11/05/some-robinhood-users-were-ab...
How do you lose more than the purchase price of the options when buying options?
(Note that in the UK private individuals can trade things like contracts for difference and spread bets which I actually think is slightly mad)
To get that certificate, you sign a form. The form is one page with a lot of white space. It says in very large letters: “I want to buy a dumb investment. I understand that the person selling it will almost certainly steal all my money, and that I would almost certainly be better off just buying index funds, but I want to do this dumb thing anyway. I agree that I will never, under any circumstances, complain to anyone when this investment inevitably goes wrong. I understand that violating this agreement is a felony.”
[1]: https://www.bloomberg.com/opinion/articles/2018-09-24/earnin... [2]: https://www.bloomberg.com/opinion/articles/2019-06-19/privat...
There is a lot of fraud that goes unpunished because the victims feel hopeless and embarrassed. As a result, it's a lot more attractive to defraud people.
A dumb investment might be dumb, it might be likely to be fraud. But if it turns out to actually be fraud, the victims should still be able to seek restitution or otherwise you are giving a free pass to commit fraud and creating a huge economic advantage for people willing to do it over people who aren't.
For example, the EOS ICO unlawfully raised over $4 billion dollars. The SEC settled with them where they paid the SEC $24 million and the SEC agreed to take no further action.
The only lesson here is that if you're going to ignore the law and sell sketchy assets with over-hyped claims to unsophisticated investors in the US... make sure you raise enough that the cost for good attorneys few million to the SEC is just a rounding error.
Instead, they have mountains of fine print that with extraordinary care make sure the recipient has absolutely no property right in the business, no claim to any title, no voting rights, usually no rights to share in profits, etc.
If you wanted to liken them to something offline, they're structured more like making a donation and getting a limited edition t-shirt in return. Maybe with some vague suggestion, but no guarantee, that the t-shirt may entitle you to discounted services in the future should the business actually begin operations.
And this is before getting into the fact that a great many of them are essentially outright scams.
The fact that many people are thinking that ICOs are "just like buying an investment in a small business"-- is a great example of how the SEC is pretty much flat out failing at this part of their job.
So, two responses here:
First, when you think about the products that could be marketed without accreditation, you can't just think about the marginal cases where there is some plausible value; you have to think about all of them, bearing in mind that there is virtually no correspondence between how well something is marketed and how plausible it is an investment. See, for instance, the unregulated nutritional supplement market, which is is a hive of scum and villainy that kind of perfectly encapsulates this problem while being self-limited (in the non-pyramid-scheme case) to the amount of colloidal silver solution any person could reasonably purchase --- unlike an investment, which begs its purchaser to plow their life's savings into.
Second, contrary to the perspective you get on this issue by just looking at tiny startups, you have to consider that the entire securities industry is in a sense gated on accreditation, because the difference between a security that requires accreditation and one that doesn't is "keeping timely audited findings with the SEC". So for example: if you did away with accreditation, why would companies need to produce audited financials?
If your belief is that the edifice of securities regulation is entirely pointless and people should be able to buy any investment product they want and companies should be able to sell any investment product they want, that's a coherent take, but not one ("let's do away with companies having to file official statements") that most mainstream people would find persuasive.
My understanding is that it's supposed to protect investor from fraud (eg. along the lines of ICOs), not necessarily from risky/volatile investments.
The wealth requirements in US are so aggravating because they pass muster by putting the consequence on the issuer, not actually barring the person from investing. Almost impossible to challenge! But how we got here is that this is a successor to a test, which had horrible guidance and resulted in rampant discrimination - a sign of the times. This proposal reintroduces the test but inherits a more established FINRA testing infrastructure. FINRA tests are still barriers of entry that will hardly make the world more egalitarian as almost all of them require sponsorship from a financial institution - even the test prep materials aren't supposed to be shared. There are ways around it like a bucketshop cant you on payroll and offer you the test but its still an unnecessary and pretentiously exclusionary hurdle, built on purpose.
How much you wanna bet a white collar worker making $200k/year has made more investment-based decisions in their life than a a blue collar worker making $20/hr?
I don't necessarily agree with the tenants of the idea of an accredited investor, but it's definitely a way to parse out a large chunk of the population unexperienced with investing.
Yes it does. If you’re investing $25k in a company, you can’t pay lawyers more than a pittance to review documents and do diligence. That makes you more susceptible to fraud.
I think a bigger risk to investors is dishonest/deceptive marketing and extremely risky and often illiquid investments being peddled as sure deals, including ones where the chance of upside is essentially nil and you're lucky if you break even.
This actually isn't true (and that's a big problem).
Leveraged ETFs (such as TVIX) typically are very leaky. [0]
[0] - https://seekingalpha.com/article/1864191-what-you-need-to-kn...
I feel like this is in the weeds though: some bad investments people get suckered into have extremely high and diversified risk of total loss, but at _best_ can only return a few percent in a year.
Not only are they negative EV, but even if you get lucky and it pays off you only end up with money market fund like income. Deals that no one who was informed and knew how to do the relevant math would ever take.
> But in fact the main thing that distinguishes public and private markets is not their legal status—private markets are mostly open to accredited investors, while public markets are open to everyone—but the fact that private companies get to choose their investors, and public companies don’t. Hedge funds, for instance, are mostly open only to accredited investors, but not all hedge funds are open to all accredited investors. The very best hedge funds mostly aren’t open to anyone: They are at capacity, won’t take new money, and mostly manage money for their own very rich employees. Other hedge funds with long track records of good performance are open to big institutional allocators who can write very large checks. If you are a dentist making $205,000 a year, and you want to invest in hedge funds … someone will definitely sell you a hedge fund! It will not be Renaissance.
Just because we legally allow people to invest in whatever they want doesn't mean it will make equal footing between investors. The investments that will accept the people who are currently 'non-accreddited investors' are going to be the worst of the private investments; it will do nothing to help the little guy compete with the rich guys.
Nobody is hyping that and most 'anybodies' don't even know that exists. (I never heard of it but everyday I read about all the wins with startups but typically almost none of the losses).
It’s designed to provide some minimal protection against sophisticated fraudsters (eg Bernie Madoff).
SEC doesn’t govern lotto/gambling within states; that happens at a state level, just like alcohol and tobacco.
I agree that the USA tends to have an incoherent stance on age of responsibility versus freedoms, but that’s largely because the federated government system and different states have different ideas about how much freedom/responsibilities their people should have.
Hang on to your hats!
But to be an accredited investor, all you need to do is have some money. There is no logical way that you can certify that a person's "competency, authority, or credibility" by merely knowing how much money is in their bank account.
Neither the existing nor the upcoming changes will protect someone like a lottery winner. Unless they seek qualified advice in setting something like a family office up, in which case their intentions are good at least.
If there is a reasonable reason to create an income threshold, presumably to protect investors from risky investments who can't withstand the loss, then why create exceptions for people who don't meet the income / asset requirement?
If you believe that investment in startups should be regulated, to save us from ourselves, it's hard to imagine this helps the average potential investor.
These exceptions will let people without a high income or net worth qualify as accredited investors by proving that they have the financial knowledge to understand these risks. For example, anyone can take the Series 65 exam.
It sounds like this could be very helpful in allowing people who are not rich to invest in startups while still protecting people who have no idea what they're doing.
I am thinking out loud here but what if this is a scenario where the SEC is trying to pass a more restrictive version, so that the more relaxed house bill never gets passed into law?
https://www.congress.gov/bill/115th-congress/house-bill/1585...
A VC firm that offers nothing more than money (larger % of them than you'd think) doesn't want to compete with tons of syndicates consisting of average retail investors.
The "accredited investor" gatekeeping allows them to provide very little value and say "doesn't matter, you need us because we're the very few that are allowed to invest in your company".
This is the right answer
Gatekeeping
If the reasoning is to protect ignorant investors and prevent fraud, it would be more effective and equatable to have a test/certification to be a qualified/investor, rather than banning large swaths of the population from investing.
The current SEC rules are inherently discriminatory whereas the law should treat people equally.
With that in mind, even just forcing investors to pass a simple test about risk in different areas of investment (bonds, index funds, major real estate types, etc) would go a long way.
I signed up for a few sites, to check out various opportunities, before I was actually an accredited investor. It's all "self certified." I am actually one now, FYI.
It's the same logic used when cashiers ask you what your age is when purchasing alcohol: if you give them a fake ID and they accept it, that's on them, but if they ask you and you lie, that's on you.
In the former case, you can take people at their words (they just declare that they are, and how they are an accredited investor in a statement).
In the latter case, you must verify via a statement from a licensed professional (e.g. their CPA) or via their bank.
A new unsponsored FINRA test for this specific purpose should be created as well (doesnt need to be in a federal proposal, just what can happen)
Finance and econ degree holders eligible too
I think this still sets the bar too high. There needs to be some way to opt out of the paternalism and take a chance in the securities market.
People are going to lose their shirts, just add a little disclaimer just like in public markets and on gambling posters.
Sometimes this will be an efficient allocation of capital for issuers that VCs dont share affinity for.
It seems that being an accredited investor isn't protecting anyone from fraud.